Static Budget

Understanding Static Budgets

A static budget doesn't change, no matter how business activity levels fluctuate. Even if actual sales are way off from what was predicted, the budgeted amounts stay the same. It's the simplest and most common type of budget.

Static Budget Variance

When actual results are compared to the static budget, the difference is called a static budget variance. Managers use this to see how well they're controlling their spending.

How a Static Budget Works?

A static budget stays the same over time, no matter what changes might happen. Some managers use it to predict the company’s financial metrics, while others use it as a spending target. For example, a company might set a static budget of $30,000 for a marketing campaign, and managers must stick to that budget regardless of the actual costs.

Use in Various Organisations

Non-profits, schools, and government agencies often use static budgets because they have a fixed amount of money to spend over a certain period.

Advantages of a Static Budget

Static budgets work best when sales and expenses are predictable, like in a monopoly. They help track how well a company performs against expectations in stable environments.

Disadvantages of a Static Budget

In more dynamic situations, static budgets can be problematic. They might not reflect current conditions if actual results are compared to an outdated budget. For instance, a manager with a large static budget might underspend and be rewarded, even if overall sales have dropped significantly and more cuts are needed. On the other hand, if sales are much higher than expected, managers might seem to overspend, even though they’re just meeting customer demand.

Static Budgets vs. Flexible Budgets

Using a static budget for variance analysis can result in significant discrepancies, especially for long-term periods when predictions are less reliable. A flexible budget, on the other hand, adjusts for changes in actual sales volume, resulting in smaller variances.

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Example of a Static Budget

Let's consider XYZ Corporation, which has created a static budget with projected revenues of $15 million and costs of goods sold (COGS) set at $6 million.

If actual sales turn out to be $12 million, there’s a $3 million negative variance in revenue. Suppose the actual COGS is $4.8 million. In this case, the variance for COGS would be positive by $1.2 million ($6 million - $4.8 million).

With a flexible budget, the COGS would adjust to a percentage of actual sales. If XYZ Corporation typically has COGS at 40% of sales, then with $12 million in actual sales, the COGS would be 40% of $12 million, which is $4.8 million. This adjustment would match the actual COGS, resulting in no variance for the COGS.

Comparison

  • Static Budget:some text
    • Projected Revenues: $15 million
    • Projected COGS: $6 million
    • Actual Revenues: $12 million
    • Actual COGS: $4.8 million
    • Revenue Variance: $3 million negative
    • COGS Variance: $1.2 million positive
  • Flexible Budget:some text
    • Adjusted COGS to 40% of $12 million sales: $4.8 million
    • No variance in COGS, as actual COGS aligns with the flexible budget adjustment

Read further: How to calculate cost of goods sold?

Conclusion

  • A static budget includes projected values set before a period begins.
  • It predicts revenues and costs over a set time but stays the same despite changes in business activity.
  • Government, educational, and non-profit institutions often use static budgets.
  • Unlike a static budget, a flexible budget adapts to changes in sales and production levels.

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