Flexible Budgeting for Business: How To Use a Flexible Budget

It’s your first holiday market, and you’ve set up your homemade earring stand. You expect to sell a few pieces, but to your surprise, you sell out completely—which should be amazing news. But if you’re locked into a static budget, you might have to wait until next quarter—when your budget resets—to restock, missing out on momentum and potential customers.

This is why many successful businesses use flexible budgeting. Unlike static budgets, a flexible budget moves with your business performance, letting you scale up when sales are strong and pull back when they’re not. Here’s how this budgeting method works and why it might be the key to growing your business more strategically.

What is a flexible budget?

A flexible budget adjusts based on your business activity—typically tied to increases or decreases in revenue. Rather than projecting a set dollar amount for variable costs like wages or material inputs, a flexible budget anticipates these costs as a percentage of revenue. This means your budget changes dynamically in real time, allowing you to adjust spending allocation based on how much your business actually sells.

The flexible budgeting process varies in complexity depending on how many factors you want to adjust. For a basic flexible budget, you might only adjust direct costs (like raw materials/inventory and direct labor) in proportion to changes in revenue. A more advanced flexible budget might also adjust variable indirect costs (like marketing and customer service expenses, which may increase in tandem with business activity) and respond to macro trends like seasonal fluctuations or changing tariffs.

Static vs. flexible budget

With a static budget, you plan every expense during the budgeting period and generally stick to your plan, regardless of business activity. A static budget cannot accommodate sudden increases or decreases in sales, which limits your ability to capitalize on unexpected opportunities or adjust during slow periods. Static budgets work better for nonprofits and organizations that are reliant on grants or endowments—they have a set amount of money to spend for a given period and need to plan accordingly.

A flexible budget, on the other hand, lets you adjust calculations based on changes in business activity, like unexpected decreases or increases in sales. Instead of assigning fixed amounts to each expense category, a flexible budget allocates a percentage of revenue, making it easy to scale production volume up or down as needed.

Advantages of flexible budgets

Flexible budgets gives you more adaptability in business operations, unlike a static budget that locks you into fixed numbers. Here are the advantages of the flexible strategy:

• More strategic allocation of resources. You can spend money according to your actual needs, based on real-time sales activity.

• More wiggle room during market fluctuations. Your flexible budget lets you make significant changes in response to the unexpected, such as selling fewer products than planned. In this case, you can adjust your budget to reduce production spending.

• Ability to pursue new opportunities. A flexible budget allows you to take a chance with new sales opportunities, provided your revenue supports them.

Disadvantages of flexible budgets

Flexible budgets aren’t right for every business. They require more time and resources to maintain, which might not be feasible if you don’t have the capacity. Here are reasons you may not want to adopt a flexible budget:

• More complex calculations. Flexible budgets require more complex math. You need to separate fixed expenses from variable expenses and determine the variable component of mixed costs, then calculate your variable cost ratio (your variable costs divided by net sales).

• More time-consuming. With a flexible budget, you need to frequently update your budget to account for varying business activity, and it has a shorter lifespan than a static budget.

• Potentially higher costs. Because it’s complex and requires regular updates, flexible budgeting means you might need to invest more in accounting hours and/or in accounting software to manage your expenses.

How to create a flexible budget

1. Figure out your revenue sources and expenses
2. Calculate the variable cost ratio
3. Plan different activity levels
4. Organize your flexible budget statement
5. Compare the flexible budget to actual results and revise

To create a flexible budget, you’ll need to gather sales data, analyze your actual costs, and forecast future expenses. Here are the steps in action using a jewelry store example:

1. Figure out your revenue sources and expenses

Start by creating a revenue forecast that accounts for all revenue sources, and estimate how much you plan to make from each source. For example, imagine you expect to sell 500 units of jewelry over the next month. For simplicity, let’s say all your jewelry sells for $30 per piece. That’s $15,000 in predicted revenue.

Then, determine your fixed expenses and variable expenses. Fixed expenses are costs that won’t change, even if you go viral and suddenly sell thousands of pieces a month. Here are simplified fixed monthly cost examples for the jewelry store:

• Rent for the brick-and-mortar store: $2,500

• Web hosting fees: $100

• Monthly marketing costs: $1,400

Total fixed costs: $4,000 per month

Variable costs increase with business activity. They include things like shipping fees, packaging costs, and wages.

For this example, you’ll want to calculate variable costs per unit sold. So if each piece costs $2 to ship, $1 for packaging, $2 for the raw materials, and an average of $3 in labor wages, your total variable cost per item would be $8. You’ll use this figure in the next step.

2. Calculate the variable cost ratio

The variable cost ratio shows what portion of your net sales goes toward variable costs. It helps you understand how much of each dollar you earn is spent on costs that scale with sales volume. Calculate it by dividing your variable costs by your net sales and multiplying by 100 (to get a percentage).

Here’s the formula:

Variable cost ratio = (Variable costs / Net sales) × 100

Using the $15,000 in predicted revenue calculated above for the net sales amount, and since it costs $8 to craft and sell each piece, this would add up to $4,000 in variable expenses.

Divide the variable expenses by predicted revenue and multiply the result by 100 to get your variable cost ratio. In this case, $4,000 divided by $15,000 and multiplied by 100 equals approximately 27%.

This means your baseline variable expenses account for just under 27% of your expected revenue. While the total amount you spend on variable expenses will change, this percentage will always remain the same.

3. Plan different activity levels

Knowing your variable cost ratio makes it easier to scale your expected expenses at different activity levels. Use this number to plan for various business scenarios. For example:

• If you think you might only sell 200 pieces over the next month and earn $6,000 in revenue, your variable costs would be $1,620 ($6,000 x 27%).

• If you plan to sell 1,000 pieces over the next month and earn $30,000, your variable costs would be $8,100 ($30,000 x 27%).

• If you exceed your goal and sell 3,000 pieces over the next month and earn $90,000, your variable costs would be $24,300 ($90,000 x 27%).

4. Organize your flexible budget statement

Put all these figures together in a clear format. In your spreadsheet, make a new tab for each of your business conditions—selling 200 pieces, selling 1,000 pieces, and selling 3,000 pieces.

These estimates can help you understand how changes in sales volume affect your costs and bottom line, and give you a clearer picture of potential financial outcomes. They’re not set-in-stone figures like a fixed budget. You could sell anywhere from one to 1,000,000 pieces, but you’ve chosen a few realistic scenarios to help you plan effectively. You can edit these based on real conditions when it’s time to revise.

Each time, your variable expenses will be 27% of your total budget, making it easy to track them. Add them to your fixed expenses to get a more accurate picture of your estimated total expenses. Subtract those from your projected revenue to understand your estimated profit.

5. Compare the flexible budget to actual results and revise

Compare your actual sales and costs at the end of the accounting period to the estimated budget. This process is called a variance analysis, and it helps you see whether you spent more or less than planned.

By analyzing the data, you can see how accurate your predictions were, then refine your budget model based on the results.