Budgeting helps you plan your business’s operations. However, you also need to control your business —– to monitor what’s actually happening. Controlling involves constantly comparing actual activity to your budget and carefully analyzing and understanding any differences. To accomplish this task, you need budget reports that compare your budgets (what should have happened) to what actually happened.
For example, suppose your company budgeted $100,000 for sales in the first quarter. Actual sales for the quarter come up short, at only $70,000. First, call the sales manager to find out what happened. (A computer snafu accidentally canceled customer orders.) Then, take corrective action. (Fix your computer and call your customers to apologize.) Finally, adjust your future plans. (Cut next quarter’s production estimates.)
Master budgeting provides the basic template for this analysis, offering projections for sales, expenses, production levels, and cash flows to help you plan for future periods. However, its major flaw is that it’s static — it projects only one scenario based on a single set of sales estimates. It can’t change.
Therefore, a $30,000 difference throws off more than just your sales budget. It also necessitates changing your production, purchases, direct labor, overhead costs, and selling and administrative expenses, ruining the entire planning process and making it impossible for you to make future comparisons between your budgets and actual results.
Enter the flexible budget. As activity levels change, you can easily adjust a flexible budget so that you can continue to use it to plan and control your business.