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What Is Flexible Budget Variance?
A Flexible Budget Variance is a gap between the adjusted budget figure and the actual output. If the value of the actual revenue is entered into the budget, then it is evident that the difference is in the actual expenses incurred by the business.
Real-world budgets often adjust for changes, reflecting their impact on company revenue and expenses. Thus, the flexible budget variance analysis indicates the pitfalls and areas for improvement to attain the desired results.
Table of Contents
- A flexible budget variance is the divergence of the actual outcome from that of the budget with the potential to incorporate changes in revenue or expenses at different levels of output or activities.
- There are three kinds of this variance, i.e., basic, intermediate, and advanced.
- It is an essential tool to determine the degree of deviation of the actual result from the budgeted figure and the problem area.
- It is different from the sales volume variance, which identifies the difference in sales volume over the period.
Flexible Budget Variance Explained
A flexible budget variance is a valuable tool for companies to keep track of the changes in the actual output when estimated revenue and expenses vary over the period. Flexible budgeting is practical in businesses as they operate in dynamic environments affected by various factors beyond demand and supply. However, the static budget has no room to change the projected figure. Hence, calculating flexible budget variance requires the static budget figure, the fixed and variable costs, and the actual outcome.
The variance can be a positive, i.e., favorable, or negative, i.e., unfavorable value. It is an accurate method to determine the extent of variation of the actual output from the estimated figure. It aids in locating the key problem area for taking corrective action. It also helps frequently revise the financial data and adjust the budget. It is a challenging method since it requires a lot of forecasting and analysis. Moreover, such an analysis requires skilled employees; thus, it increases labor costs. Also, it requires complete revenue and expense data for evaluation.
Examples
Let us understand the concept with the help of illusionary examples:
Example #1
Suppose the finance manager of PQ Ltd. estimated that the change in the cost of shipping the raw material and the rent increase would have the following impact on the budget:
| Particular | Static Budget (1000 units) | Flexible Budget (1000 units) | Actual Cost (1000 units) | Flexible Budget Variance (1000 units) |
|---|---|---|---|---|
| Rent | $1,200 | $1,350 | $1,350 | 0 |
| Shipping Cost | $1,500 | $1,600 | $1,650 | $50 |
| Total | $2,700 | $2,950 | $3,000 | $50 |
Thus, the total cost of production will increase by $50.
Example #2
Let's say STV Pvt. Ltd. prepared a flexible budget for the year, estimating the per unit price to be $120 while the projected sales for November were 2,000 units. However, the product's market price increased to $125 in November while the sales volume was 100% realized. Therefore, the company had a rise in sales revenue of $10,000, which is a favorable variance.
In the above illustration, if the company's cost per product also increased by $3, there will be an unfavorable variance of $6,000. When both conditions are evaluated together, the company derives a positive value of $4,000, making it a favorable variance for the business.
Flexible Budget Variance vs Sales Volume Variance
The sales volume variance (SVV) is just a part of the flexible budget variance analysis, while the latter is a broader concept. Let us understand the differences between the two in detail below:
| Basis | Flexible Budget Variance | Sales Volume Variance |
|---|---|---|
| Meaning | It is a variation in the actual output when compared with the modified budget figures. | The sales volume variance is the deviation in sales volume over the period and its impact on the per unit price, profit, or contribution. |
| Components | Fixed cost, variable cost, static budget, expected change, actual result | Sales data, price per unit, contribution per unit, profit per unit. |
| Importance/Scope | It fits in the real-world scenario, helps in identifying a problem area, facilitates budget revision, and takes corrective measures. | Sales forecasting, determining the need for changes in the production process and supply chain, and comparison with competitor's sales. |
| Factors/Causes | Wrong sales or cost projection, limited data, lack of planning or control, poor economic condition, change in prices of input factors, etc. | Change in technology, market demand, production process, supply chain, production volume, competitor's pricing, season or weather, etc. |
| Formula | Actual cost - (fixed cost + (variable cost at each activity level). | (Actual sales units - budgeted sales units) x budgeted price per unit, standard profit per unit, or standard contribution per unit. |
| Example | It is evaluated in a condition where the budget changes when the per unit cost of production increases due to a change in raw material price. | It is computed when the actual sales exceed the estimated sales due to the increase in the price of the competitor's product. |
Frequently Asked Questions (FAQs)
A company can use the following steps to calculate flexible budget variance:
1. Evaluate the fixed and variable expenses.
2. Prepare a budget using these expenses and projected sales.
3. Find out the possible change in the revenue or expense.
4. Draft the flexible budget based on the new figures.
5. Compare the budgeted figure with the actual revenue or cost to know the difference between the two.
There are three kinds of flexible budgets, and so are the variances:
• Basic flexible budget
• Intermediate flexible budget
• Advanced flexible budget
A static budget variance is a difference in the actual revenue or cost incurred from the standard budgeted revenue or expense for a single activity or output level; thus, the value remains constant.
On the contrary, the flexible variance is derived when the actual result deviates from the budgeted figure, which has room for incorporating changes at different output levels or activities.
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