Download Flexible Budgets ACC/543 Budgeting is a key concept in business

Flexible Budgets
ACC/543
Budgeting is a key concept in business. Knowledge of budgeting tools and
competency in their applications are crucial to the operational success of any business.
Budgeting tools help business perform effective financial forecasts and manage financial
events while taking into account the dynamics between fixed and variable costs for use in a
flexible budget. Company management and stakeholders make key business and
investment decisions based on financial information provided by flexible and static
budgets, as well as Cost-Volume-Profit analysis. Furthermore, company management uses
the information provided by flexible budgets in order to provide vital support for
operational decisions and performance evaluations. In order to do financial forecasts,
management needs to do an effective analysis of cost and their associated budgetary
impacts on past net incomes to gain useful insights to future net incomes. With the help of
this information, management can better make strategic decisions on investment projects
and on the financial sustainability of the company.
Fixed and Variable Costs
Company management plans and controls cost by analyzing cost behavior, which
entails understanding of how costs change or respond to various internal and external
stimuli, such as variations in production volume or activity. Analysis of cost behavior can
help management understand and predict how changes in operating expenses affect net
income. The net income cannot be determined without identifying the fixed and variable
costs of a business company. Fixed and variable costs are expenses that are incurred in the
production of goods or services. In order to determine the cost components associated with
different goods or services, it is important to have a clear understanding of the concept of
cost. Mixed costs combine the allocations of both fixed and variable costs. Fixed costs are
expenses that are not directly related to the level of output or production. Hence, these
expenses remain constant regardless of business activity, such as rent, advertising, office
salaries, and office utilities. In contrast, variable costs are expenses that are directly related
to the products and change with the levels of output, such as raw materials and direct labor
costs. Closely related to fixed and variable costs is the concept of cost structure. For most
businesses, the application of the appropriate cost structure depends on the expected or
generated revenue. Businesses can either apply a fixed or variable cost structure. A fixed
cost structure focuses on the fixed costs associated with a company’s operations.
Regardless of sales, costs remain the same, which means increase in sales leads to high
profits and decrease in sales leads to huge losses. The other alternative is a variable cost
structure that focuses on the variable costs affecting a business. As sales go up the costs
increase, and vice versa. This cost structure provides minimal risk and greater
predictability. A business with increasing sales volume will benefit from a fixed cost
structure, while a business with decreasing sales volume will benefit from a variable cost
structure. The choice of cost structure will affect the company’s profitability. In fact, the
effect of cost structure on profitability is so great that most income statements classify
costs based on their patterns of behavior (Edmonds, Edmonds, & Olds, 2007).
Flexible and Static Budgets
Businesses make use of both flexible and static budgets for different purposes.
Flexible budgets are used by management to plan for potential outcomes of new business
ventures, and to create what-if scenarios in which to base strategic decisions. In a flexible
budget, the unit amounts will vary with changes in various factors, such as level of output,
material cost, labor and revenue. The flexibility of this budget allows management to create
different options and to determine which options are the most beneficial for the company.
This can further help companies in planning for costs and production outputs, as well as in
employee and process evaluations. In contrast, the static budget is the master budget that
guides company expenditures based on financial forecasts from previous fiscal years. It
makes up the company’s realistic expectations of production costs, sales and revenue. The
unit amounts depict projected expenses and revenues for a given period. Data from the
static budget are used to determine the budgets for the other operating units of the
company, such as marketing and advertising (Edmonds, Edmonds, & Olds, 2007). The two
types of budgets have different uses and provide different information. Understanding how
each budget works and differs from each other is critical to the success of management
planning. Incorrect use and analysis of budgets could cause huge losses to a company due
to misguided financial decisions.
Flexible Budgets and Cost-Volume-Profit Analysis
Management regularly monitors business operations to find out if the company can
achieve the desired levels of profit. Cost-Volume-Profit (CVP) analysis is one of the most
powerful tools that management can use for this purpose. It is helpful in understanding the
relationship among cost, volume and profit. Management can find out the Break-Even-Point
(BEP), which shows the minimum production level to avoid losses. It shows the level of
output to achieve a target profit margin. It identifies how changes in price, cost and volume
affect the company’s profit. The CVP analysis requires that all expenses, such as production,
marketing and administrative costs, be identified as either fixed or variable costs
(“Cliffnotes,” n.d.). Based on cost strategies and pricing decisions, it is a simple and flexible
tool for exploring profits. The CVP analysis makes use of the following accounting concepts
and equations:

the equation technique, where sales = variable costs + fixed costs + profits;

the breakeven analysis, where sales = variable costs + fixed costs;

The contribution margin equation, where contribution margin = sales - variable
costs.
A flexible budget lends itself to CVP analysis because it shows the costs at different
levels of output (“Accounting Cost,” n.d.). A flexible budget takes account of input activity
data and output achieved; this permits analysis of variances in volume, efficiency and
expenditure in order to reconcile the actual cost of profit and the projected profit. These
variances are recorded as either favorable or unfavorable, thereby helping management
improve productivity and profitability (“Cost-Volume,” n.d.).
A successful business knows how to budget efficiently and effectively. This entails
identifying and allocating for fixed and variable costs. Knowing the effects of fixed and
variable costs on static and flexible budgets, as well as the appropriate cost structure to
adapt are likewise important for the company’s financial planning. Cost-Volume-Profit
analysis, discussed above, provides a powerful tool for exploring profits at different
production levels. All these are in aid of providing vital information so that management
can make short-term and long-term strategic decisions for the financial success of the
company.
References
Edmonds, T. P., Edmonds, C. D., & Olds, P. R. (2007). Fundamental Financial and Managerial
Accounting Concepts. Retrieved from http://www.ecampus.phoenix.edu/content/
eBookLibrary2.
Accounting Cost-Volume-Profit Analysis. (n.d.). Simple Studies: Accounting Made Simple.
Retrieved from http://simplestudies.com/accounting-cost-volume-profitanalysis.html
Cliffnotes: Cost-Volume-Profit Analysis. (n.d.). Retrieved from
http://www.cliffsnotes.com/study_guide/Cost-Volume-ProfitAnalysis.topicArticleId-21248,articleId-21229.html
Cost-Volume-Profit Analysis. (n.d.). In Reference for Business Encyclopedia of Business.
Retrieved from http:www.referenceforbusiness.com/management/com-De/CostVolume_Profit-Analysis.html.