Why are flexible budgets useful? Flexible budgets work well as a performance evaluation tool in conjunction with a static budget and are basically a comprehensive accounting of the static budget’s cost variance. Flexible budget expenditures can be stymied by offering employee performance incentives directly relating to staying on the static budget.
A basic rule of thumb about flexible budgets is that they are a business cycle analysis tool and cannot be compiled before the end of the business cycle itself (Mueller 2012). Analyzing the flexible budget at the end of the business cycle allows management to adjust the next business cycle’s static budget forecasts to match the changing circumstances of operating costs. In the simplest terms, a flexible budget can be described as an end of period actual accounting of expenses on which to form a comparison with the original static budget (Mueller 2012). What are variances and why do these occur? When should one investigate budget variances?
What factors would you consider when deciding whether to investigate a variance? As a manager, how you would you handle variances? A budget, defined basically, is a strategic financial plan. It usually considers income and expenditures. In doing so, a number of other factors, such as labor and raw material availability, may need to be considered. A budget variance arises when there is a difference between the plan and the outcome (WiseGeek 2012). When considering budget variance, it can be very important to differentiate between the things that affect the budget that can be controlled and those that cannot.
There are a number of reasons why a budget variance can occur. One reason is that the budget was poorly planned. This is an example of a controllable factor (WiseGeek 2012). Some causes of budget variance can be controlled. Labor costs are another example. A company can control its spending in this area by making decisions such as prohibiting overtime and outsourcing projects that would otherwise require high salaried staff members (WiseGeek 2012). Some causes of budget variance are uncontrollable. Factors in this category are commonly external.
This means that these factors are determined by entities outside of the company that has made the budget. A rise in utility prices can be an example of an uncontrollable factor. If a natural disaster causes a shortage of some raw materials, this is also an uncontrollable factor.