a) Outline the roles of both flexible and rolling budgets in an organisation, explaining clearly the differences between both approaches
A flexible budget is a budget which is designed to adjust the permitted cost levels to suit the level of activity actually attained. The process by which this is done is by analysing costs into their fixed and variable elements so that the budget may be flexed according to the actual activity. A flexible budget is essential for the control aspect of budgeting.
A rolling budget is a twelve month budget which is prepared several times each year (say once each quarter). The purpose of a rolling budget is to give management the chance to revise its plans, but more importantly, to make more accurate forecasts and plans for the next few months. When rolling budgets are prepared both the activity level and costs/revenues are reviewed. This extra administration costs and effort of producing several budgets instead of just one, should be balanced with more accurate forecasting and planning.
Whereas rolling budgets focus on developing up to date and realistic plans for a business, flexible budgeting is mainly concerned with providing relevant reliable and accurate information from the budgetary control process to inform management planning and decision-making. The key difference between a flexed budget and a rolling budget, is that a flexed budget adjusts the volumes to actual activity and keeps the budget cost structure, while a rolling budget reassesses both volumes and costs to provide more realistic estimates based on more up-to date information.
b) Outline how flexible budgets assist in analysing variances
The master budget for a business is often called a fixed budget as it is based on fixed assumptions regarding economic conditions, forecast sales and sales growth. However it is seldom that forecasters get these predictions right as the business environment is quite a dynamic one. It can be meaningless to compare a fixed budget based on certain economic conditions to actual performance based on completely different economic conditions. It is far more informative for the business to compare performance under similar conditions. Thus the use of flexible budgets allows the fixed budget to be adjusted (flex the fixed budget) to allow for actual activity in making the comparison between actual and budgeted performance. For example, there is little value in comparing a hotels performance based on forecast sales of 80,000 bed-nights compared to actual sales of 120,000 bed-nights. We are not comparing like with like. Not alone will sales be different, but also variable costs will differ as they will vary with sales. Fixed costs may be greater than budgeted due to the fact that the hotels sales performance has exceeded the relevant range. Part of the process of comparing budgeted performance with actual involves flexing the fixed budget to the same activity level as actual, and then comparing actual sales and costs with the flexible budget. Thus overall variances can be broken into
- Volume variances representing variances (both cost and revenue) caused by the difference between the budgeted sales volume and actual sales volume.
- Price/cost variances representing variances caused by changes to sales prices as well as inefficiencies with regard to materials labour and overheads.
This level of analysis can provided management with more useful information to improve planning, control and decision-making.
