Key Advantages & Disadvantages of Using a Static Budget

Key Advantages & Disadvantages of Using a Static Budget
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A static budget is a company budget that does not change as sales change. Static budgets are set in advance and are based on information about profit and expenses collected before the budget period begins. A static budget has a number of uses for data collection and analysis and is often used together with a flexible budget to make comparisons between predicted sales and costs and actual sales and costs.

Easy to Use

One key advantage of a static budget is that it is easy to develop and use. This is because a static budget does not need to be adjusted as sales volume and turnover change. When using a static budget, you simply calculate costs and estimate total sales over the period of the budget – generally 12 months. At the end of the budget period, determine actual costs and revenue and use this information to prepare the next budget. This may be particularly useful for a small business, because it allows those without much business experience or expertise to develop a budget.

Tax Simplification

A static budget also can make it easier to estimate taxes owed. This is a big advantage for small companies, where the owner-operator may be performing some of the accounting functions. Small companies often make estimated tax payments on a quarterly basis to avoid making interest payments on money owed. A static budget allows companies to estimate the total taxes owed and set aside the right amount each quarter. Larger companies may use a static yearly budget and flexible monthly or quarterly forecasts, to allow for more accurate tax reporting.

Master Budget

For larger businesses, a key advantage of static budgets is that they are often used as a master budget. Master budgets are useful in data analysis and forecasting. A static budget will be prepared for the entire business, and a flexible budget is then prepared for each division or department in the company. The static budget can then be used as the basis for variance analysis. In variance analysis, the actual results are compared with those in the static budget. If the variance is unfavorable -- in other words, if the revenue is less than in the static budget -- the analyst knows that next year's budget will need to decrease. Similarly, if the variance is favorable, the next year's budget can be larger.

Lack of Flexibility

One key disadvantage of a static budget is that it is not flexible and so it cannot be changed to take advantage of changes in revenue or expenses as the year proceeds. With a static budget, companies cannot manage the impact of changes, for example, by decreasing a portion of the budget in response to slow sales. This translates into a lack of control of budgeting functions. Static budgets also make cross-charging difficult. In cross-charging, the cost of services that are shared by different divisions in the company can be shared between the budgets of those divisions. In a static budget, if one of the cross-charging divisions loses money, its share of the charges cannot be shifted to the division that is still in the black.