How to Create a Flexible Budget with Any Income?
The easiest way to understand a flexible budget is to compare it to the sort of budget with which most of us are already familiar – a static budget. With a static budget, I evaluate my total income and my total expenses and allocate a specific amount for each type of expense. Then at the end of each month (or other predetermined period), I compare my budget to actual income and expenses.
If I’ve made more than anticipated, that’s a win. If I've spent more than I’ve budgeted for, that’s bad! The budget doesn’t tell me why these things have happened, but it’s an essential starting point for figuring that out. Let’s look at an oversimplified small business budget so we have actual numbers to use as an illustration. After that, we’ll look at how a flexible budget is different, then talk about how to create a flexible budget that works for you.
“Flexible budgeting” has a formal definition, which we’ll cover below. It’s worth keeping in mind, however, that there are all sorts of ways to analyze your spending and investments beyond a basic spreadsheet budget. We should also acknowledge up front that there’s almost always a gap remaining between what we’re able to analyze and say for sure and what we decide to do. Like everything else related to small business (or even personal decision-making, for that matter), at some point, we take all the information we have and take a leap of faith to get us the rest of the way.
Nothing we’re going to talk about here can eliminate that part of the equation. What it can do is help you make a much more informed leap.
Flexible Budget Basics
AccountingTools defines “flexible budget” this way:
"
A flexible budget adjusts to changes in actual revenue levels. Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs. The budget is then compared to actual expenses for control purposes.
"
They go on to discuss the various approaches and talk accounting talk about flexible budgeting. It’s actually a pretty helpful little summary if you want to take a moment to peruse it, or at least mark it to come back to.
What I’d like to focus on here is a more hands-on, non-accountant approach. Until you see how flexible budgeting can help your business or your personal financial decisions, the technical stuff probably doesn’t matter to you much.
Using A Static Budget As An Evaluation Tool
Let’s say I make promotional lunchboxes. You have a band, a product, a service you want to promote, your contract with me to produce an old-school lunchbox and thermos for you to sell or give away. Just to make it sound more legit, let’s assume that while the style is intentionally retro, the design is deceptively modern and can be used effectively to keep your lunch fresh and your drinks cold or whatever. (Yes, I have a thing for cool retro lunch boxes – but that’s a whole other discussion.)
Using nice round numbers to keep things simple, here’s my greatly oversimplified small business budget:
Expenses
| Office and Warehouse Rental | $1,000 / month |
| Utilities | $300 / month |
| Materials / Supplies | $1,700 / month |
| Payroll (2 employees) | $5,000 / month |
| Advertising / Promotions | $1,000 / month |
| Insurance / Benefits / Etc. | $1,000 / month |
| Total Monthly Expenses | $10,000 / month |
If I want to remain profitable, not to mention putting food on my own table, I need my small business income to be somewhere north of $10,000 / month. Based on the past year, I’m estimating that I’ll accomplish this, albeit barely:
Income
| Anticipated Monthly Revenue (Sales) | $12,500 / month |
Hey, look at that! I’m clearing $2,500 / month. Nice. That gives me enough to live on (well... almost) while still reinvesting in my business from time to time.
Or am I? See, this is my anticipated static budget. Sometimes things don’t actually go quite that way. Let’s look at three months of actual pretend numbers:
| Budget (x3) |
April 2021 |
May 2021 |
June 2021 |
3 Month Variance |
|
|---|---|---|---|---|---|
| Office & WH Rental | $1,000 | $1,000 | $1,000 | $1,000 | *** |
| Utilities | $300 | $285 | $300 | $340 | ($25) |
| Materials / Supplies | $1,700 | $1,600 | $1,900 | $2,200 | ($600) |
| Payroll (employees) | $5,000 | $5,000 | $5,000 | $2,500 | +$2,500 |
| Advertising / Promotions | $1,000 | $1,000 | $1,250 | $1,000 | ($250) |
| Insurance / Benefits / Etc. | $1,000 | $1,000 | $1,000 | $700 | +$300 |
| Total Monthly Expenses | $10,000 | $9,885 | $10,450 | $7,740 | +$1,925 |
| (Anticipated) | April 2021 | May 2021 | June 2021 | Variance (3m) | |
|---|---|---|---|---|---|
| Actual Sales Revenue | $12,500 / mth | $12,500 | $10,800 | $19,600 | +$5,400 |
Favorable and Unfavorable Variances
At the most basic, a favorable variance means you’re left with more money than you’d planned at the end of the month, at least in a given category. An unfavorable variance means you’re left with less.
