What Is a Static Budget?
A static budget is a type of budget that incorporates anticipated values about inputs and outputs that are conceived before the period in question begins. A static budget–which is a forecast of revenue and expenses over a specific period–remains unchanged even with increases or decreases in sales and production volumes. However, when compared to the actual results that are received after the fact, the numbers from static budgets can be quite different from the actual results. Static budgets are used by accountants, finance professionals, and the management teams of companies looking to gauge the financial performance of a company over time.
Understanding a Static Budget
The static budget is intended to be fixed and unchanging for the duration of the period, regardless of fluctuations that may affect outcomes. When using a static budget, some managers use it as a target for expenses, costs, and revenue while others use a static budget to forecast the company's numbers.
For example, under a static budget, a company would set an anticipated expense, say $30,000 for a marketing campaign, for the duration of the period. It is then up to managers to adhere to that budget regardless of how the cost of generating that campaign actually tracks during the period.
Static budgets are often used by non-profit, educational, and government organizations since they have been granted a specific amount of money to be allocated for a period.
- A static budget incorporates expected values about inputs and outputs that are conceived prior to the start of a period.
- A static budget forecasts revenue and expenses over a specific period but remains unchanged even with changes in business activity.
- Static budgets are often used by non-profit, educational, and government organizations.
- Unlike a static budget, a flexible budget changes or fluctuates with changes in sales and production volumes.
A static budget based on planned outputs and inputs for each of a company's divisions can help management track revenue, expenses, and cash flow needs.
Benefits of a Static Budget
A static budget helps to monitor expenses, sales, and revenue, which helps organizations achieve optimal financial performance. By keeping each department or division within budget, companies can remain on track with their long-term financial goals. A static budget serves as a guide or map for the overall direction of the company.
Within an organization, static budgets are often used by accountants and chief financial officers (CFOs)–providing them with financial control. The static budget serves as a mechanism to prevent overspending and match expenses–or outgoing payments–with incoming revenue from sales. In short, a well-managed static budget is a cash flow planning tool for companies. Proper cash flow management helps ensure companies have the cash available in the event a situation arises where cash is needed, such as a breakdown in equipment or additional employees needed for overtime.
When using a static budget, a company or organization can track where money is being spent, how much revenue is coming in, and help stay on track with its financial goals.
Static Budgets vs. Flexible Budgets
Unlike a static budget, a flexible budget changes or fluctuates with changes in sales, production volumes, or business activity. A flexible budget might be used, for example, if additional raw materials are needed as production volumes increase due to seasonality in sales. Also, temporary staff or additional employees needed for overtime during busy times are best budgeted using a flexible budget versus a static one.
For example, let's say a company had a static budget for sales commissions whereby the company's management allocated $50,000 to pay the sales staff a commission. Regardless of the total sales volume–whether it was $100,000 or $1,000,000–the commissions per employee would be divided by the $50,000 static-budget amount. However, a flexible budget allows managers to assign a percentage of sales in calculating the sales commissions. The management might assign a 7% commission for the total sales volume generated. Although with the flexible budget, costs would rise as sales commissions increased, so too would revenue from the additional sales generated.
Limitations of Static Budgets
Static budgeting is constrained by the ability of an organization to accurately forecast its needed expenses, how much to allocate to those costs, and its operating revenue for the upcoming period.
Static budgets may be more effective for organizations that have highly predictable sales and costs, and for shorter-term periods. For instance, if a company sees the same costs in materials, utilities, labor, advertising, and production month after month to maintain its operations and there is no expectation of change, a static budget may be well-suited for its needs.
If such predictive planning is not possible, there will be a disparity between the static budget and actual results. In contrast, a flexible budget might base its marketing expenses on a percentage of overall sales for the period. That would mean the budget would fluctuate along with the company’s performance and real costs.
When the static budget is compared to other facets of the budgeting process (such as the flexible budget and the actual results), two types of budget variances can be derived:
1. Static Budget Variance: The difference between the actual results and the static budget
2. Sales Volume Variance: The difference between the flexible budget and the static budget
These variances are used to assess whether the differences were favorable (increased profits) or unfavorable (decreased profits). If an organization’s actual costs were below the static budget and revenue exceeded expectations, the resulting lift in profit would be a favorable result. Conversely, if revenue didn't at least meet the targets set in the static budget, or if actual costs exceeded the pre-established limits, the result would lead to lower profits.