There is no "one size fits all" approach regarding financial planning—different types of budgets suit various business models and situations. A static budget is a financial planning tool that forecasts fixed revenue and expenses for a given period. A static budget will remain fixed regardless of a change in sales volume or production costs.
Despite the perceived advantages of a static budget, it is often criticized on several grounds due to its rigidity and inability to accommodate changes, unlike some other types of budgets.
Continue reading for a deeper dive into static budgets!
What is a static budget
A static budget is a budget that forecasts a company's anticipated revenue and expenses over a given period. Companies use a static budget to create a blueprint or basic outline of their activity levels for the next accounting period.
Such a budget remains fixed until the end of the given period regardless of any increase or decrease in production cost, sales volume, or other unforeseen circumstances. Unlike flexible budgets that are updated in line with the company's activity level change, a static budget will remain fixed even if any circumstance arises within the budgetary period that may affect the costs of the business.
How to create a static budget
The procedure of creating a static budget is similar to that of developing other types of budgets. When making a fixed budget, you begin with your historical data. Adjust these data points to reflect anticipated changes in demand, expansion plans, cost of goods sold, and other factors.
For example, if you need to hire 2 more members, you need to allocate more funds for your headcount. This includes salaries, taxes, and benefits associated with hiring these 2 new members. You cannot change this budget mid-year, so if in 6 months, you realize that you actually need 3 new team members (this represents an unfavorable static budget variance), you will be unable to hire the 3rd, as you have used the extra funds to hire the initially planned 2 members.
Alternatively, if only one additional team member is enough, the following year, you will have to adjust the headcount budget because your actual costs were below your projected costs, and those extra funds can be allocated somewhere else.
It is beneficial to start your budget with accurate data and realistic assumptions. Remember that you cannot adjust a static budget throughout a given budgetary period. At the end of the period, do a budget variance analysis and adjust the budget for the next period.
Advantages of a static budget
It prevents overspending
Many business owners, finance professionals, accountants, and management teams use a static budget to ensure financial discipline and prevent overspending.
It helps the management team ensure monetary control
A static budget makes it easy for companies to track their cash flow - all outgoing payments and incoming revenues will be monitored and kept within the limit of the company's budget. By doing so, the management team will have financial control over all departments and ensure the company is working towards its long-term financial goals.
It is easy to maintain
One of the significant advantages of a static budget is the ease of maintaining it. A static budget model will make financial modeling a breeze for business owners and managers lacking in-depth accounting knowledge.
You don't need to adjust it periodically to match changes in production level and sales. Once you estimate your expenses and project your revenue at the beginning of the accounting period, you don't have to revisit it until the end of the period.
Disadvantages of a static budget
It is rigid
The major flaw of a static budget is its unyielding nature. It cannot be adjusted despite any change in the company's activity level or external circumstances. It is a significant setback to a company's financial plan since it may be impossible to make accurate forecasts.
It requires precise planning
It is often difficult to predict the cost of production and operating expenses accurately. Several circumstances may affect the cost of raw materials, labor, utilities, and marketing.
If you are using a static budget, you wouldn't be able to make the necessary adjustment to your estimated expenses.
It can stifle your growth
A static budget does not give room for innovation and significant business growth. Since the figures are fixed at the beginning of the budgetary period, there would be no room for the firm to take advantage of opportunities and innovations that may foster competitive advantages.
A fixed budget will leave the company with little or no money for emergencies (e.g., a sudden breakdown of major equipment).
Difference between a static budget and a rolling budget
Rolling budgets are also referred to as flexible budgets. Flexible budgets change with the business. It allows companies to create a more accurate plan and align their financial goals with recent trends.
Unlike fixed budgets that are not revised until the end of the accounting period, rolling budgets are adjusted and updated at set intervals in line with significant changes. A company may choose monthly or quarterly intervals to update its rolling forecast. A rolling budget follows an add/ drop approach such that a new forecasting period will be added on a rolling basis.
Rolling budgets forecast revenue and expenses in percentages, unlike static budgets that use fixed amounts. This projection method will allow you to make realistic adjustments to costs directly tied to your actual revenue. For instance, a company decided to pay a 10% sales commission. That means the higher the actual sales, the higher the commission payout, and vice versa. However, if the budget is to pay $50,000 as commission, the payout is fixed regardless of whether the company records additional sales or lower sales.
Some organizations prefer a static budget due to its uncompromising nature, yet it is tragically inadequate for others. A fixed budget can be a great way to predict annual revenue and expenses for companies with consistent yearly earnings and new businesses not expecting any significant business development.
However, If your firm is experiencing a lot of change, a fixed budget will not provide the flexibility and agility needed to continue operating.
On the flip side, some businesses stay clear of rolling budgets because it is time-consuming. It requires a large amount of data that has to be updated at intervals, unlike a static budget that may not be revisited till the end of the fiscal year.
What type of budget should you use?
There is no right or wrong budgeting model in business. As a business owner, your business model and industry will determine your choice of financial planning tool. It is better to weigh the pros and cons of different types of budgets and consider their implications for your business before you make a choice.
A static budget is most suitable for organizations that rely on fixed allocated funds and operate in a relatively stable business environment with low competition, such as government corporations, educational institutions, and NGOs.
You can also use a static budget if you have highly predictable sales and fixed costs.
A static budget is not a good option if you operate in a volatile and competitive business environment. A flexible budget will allow you to adjust your financial plan in line with the twist and turns of the business environment. You will also be able to incorporate new innovative ideas to get ahead of your competition. Because flexible budget changes according to your needs, it may be the wiser choice for you.
Both static and rolling budgets are mutually beneficial. You don't have to use them in isolation. A company can take advantage of the two budgeting models.
You can use a static budget to allocate money to predictable costs that you believe will remain fixed throughout the budgetary period. Such fees may include utility bills and property rents.
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