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A flexible budget variance is the difference between the amount a company plans to spend or earn during a specified period of time and the amount that is actually spends or earns. The variance or difference can either be a positive number, meaning costs exceed the budget or income exceeded expectations, or a negative number with costs being lower than expected or income being less than planned. Managers and investors might use flexible budget variance to measure the performance of not only the company, but also of different managers.
When a company or department’s actual performance differs from what was planned for a month, quarter, or even year, measuring the flexible budget variance helps with controlling costs. Trying to apply the standards of the static budget does not work if the expected costs or earnings differ, making evaluating the company’s profitability or performance impossible. Without an accurate way of measuring performance, management cannot know if corrections in the company or a department’s actions are necessary.
For a flexible budget variance to work, a company must first have a static or fixed budget. The static budget plans for a certain amount of income and a certain amount of expenses, based on management’s predictions of market conditions and the company’s performance. When looking at the variance, managers or investors still use the same fixed cost and income values as were set in the static budget. If a cost or income values were variable in the static budget, then the flexible budget must use variable figures for those costs or income values as well.
Differences in a company’s actual costs or earnings versus those that were projected by a static budget provide valuable information about performance. For example, a company might appear to earn more money by selling a higher number of units during a month or quarter than what was originally expected in the static budget. A flexible budget’s variance, though, might show that the amount earned per unit was lower than projected, possibly leading to the company making less net revenue off the higher number of sales.
Evaluating an individual manager’s performance using a flexible budget variance only works well if the appropriate information is used for the evaluation. Any budgetary information, whether from the static or flexible budgets, must be under the scope of responsibility of the manager being evaluated. The higher the manager’s level or authority in a company, the more of the company’s overall budget variances should be used to measure his performance.