What is a flexible budget?
A flexible budget is the exact opposite of a static budget — it allows you to adjust how much you allocate to various departments, projects, and activities based on your business' revenue and changes in sales volume.
These budgets enable companies to change strategies and shift directions when something changes within the organization. While a static budget is the same throughout a particular period and doesn't take seasonality or changes in sales into account, flex budgets fluctuate with sales, production, and other business activities.
Flex budgets can be used for everything from marketing to labor costs to increase production volumes during the busy season.For instance, retail stores can benefit from a flexible budget that allows them to hire more employees during the holidays when they're the busiest because they have increased sales volumes.
Flexible budgets usually work with percentages. For example, a company may allocate 20% of its revenue to marketing initiatives, regardless of what those marketing initiatives are.
Therefore, if a company has a revenue of $500,000, it allocates 100,000 towards various marketing campaigns like social media, email marketing, paid traffic ads, and traditional marketing strategies.
However, if the company increases its revenue to $1,000,000, its marketing budget becomes $200,000, allowing it to invest more money into marketing initiatives that, in turn, result in more sales.
Like static budgets, flexible budgets can be used to evaluate your business's performance, but it's much more complicated because the budget changes based on various fluctuations within the business. Flexible and static budgets can be used together to evaluate the performance of your business activities and their ROI.
Flexible budget pros
Since flex budgets shift depending on sales and revenue, they offer several benefits a static budget can't, such as:
Allows you to address changes
Changes in business are quite common, especially for startups and small businesses that experience frequent fluctuations and seasonality. Your sales might be soaring high one month and incredibly low the next, especially if you're just starting out.
Flexible budgets allow you to adjust how much you spend on projects and different business activities based on your revenue to prevent overspending, allowing you to adjust easily to change.
For instance, if you increase sales in one month, it may be tempting to take it as a profit. Nevertheless, you should consider spending more in another area of the business to increase sales in the future.
Static budgets are strict and don't allow you to pull money from one project to another. Instead, if you reach your budget and still need to spend more, you'll have to compromise. Consider a house flipper.
These individuals give themselves a budget for how much they want to spend on renovating a home based on comparable home prices in the neighborhood to ensure they can make a profit.
Unfortunately, projects rarely go as planned. When they end up spending too much on one project, it leaves them with less for another because they have fixed budgets. Since they know there's a price ceiling for homes in the area, they can't charge more just because they spent more.
Luckily, most businesses don't work like this. There's no ceiling for how many sales you can make as long as you have inventory. A flex budget allows you to choose a percentage of your overall revenue you want to put toward a specific goal, so when you sell more, you can spend more.
More accurate financials
Flexible budgets are more accurate than static budgets because it's almost impossible to predict all of your costs. For example, every business has some fixed costs like rent, but there are several variable costs and new costs that seem to pop up every day.
With a flexible budget, you'll know exactly how much your business spends on these variable costs, and it won't impact your ability to afford various internal and external projects like marketing campaigns, customer service, labor, and equipment.
What happens if you have a static budget and go over it? There's always the risk of overspending because you have to.
A static budget doesn't fluctuate based on your needs, which can delay projects and impact your business in several ways. While your static budget should prevent overspending, not having flexibility can cause issues.
For instance, if you're running a marketing campaign and run out of money, you can't effectively measure the results of your campaign because you ended it too soon. Meanwhile, if you're developing a new product and don't accurately predict the cost, you may run out of money before ever actually finishing it.
Accounts for unexpected expenses
Unexpected expenses can happen at any time. Your equipment can malfunction, you can get sued, or a pipe could burst in your office. Whatever happens, you'll need to pay for it. Unfortunately, static budgets leave no room for unexpected costs as a part of doing business, so if you happen to have one of these emergencies, you might not have enough funds to pay for them.
On the other hand, a flex budget accounts for these issues, allowing you to mitigate this type of risk by helping you pay for unexpected expenses when they happen.