A static budget is one that forecasts expected expenses and revenues for a period that hasn't yet begun. These numbers remain the same, even if actual expenses or revenues during the period differ from the budgeted amounts.
Here's what you need to know about static budgeting and how you can use it in your business.
What Is a Static Budget?
A static budget is essentially an estimate of how the upcoming budgeting period will play out. It includes expected expenses and revenues. The static budget uses fixed dollar amounts that are determined by projections. For each line item, a fixed dollar amount is inserted into the budget. This number does not change, even if it doesn't reflect the actual income or costs that the business experiences throughout the budgeted period.
How Does a Static Budget Work?
A company’s budget is an internal planning document that is prepared for a specific time period, such as a month, quarter, or year. The budget states its anticipated revenue 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 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.
Static budgets are a kind of operating budget.
Some costs work better with static budgets than others. Overhead costs, for example, are typically static. Overhead costs like rent, utilities, and administrative costs don't change with sales volume or any other factors. Therefore, it's easy to forecast them with greater accuracy.
When using a static budget, it's important to plan for costs to increase every year. Due to inflation and other factors, costs—even fixed costs—rise most years. Some companies will account for this by picking a percentage, like 5%, and increasing each line item by that amount. Other companies will use the projected rate of inflation for the next year and add an extra few percentage points on top of that as a buffer.
For example, imagine that a small business sells only one product—call it a "widget." If the manager of the company is developing a static budget for the next year, they may look at last year’s sales of widgets and add 5% to that sales figure. Then, they would input that number into the "sales" line item on their static budget for the upcoming year. That procedure would be applied to every line item on the company’s static budget for the coming year.
An advantage of the static budgeting method is that it’s easy. Relatively inexperienced small business managers can use it without spending too much time or energy. It allows management to place spending limits on each line item in the budget, and allocate extra resources toward priority efforts. The static input serves as a starting point at the beginning of a budgetary period, which encourages management to detail their plans for the budgeting period ahead.
Issues with the Static Budget
An obvious problem with the static budget is its rigidity. It does not change as sales and costs change. Unless the company has extremely stable revenue and expenses (such as a utility company) then this rigidity can become problematic.
For companies with less stable sales and costs, a static budget won't allow the company to allocate more resources toward improving sales if sales are lagging under expectations. Conversely, if sales are better than expected, the company can’t move resources from sales to another line item that is underperforming.
Alternatives to the Static Budget
Static budgets work great for some types of businesses, but they may not be a perfect fit for everyone. If a static budget would be too rigid for your business, try one of these alternatives.
The Flexible Budget
A flexible budget allows management to recalculate revenue based on expenses and other factors as time passes during the budgetary period. This gives management better financial control of the firm. Flexible budgets also tend to be more accurate on an ongoing basis than static budgets, making them useful as an evaluative tool at the end of the budgetary period.
Using a Combination of Static and Flexible Budgets
Using static and flexible budgets together is a powerful tool in evaluating the performance of a company. A technique called variance analysis is used by accountants to compare static budgets 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.
These comparisons give the manager a sense of 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 improve static budgets in the future.
- A static budget is a business document that outlines expected expenses and revenues in the upcoming budgetary period.
- Static budgets do not change throughout the budgetary period, so there may be inaccuracies if costs and income don't go according to plan.
- Some line items, businesses, and industries are better suited for static budgets than others.
- Some businesses use a mix of static and flexible budgets to measure the variability of expenses and revenues.