What is a Static Budget?
A static budget can be defined as the kind of budget which anticipates in advance all revenue and expenses which will occur over a particular period. Here changes in the level of production/ sales or any other major factor does not affect the budgeted data and hence it is also called as fixed budget.
Explanation
- Under a static budget, figures are all predetermined concerning inputs and outputs for the specified period. It can be described as the prediction of income and expenses for the time being, which is not affected by an increase or decrease in sales or production levels. It may so happen that actual figures accrue in line with the budget or may have wide variations depending on change in anticipated situations.
- It remains fixed for the duration covered. To analyze different reasons, organizations do prepare flexible budget keeping in line current scenario. It is used by finance professionals and management teams to fix target revenue and its related expenses, cost, etc.
- All business organizations commonly use this type of budget. Like the public, private companies, non-government organizations, educational institutions, and non-profit organizations due to the limitation of available funds for the given period.
Example of Static Budget
Marc Inc. is in the process of establishing a new manufacturing unit in the US. The company is planning for availing loan from US Bank of $10,00,000. For this purpose, the company wishes to prepare a static budget with the following available data: –
- Sales 1,00,000 units @ $14 each;
- Prime manufacturing cost @ $4 per unit;
- Overheads @ $4,00,000;
- Sales Variable expense @ 2 unit;
Budget will be as follows: –
This budget will remain static despite the change in quantity produced/ sold.
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Importance
- A static budget is planning of outputs and inputs of a company department’s which helps the business management to monitor cash flows, income, and expenses, thereby assist the organization in attaining maximum results in the best possible manner.
- By maintaining such a budget, the financial requirements of each department company can monitor on a day to day work as well as long term financial plans. It is a blueprint or guiding scale of a business organization for a particular period.
- It is a useful tool for every stakeholder within the company. It can be used by accountants and CFO’S to ensure monetary controls. It saves the organization from overspending and to make the balance between outgoing payments and incoming revenues, i.e., it controls the flow of funds as per planning.
- It can also be termed as a cash flow planning tool for the organization. If a company has a well-maintained cash flow system, then it will never fall short of cash in any situation arising out of any contingency like the breakdown of equipment or more production requirement, etc.
- It is an essential tool by which a company can monitor fund flows. I.e., where the money is coming within the organization and whether it is in line with initial planning? Also, it helps the company to track expenses, i.e., whether the money is getting expended following predefined limits and timing set.
Static Budget vs. Flexible Budget
- A flexible budget is a form of costing analysis tool which changes with the change (increases or decrease) in sales and production level of business. Flexible budgets are fundamental tools to measure the performance of business about the static budget.
- The flexible budget helps in ensuring whether fund flows/ income expenses are in line with static budget anticipations, thereby enabling the business owner to monitor business efficiency. As flexible budgets are performance analysis tools of business, you can use it before either during the planned period or at the end of the business cycle.
- With the help of flexible budgets, management of the business can adjust the next year’s static budget accordingly to manage the operating/ administrative/ selling or any other expenses. You can use a flexible budget to meet any unforeseen situation like the requirement of more supplies in case of increased production due to an increase in demand. Or in case the company needs more employees for overtime in times of increased production and planning for product pricing, product costing, etc.
Advantages
- It provides the blueprint of organization activities, which will be performed over some time. Knowing in advance what the organization needs to do will always be beneficial for it to perform various activities efficiently.
- It does not need continuous updates throughout the year with any increase or decrease in sales or production level, so they are straightforward to implement and follow.
- Moreover, It provides a more in-depth knowledge of the company’s profits and costs. An organization can change its policies and strategies for the future. This budget allows the company to track underestimating/ overestimating its income and expenses.
- Static budgets don’t allow any change if figures by any change in company production so these companies can lower costs by making smarter decisions.
Disadvantages
- The most significant disadvantage is flexibility. If an organization plans a budget on a certain level of sales and conditions and the level of sales increases/ decreases due to any reason, the static budget cannot allocate the additional sales and its cost incurred in the existing budget.
- The company can’t increase or decrease funds in areas where it finds under-performance to make better utilization. It will harm companies’ profits. It works on data available from the previous cycle, but it is challenging for new business organizations to work on such budgets and apply.
- This budget is useful in case of a business where sales and expenses are highly predictable. In contrast, when companies see changes in sales and production levels from time to time, they can’t use a static budget. This budget in itself cannot act as a tool for cost and benefit analysis. It will always be used in concurrence with a flexible budget to analyze the area for improvements.
Conclusion
You can describe a static budget as the basic outline or blueprint of series of activities that will be carried out by an organization along with its financial figures usually prepared at the initiation of either a new business plan or at the start of a new accounting period. It has its advantages and disadvantages like it provides a roadmap for spending on each activity like allocating funds for administrative, selling expenses, etc.
Accordingly, an organization can keep track of its expenses and ensure whether it is going on as per plan or not. The static budget becomes dysfunctional in case of a change in anticipated situations like a significant change in actual production/ sales. Overall it is a very beneficial tool for every organization as a tool for product profitability and cost analysis.
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