Flexible Budgeting

Summary

In this video, the concept of flexible budgeting is explained through the example of a movie theater. The initial budget is created assuming 10,000 customers, but when actual attendance is 12,000, the budget needs adjustment. Flexible budgeting recalculates revenue and expenses based on actual activity levels, helping to manage performance more accurately. Variance analysis is introduced, comparing the original budget with the flexible one to identify favorable or unfavorable variances. The video highlights the importance of flexible budgets in controlling costs and improving financial insights, with a promise to delve into revenue and spending variances in the next video.

Takeaways

• 😀 Budgets are useful tools for both planning and control, but they need adjustments when the actual activity level (e.g., the number of customers) differs from what was initially expected.
• 😀 Flexible budgeting is an essential concept that allows for adjustments to a budget based on actual outcomes (e.g., actual number of customers) rather than sticking rigidly to the original budget.
• 😀 A simple example is a movie theater budget, where revenue is expected based on an estimated number of customers (Q), and expenses vary based on this number.
• 😀 Fixed costs, like wages, rent, and insurance, remain the same regardless of the number of customers, while variable costs, like popcorn, soda, and candy, change with the customer count.
• 😀 The movie theater originally budgets for 10,000 customers, calculating revenue as $10 per customer, which results in $100,000 in revenue for the month.
• 😀 Expenses are also calculated based on the expected number of customers, with popcorn, soda, and candy expenses varying with the quantity of customers.
• 😀 If the actual number of customers (Q) is different, the budget should be adjusted accordingly to reflect the true activity level.
• 😀 For example, if 12,000 customers attend the theater instead of 10,000, the revenue should be adjusted to $120,000, and expenses should be recalculated based on the increased customer count.
• 😀 The flexible budget uses the same formulas as the original budget but adjusts them according to the actual customer count to reflect what the budget would have been had the actual number of customers been known in advance.
• 😀 Variances are calculated by comparing the flexible budget numbers to the original budget, with favorable or unfavorable variances indicating whether performance exceeded or fell short of expectations.
• 😀 In cases like the popcorn expense, an increase in customers leads to a higher popcorn expense, which is an expected outcome, and a variance would be considered unfavorable due to the higher cost, even though more customers bought more popcorn.

Q & A

What is the main purpose of a budget in the context of this video?

The main purpose of a budget is to serve as a useful tool for both planning and control. It helps businesses estimate their revenues and expenses based on certain assumptions, but if actual activity levels differ from what was planned, adjustments may be needed.

What is the limitation of using a static budget when actual activity levels differ from expectations?

The limitation of a static budget is that it is based on fixed assumptions (like the number of customers), and when actual numbers differ, it becomes less effective for control purposes. Adjustments are necessary to reflect actual performance.

What is a flexible budget and why is it necessary?

A flexible budget is an adjusted version of the original budget that takes into account actual activity levels, such as the number of customers. It is necessary because it allows businesses to compare expected outcomes with real outcomes, leading to better control and performance evaluation.

How did the example of the movie theater illustrate the use of a flexible budget?

The movie theater example illustrated flexible budgeting by showing how the revenue and expenses, which depend on the number of customers (Q), were recalculated when the actual number of customers turned out to be 12,000 instead of the originally expected 10,000.

What role does the number of customers (Q) play in the budget of the movie theater?

In the movie theater’s budget, the number of customers (Q) directly affects revenue and variable expenses like popcorn, soda, and candy. The budget was initially created with the assumption of 10,000 customers, but if the actual number of customers changes, the budget needs to be adjusted accordingly.

What expenses in the movie theater budget are considered fixed?

In the movie theater budget, fixed expenses include wages, rent, and insurance. These costs do not change with the number of customers, unlike variable costs such as popcorn, soda, and candy.

How do we calculate the revenue in the flexible budget for the movie theater?

To calculate revenue in the flexible budget, we multiply the actual number of customers (Q) by the expected price per customer. For example, with 12,000 customers and $10 per customer, the revenue would be $120,000.

What is the variance in the budget, and how is it categorized?

Variance is the difference between the actual results and the flexible budget. It is categorized into favorable or unfavorable: favorable variance occurs when actual results exceed the flexible budget (e.g., higher revenue), and unfavorable variance occurs when actual expenses exceed the flexible budget (e.g., higher costs).

Why is it important to adjust the budget when actual performance differs from the original assumptions?

Adjusting the budget is important because it provides a more accurate reflection of the business’s performance. A flexible budget helps evaluate how well managers controlled costs and whether the business performed as expected, based on real activity levels rather than initial estimates.

What did the script say about the potential for 'unfavorable' variances in the example of popcorn costs?

The script explained that while the popcorn cost was higher than expected (a $500 unfavorable variance), this was not necessarily a negative outcome. It was actually expected due to the higher number of customers, so the term 'unfavorable' simply reflects that more was spent, not necessarily a problem with management.