In reality, like everything else about running your own business, it’s more complicated than that. In the example above, materials and supplies are budgeted at $1,700 / month, but for two consecutive months shoot well above that. Does that mean costs are out of control? Not necessarily – overall costs are down.
But why is that? Oh, that’s right – Tony quit at the end of May and you haven’t replaced him yet. That’s a whole different issue than materials expenses, but if you aren’t paying attention to your budget it could easily look like you must be doing a great job controlling costs because you have $1,925 more than expected at the end of the quarter. (Keep in mind this is an intentionally oversimplified example.)
So maybe materials and supplies costs are getting a bit steep. Do you need to cut back? Not necessarily. Notice what happened to your sales in the same period. They dipped a bit in May, but then skyrocketed in June. Maybe you need to rethink your budget. Or, maybe your business is seasonal. Or maybe your main competitor just went under after a series of local scandals and it’s just a matter of time before someone else shows up to take their place. Also, there’s no way you can keep up with demand without replacing Tony, so that will impact your budget yet again!
Whatever you end up doing, the only reason you’re even able to make an informed decision is that you’re using a fairly detailed budget. This one is a static budget, however, meaning it works best if all the numbers stay the same, or at least stay within a relatively predictable range.
Flexing Your Budget
Let’s pick just a few things from the above sample tables and look at how to create a flexible budget with a few simple categories.
| Budget (x3) |
March |
April |
May |
3 Month Variance |
|
|---|---|---|---|---|---|
| Materials / Supplies | $1,700 | $1,600 | $1,900 | $2,200 | ($600) |
| Payroll (employees) | $5,000 | $5,000 | $5,000 | $2,500 | +$2,500 |
| Advertising / Promotions | $1,000 | $1,000 | $1,250 | $1,000 | ($250) |
| (Anticipated) | March | April | May | Variance (3m) | |
|---|---|---|---|---|---|
| Actual Sales Revenue | $12,500 / mth | $12,500 | $10,800 | $19,600 | +$5,400 |
Our promo lunchboxes (with the nifty thermos, don’t forget) sell to our customers for $25 each. Now, in reality, the price would probably vary with how many they ordered or which styles they wanted, but we’re going super-basic here for our example.
In March we sold 500 lunch boxes for total revenue of $12,500. If our costs for that month total $7,600 (Materials + Payroll + Advertising), then the total cost to us for each lunchbox we made was $7.600 / 500 = $15.20. (In reality, our costs for those particular lunchboxes would probably bleed over from the month before – but stay with me, here...)
April was not a great month. Our costs were up to $8,150 and we sold fewer lunchboxes – a mere 432. Our cost per box sold in April was just over $18.85. That's still profitable, but not by nearly as much.
So just glancing at May, was it a better or worse month than April? How about March? Here’s where we have to decide how we’re going to figure things. Our payroll costs dropped substantially when Tony left, but it’s been brutal trying to keep up without him and we’re probably going to have to hire someone for more money than he was making then train them before they’re any real use to us. If we consider just June, however, it was a great month. Total costs were a mere $5,700 while sales hit $19,600. That's 784 lunch boxes sold at a cost to us of only $7.27 each.
What if Tony hadn’t left, or we’d already replaced him? Let's do the math again with his salary still in it. I want to know if the profits were a fluke based on his unexpected departure or if we really did that well.
If payroll had held steady from March and April, total May expenses would have been $8,200 – higher than in previous months. With sales of $19,600, however, our cost per box would have been $10.46. In other words, if we can figure out what worked in June and keep it going, I can probably afford to hire someone to replace Tony even if they do cost me a bit more.
