How to Calculate the Activity Range in a Flexible Budget
Businesses use budgets to plan out their activities and predict their financial performances based on estimated revenue and expenses. Flexible budgets are budgets that can accommodate different estimates and change predictions in response to those changing estimates. For flexible budgets to function, businesses must be able to establish or learn of certain fundamental assumptions about their revenue and expenses. It is these assumptions that enable businesses to create mathematical formulas that model their operations. Activity range, or relevant range of activities, is the range of activities in which those assumptions and, thus, the mathematical equations built upon them remain functional.
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Instructions
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Find the mathematical equation that needs its range of relevant activities to be calculated. For example, if a business is attempting to calculate the range of numbers of units of its product being produced for which its cost equation remains true, then find and state the cost equation. In this case, assume that the business must spend $12,000 in rent and other fixed costs to run its operations and $200 in direct labor and materials per unit produced, meaning that its production costs equal $12,000 plus $200 multiplied by the number of units produced.
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Find the documents and relevant information that enabled the business to create its assumptions. Depending on the business and the nature of the activities being determined, these documents and relevant information might come from the business's suppliers, the business's own past experience and/or a combination of other sources. In this example, assume that the business has created its cost equation based on its costs and production numbers in previous time periods.
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Determine the range of activities in which those assumptions remain true using the documents and relevant information. Since the business in this scenario created its cost equation using its past experiences, it can base its estimates of the limitations of its range of activities based on those experiences. For example, the business has fixed costs of $12,000 that are incurred regardless of its production numbers, meaning that the bottommost limit of its range of units produced is zero. If the business determines through its past experiences or is told by the manufacturers of its production equipment that its operations can produce no more than 800 units of product in each time period, then 800 units is the uppermost limit of its range of units produced. Eight hundred is the uppermost limit because if the business desires to produce more units, it needs to spend more to set up the facilities needed to produce those additional units, at which time the $12,000 fixed costs listed in its original cost equation become inapplicable.
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Sum up the results as the equation's relevant range of activities. For the business described in the scenario, the relevant range of activities for its cost equation is zero to 800 units of products produced.
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Tips & Warnings
Since the question of the relevant range of activities can be applied to any and all variable factors in a mathematical equation, there is no one single method that can be used to calculate the range in all scenarios. In most cases, a combination of common sense and simple mathematics should suffice, but more obscure variables can require more and harder calculations to find out their relevant ranges.
References
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