A static budget is a budget based on one expected level of output or sales for the period, with revenues and costs planned for that level only. Once approved, its figures do not change, even if the business ends up selling or producing much more or less than planned. It is also called a fixed budget. Most annual master budgets, including the budgeted income statement and budgeted balance sheet, start out as static budgets.
Static budgets are useful for planning and for controlling costs that do not depend on activity, but they are a poor benchmark for evaluating costs that rise and fall with volume. For that purpose, managers use a flexible budget, which restates the budget for the activity level actually achieved.
How a static budget is used
At the start of the year, managers forecast sales volume and prices, then estimate the costs needed to support that volume, using cost formulas for variable costs and fixed amounts for fixed costs. The result sets targets for each department, determines funding needs and feeds the cash forecast. During the year, actual results are compared with the static budget, and the differences are reported as static budget variances, a form of budget variance.
Worked example
A bicycle maker prepares a static budget for 10,000 bicycles at $400 each. Variable costs are planned at $220 per bicycle and fixed costs at $1,200,000. Actual sales are 12,000 bicycles at $400, with actual variable costs of $2,700,000 and fixed costs of $1,230,000.
| Item | Static budget (10,000 units) | Actual (12,000 units) | Static budget variance |
|---|---|---|---|
| Sales | $4,000,000 | $4,800,000 | $800,000 favorable |
| Variable costs | $2,200,000 | $2,700,000 | $500,000 unfavorable |
| Fixed costs | $1,200,000 | $1,230,000 | $30,000 unfavorable |
| Operating income | $600,000 | $870,000 | $270,000 favorable |
The $500,000 unfavorable variance in variable costs looks alarming, but it is mostly the natural result of making 2,000 more bicycles. A flexible budget for 12,000 units would allow variable costs of 12,000 times $220, or $2,640,000. Compared with that, the true overspending is only $60,000. The analysis therefore splits the total into two parts:
Here the sales volume variance is the difference between the flexible budget and the static budget, caused purely by the change in volume, and the flexible budget variance is the difference between actual results and the flexible budget, caused by prices and efficiency. For operating income, the flexible budget at 12,000 units is $4,800,000 minus $2,640,000 minus $1,200,000, or $960,000. The sales volume variance is $360,000 favorable, and the flexible budget variance is $90,000 unfavorable, made up of $60,000 on variable costs and $30,000 on fixed costs. Together they give the $270,000 favorable static budget variance.
When static budgets work well
- Organizations whose activity is fairly predictable, such as government agencies and many nonprofits, which use fixed appropriations similar to a government budget.
- Costs that are largely fixed, such as head office administration, insurance, rent and research programs, where volume has little effect.
- Capital and project budgets, where a fixed amount is approved for a defined purpose.
- Setting overall targets, especially for revenue, where a static goal motivates sales teams.
Limitations
For businesses with volatile volumes, a static budget quickly becomes out of date and can mislead. A manager whose department produced less than planned may appear to have controlled costs well simply because volume fell, while a manager who handled a surge in orders may look like an overspender. Static budgets can also encourage budgetary slack and year-end spending to use up allocations. Many companies therefore keep the static budget as a planning target, assess performance with flexible budgets, and update forecasts during the year through rolling forecasts. Understanding cost behavior is the key to deciding which approach fits each cost.