What Is a Static Budget?
A company’s budget is an internal planning document that is prepared for a specific time period, such as a month, quarter, or year, and states its anticipated revenue (income) and expenses for that time period. Companies have different types of budgets, but the main budget is called a master budget, which is comprised of two parts: the operating budget and the financial budget.
The operating budget states the company’s revenues (income) and expenses from the income statement. The financial budget states the company’s cash receipts and cash disbursements from the previous time period’s Statement of Cash Flows. Cash receipts are what your company takes in from customers, including receipts from credit sales. Cash disbursements are what your company pays out to vendors.
The Static Budget
The static budget incorporates fixed dollar amounts that are decided upon before the budgetary period begins. It presets revenue and expenses based on projections. For each line item, a fixed dollar amount is inserted into the budget.
For example, let’s say a small business sells only one product called a widget. If the manager of the company is developing a static budget for the next year, they would look at last year’s sales of widgets and add an amount to last year’s sales. Then they would insert the combined amount into the line item “Sales” on their static budget for the next year. That procedure would be followed for every line item on the company’s static budget for the coming year.
An example of one item that is usually static on a budget is overhead. Overhead is fixed expenses incurred by the company that doesn’t change with revenue or expenses. Examples are rent, utilities, and administrative costs.
Where does the amount come from that management adds to the current year’s budget line items for the next budgetary year? The answer is that each company is different. Some companies will typically use a percentage, like 5%, and increase each line item by that amount. Other companies’ will take the projected rate of inflation for the next year and add a percentage on top of that.
Issues with the Static Budget
An obvious problem with the static budget is that it does not change as sales and costs change. This is a problem for most companies unless the company has stable revenue and expenses, such as a utility company. Utilities can use static budgets more effectively than most companies.
For other companies with less stable sales and costs, if sales drop, the company can’t allocate more resources for improving sales. If sales go up, it can’t move resources from sales to another line item that is underperforming.
An advantage to using a static budget is that it’s easy, and relatively inexperienced small business managers can use it. It allows management to place spending limits on each line item in the budget, but it only relies on current data. A static budget also allows a manager to allocate certain resources to achieve particular outputs. The static input serves as a starting point at the beginning of a budgetary period which allows it to be used with a flexible budget, or actual results at the end of the time period to evaluate the company.
The Flexible Budget
A flexible budget allows management to recalculate revenue based on expenses and other factors as time passes during the budgetary period. It allows costs to be adjusted based on sales volume and gives management better financial control of the firm. Flexible budgets tend to be more accurate on an ongoing basis than static budgets. They are very useful as an evaluative tool at the end of the budgetary time period.
Using Static and Flexible Budgets in Performance Evaluation
Using static and flexible budgets together is a powerful tool in evaluating the budgetary performance of a company. A technique called variance analysis is used by accountants to compare static budgets and actual results and static and flexible budgets. Comparing the static budget at the beginning of the budgetary period and the flexible budget at the end of the budgetary period gives the manager the sales volume variance.
Comparing the static budget and actual results at the end of the budgetary time period gives the manager the static budget variance and a look at whether the variances between the static budget and actual results were favorable or unfavorable to the company. These budget variances are analyzed by management to determine how to best budget in the future.