Noel has taught college Accounting and a host of other related topics and has a dual Master's Degree in Accounting/Finance. She is currently working on her Doctoral Degree.
This lesson examines the uses, advantages, and limitations of a static budget. We'll also discuss the implications of utilizing a static budget for controlling expenses and revenue.
What Is a Static Budget?
Steve is a sales leader in charge of the budget and resource allocation of a large sales department. Each year, Steve must determine the annual budget numbers for his department for the upcoming year and submit the budget to senior leadership. Since Steve runs a sales area, part of his budget will include the sales commission expense, which is the amount of commission that salespeople are paid, and the total sales for the year.
Based on sales for the previous year, Steve decides to set the sales commission expense to $300,000 and total sales to $3 million. Steve is pleased with his budget numbers and has confidence that the sales teams will meet next year's targets.
After six months pass, Steve decides to compare actual sales for the last six months to his annual budget. Based on Steve's projections, the total sales should be at $1.5 million. However, total sales are now at $2.5 million, and they are only halfway through the year! This is great news for the sales department and Steve. However, Steve can't make changes to his budget because he already set the figures for the year.
The type of budget Steve created is called a static budget, which is one that doesn't change throughout the year regardless of the situations that occur during the normal course of operating a business. Leaders create static budgets before the year begins, and they base budget numbers on previous trends as well as actual profit and expenses from previous years.
Limitations of a Static Budget
Although Steve's department has an increase in sales this year, the budget Steve prepared does not reflect the increase and can't change. One of the limitations of a static budget is that it's not flexible enough to make changes as sales and expenses change. And so, Steve can't manage the impacts of changes in profits, losses, revenues, or expenses.
Over 79,000 lessons in all major subjects
Get access risk-free for 30 days,
just create an account.
Another limitation of a static budget exists when a company cross-charges expenses back and forth to other divisions within the company. For example, if Division #1 is losing money throughout the year, the division will not be able to pay for its share of the expenses. With a static budget, the division's expenses can't shift to other divisions that may be operating within budget or above sales goals for the year.
Advantages of Static Budgets
Despite the limitations, there are some benefits when using static budgets. First, they're easy and simple to use and create. A primary reason for the ease of use is that once the budget is complete, leaders do not need to make adjustments and keep up with tracking sales figures and expenses throughout the year. With that, static budgets are best-suited for companies with little fluctuation in sales and expenses. Second, static budgets may also help leaders control budget costs because the budget calls for a cap on expenses, which can prove helpful for managing expenses and revenue.
Let's review what we've learned. In advance of the upcoming year, leaders develop static budgets, which are budgets that don't change throughout the year regardless of the situations that occur during the normal course of operating a business. A static budget is useful for businesses that do not have large fluctuations in sales and expenses throughout the year.
Static budgets are easy to create and use because once leaders determine the figures for the year, they don't have to worry about making periodic adjustments to the budget. However, there are limitations to using a static budget. When sales fluctuate frequently, businesses can't adjust expenses. Also, when one division experiences a loss, division expenses can't shift to other divisions that may be operating within budget or above sales goals for the year.
Did you know… We have over 200 college
courses that prepare you to earn
credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the
first two years of college and save thousands off your degree. Anyone can earn
credit-by-exam regardless of age or education level.