Question

What is a flexible budget? What types of organizations might use flexible budgets? Why are flexible budgets useful?

Answer 1

Meaning Of flexible budget

“a flexible budget is defined as a budget which, by recognizing the difference between fixed, semi-variable and variable costs is designed to change in relation to the level of activity attained.” Unlike static (fixed) budgets, flexible budgets show the expected results of a responsibility center for different activity levels.

You can think of a flexible budget as a series of static budgets for different levels of activity. Such budgets are especially useful in estimating and controlling factory costs and operating expenses. It is more realistic and practicable because it gives due consideration to cost behaviour at different levels of activity. While preparing a flexible budget the expenses are classified into three categories viz.

1. Fixed,
2. Variable, and
3. Semi-variable.

Advantages of flexible budget :

1. With the help of flexible budget, the sales, costs and profit may be calculated easily by the business at various levels of production capacity.
2. In flexible budget, adjustment is very simple according to change in business conditions.
3. It also helps in determination of production level as it shows budgeted costs with classification at various levels of activity along with sales. Hence the management can easily select the level of production which shows the profit predetermined by the owners of the business.

Flexible budgeting may be resorted to under following situations:

1. In the case of new business venture due to its typical nature it may be difficult to forecast the demand of a product accurately.
2. Where the business is dependent upon the mercy of nature e.g., a person dealing in wool trade may have enough market if temperature goes below the freezing point.
3. In the case of labour intensive industry where the production of the concern is dependent upon the availability of labour.

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