Remember in our previous chapter we discussed how comparing our actual performance to our budgeted performance might not be a great comparison? The assumptions under which we made our budget might have changed due to a change in the global economy, in the business’s industry or with customers or a supplier. We raised the idea of a better way of creating a comparison by using a flexible budget. In this chapter, we are going to learn more about how to use a flexible budget to evaluate short-term performance.

Let’s look at an example

Bar Xpresso (the name of my dad’s cafe before he retired) prepares a budget for the year. Projections are prepared about how many hot and cold beverages, toast and pastries and hot lunches will be sold each month.

However, COVID19 hits and Bar Xpresso’s business is severely affected. No in-cafe dining is permitted, resulting in less hot lunches sold and an overall decrease in customer traffic. Therefore, to be able to figure out whether Bar Xpresso is performing well against the budget – the budget needs to be adjusted to be flexible. Once adjusted for the actual sales, the business doesn’t seem to be making as much profit as it should be. The Bar Xpresso owner also notices that they seem to be using higher levels of beans and the wage bill is disproportionately higher. How can the business try and investigate the potential causes of these differences?

Variance analysis!

Variance analysis will allow the business to identify exactly what is driving higher or lower profits by digging into the components of the budget – the prices at which they sell their goods, the prices of inputs and how efficiently the business uses its inputs to create the product or service that they sell.

In this chapter, we will cover the following learning objectives:

• Create a flexible budget
• Conduct variance analysis using a static budget and flexible budget
• Identify what drives variances between the static and flexible budgets for sales, materials and labour
• Discuss how this information can be used to improve a business