How to Calculate Flex Budgets

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In the business world, the word "flexible" is synonymous with "variable," the opposite of which is "fixed." A flex budget is meant to be changed according to the level of volume or activity. It is also a good tool for recognizing the difference in cost behavior; that is, how employees operate under a fixed vs. variable cost structure. The difficulty in preparing a flex budget is forecasting demand. For this reason, it is best to calculate a flex budget based on one level of output.

Determine whether your business is suitable for flex budget accounting. Companies affected by weather, or with large new product introductions or large exports, should stick with a fixed budgeting methodology.

Select a measure of activity. This can be units of production, or hours of service, or whatever unit you use to measure costs.

Forecast a range of activity for the metric. For instance, 5 percent up or down from the previous month or year.

Identify cost items to include. These are all variable costs of production. This may include hourly labor, travel, raw materials, energy and any other resource that is dependent on the level of activity.

Use assumptions based on historical prices to forecast the effect of one unit of production on each of the cost items identified. For instance, every one unit of production sold requires 50 direct labor hours, $200 in raw materials and $50 in energy usage.

Conduct a sensitivity and scenario analysis using different levels of activity to be budgeted. A sensitivity is a change in the units of production. For example, look at costs with a 5 percent, 10 percent and 20 percent increase in the level of demand. A scenario analysis looks at different situations. For example: What would be the effect of a natural disaster or the loss of a critical supplier on the flex budget?

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