This is where suddenly those word problems from high school algebra come back to haunt us all. “If Goalry Lunchboxes is able to produce 5,000 lunchboxes with 2 employees making Y dollars per month at an average cost of X dollars per lunchbox and hiring a third employee would allow a 37% increase in production, at what salary would the new employee still be a profitable investment for the owner?”
My Brain Hurts
Here’s the good news. Flexible budgets are actually easier to play with when it’s your personal or small business budget being manipulated. That’s because the numbers are far less theoretical – they're actual expenses and realities you deal with every day. You also don’t have to set up a 15-variable equation and solve for maximum theoretical profitability in order for the process to help you take more effective control of your personal or small business finances.
Use Technology in a Smart Way
Here’s the best part, however: technology can make this way easier for you, even if you’re positive right now that you never want to think about another expense table again as long as you live. Technology is horrible at making important personal decisions for you. It’s not that great at relationships or figuring out what is or isn’t a good strategy for finding the right business partner. But technology is amazing at crunching numbers and considering multiple variables at once. It’s great at helping you track spending, project seasonal expenses and sales, or compute actual profitability based on changing inputs.
The right technology leaves all of the power and decision-making in your hands and magically crunches the numbers or organizes the output based on whatever you tell it is important to you.
Side Note:
Even if you’re not ready to get that crazy with a flexible small business or personal budget, imagine how much easier your life could be if you just had a reliable, intuitive, flexible budget tracker you could access and use as easily as you text your friends or share those horrible videos on social media. Instead of sitting down every month (or two, or three) and trying to sort through piles of receipts and remember where everything went, a few clicks or swipes as you go can categorize and analyze everything for you.
More information means better decision-making with less time invested. Who couldn’t use more of that?
Make the Best Budget Using the Best Tools.
Welcome to the Budgetry Store.
How To Create a Flexible Budget That’s Useful For YOU
If you’re running a fairly complex business and want to do better modeling of what’s likely to happen if you adjust individual factors – increase your advertising, hire more employees, cut back on product options, etc. – you might want to hire a professional advisor who analyzes such things in detail. Then again, given today’s technology, you can create a budget online yourself and envision various scenarios almost as easily.
Just like with a basic family budget, you want to allow a little time to get yourself started. If you haven’t used a detailed budget before, it can seem a bit intimidating at first. Most of us need a few months of using our budget to make adjustments and improve accuracy and usefulness. Keep in mind that it’s a long-term change, not a one-and-done silver bullet for anything. Like eating better or paying more attention to your kids, have a little grace for yourself, but also realize that the cumulative effect is usually more important than any one moment or event.
How Effective Budget Can Help You
Budgets may seem limiting, but they’re really not. Your budget doesn’t tell you what you can or can’t do. It’s your money. Spend it however you like. An effective budget tells you where your money actually goes so you can make more informed decisions. It doesn’t tell you what should be important to you; it tells you what is actually important to you, at least in terms of your spending, so you can decide whether or not you’re OK with that.
Honestly, the number one reason most of us have trouble sticking to our budgets – personal or small business – is that they sometimes tell us more about ourselves than we’d like.
Speaking of sticking to it, take a few minutes regularly to browse personal or small business advice, especially tips to stick to a budget. I’m not talking about hours of research. I’m talking about 10 minutes here and there while you’re having lunch. (Do you REALLY need to watch SportsCenter or The Bachelor recaps on your phone NOW?) Just like with your budget, it’s the ongoing little things that help you improve your time management and understanding.
Let’s Recap
- A flexible budget adjusts to changes in revenue so you can more effectively determine what’s going right, what’s going wrong, and why the changes are happening.
- Technology makes it much easier to analyze both real and potential scenarios for your small business or your complicated daily life.
- Take a breath and let yourself learn a little at a time. You can do this.
Keep your eyes here for details on our upcoming release of a suite of tools we’re so excited about we can barely sit still long enough to type. We’ve completely re-imagined what should be possible in unifying personal or small business finance across the Goalry family of finanical sites, and now we’ve brought even that all together in an app that could be a complete game-changer for you, for us, and for the industry.
In the meantime, let us know if you have questions or how we can help. We can’t make budgeting completely effortless, but it doesn’t have to be as hard as it’s sometimes seemed. And you don’t have to do it alone.