What is the primary difference between a static budget and a fixed budget?

What is the primary difference between a static budget and a fixed budget?

Every organization strives to achieve positive business outcomes. As such, managers implement strategic practices that give the company leverage over competitors. Part of the strategic management practices include sufficient resource allocation. A company’s resources may include physical assets such as buildings, furniture and equipment. There’s also the intangible resources that a company may possess, such as human capital. Employees serve as the creative hub of a company.

Definition of budget

What is the primary difference between a static budget and a fixed budget? Image credit | worldwide web

A budget is a financial document used for internal planning of a company’s financial activities for a specified period of time. It is an approximation of the total expenditure and revenue of a given institution. A budget serves by projecting occurrences in a company’s ledger. In so doing, a firm is able to plan ahead on how best to conduct business to meet the financial goals of the company.

The accounts department is one of the key drivers of organizational performance. In that regard, the department is tasked with the responsibility of structuring and overseeing budget allocations in a given company. As a manager, a budget is an indispensable tool that triggers anticipation of market changes and plans of addressing these changes responsibly to meet a firm’s goals.

A Static Budget

A static budget is a form of budget that factors in projected values of expenditures and incomes before the actual financial period commences. A static budget acts like a forecast of financial inputs and outputs for a given period of time. Static budgets are not influenced by sales performance and fluctuations in production.

Who are the users of static budgets?

A static budget is a critical financial tool that can help you plan ahead for business activities. If you are an accountant, a team manager or a finance professional, this is the budget you may have to adopt. Chief finance officers will find this budget type convenient as it provides a measure of performance against the company’s targets. You can use static budgets in both private and public institutions. Such budgets are popular among non-profit organizations, government bodies and learning institutions. By using the static budget, monitoring of financial performance becomes a seamless experience for any organization.

Benefits of a static budget

The following are the advantages of using a static budget;

  • A static budget is an accommodative allocation of funds that ensures all the intended business activities are catered for in a specified period of time.
  • It requires minimal adjustments as approval is done before the actual commencement of a project.
  • Changes in production or fluctuations in the sales volume do not affect this budget type.
  • It is an essential financial tool that can apply in either private or public institutions.
  • A company can easily keep track of monthly and annual revenues.
  • It helps in the observation and management of cash flows in a firm.
  • It monitors expenses in various departments hence limiting overspending and cash fraud.
  • A static budget provides a financial map on how departments should use funds to stimulate business growth.
  • It equips chief finance officers with financial control tools to promote accountability in an organization.
  • Heads of departments are kept in check by this budget type as they have to plan their activities within the budget.
  • All members of an organization are aligned with long term business goals.
  • The cash flow planning tool assists a company by providing funds for emergency situations that require immediate cash allocations.

An Example of a Static Budget

In January, company X allocates $20,000 to cater for salaries for sales agents. The company’s target revenue is $800,000. The sales team achieves 90% of the given target and earns the company $720,000. Salaries worth $20,000 are paid out to the agents.

In the month of February, the sales team gets a salary budget allocation of $20,000 with a revenue target of $800,000. However, the sales team surpasses the target and brings in a revenue of $1,000,000. The company still makes salary payouts worth $20,000.

This scenario shows that a static budget is unaffected by the sales volume. Before allocation, the company has assessed the possible cost of marketing inclusive of salary payouts. In this way, the business maintains a sustainable cost of running business in all seasons.

The limitations of using a static budget

An effective static budget requires laser-sharp forecast of operational costs. It only serves best when there is a predictable pattern of production and sales. In the event of underperformance in sales, a company will find it difficult to allocate more resources to the affected department. Moreover, it is restricted to short term financial goals for it to achieve optimal performance.

Variance

The value difference between the original budget and the actual budget is called a static budget variance. When you compare a static budget with the actual financial performance, the variance derived can be used to explain financial factors that contribute to the growth or redundancy of a company.

A Fixed Budget

A fixed budget is a time-bound and volume-bound financial plan that a company uses to manage expenditure. It operates on the assumption that the firm will record consistent figures in sales and revenues. Fixed budgets have no room for extra costs. They are rigid and restrict managers to operate within the given working capital. Fixed budgets are uncommon as they often differ greatly with the end results. As such, the major drawback of this budget type is inflexibility. The rigid nature of this budget does not allow adjustments and can therefore only work in small businesses. Additionally, fixed budgets rely on previous data that may not make much financial sense to warrant a concrete financial resource allocation.

Benefits of a fixed budget

  • Instrumental in measuring performance on a short-term and long-term basis.
  • Promotes accountability of funds for small and big projects.
  • It eases the monitoring and measuring of profits.
  • It instills financial discipline in all departments by training personnel to work with limited resources for maximum gain.
  • It is simple and fast to create a fixed budget as previous data is used.

What is the primary difference between a static budget and a fixed budget? Conclusion

If you are operating a small company, a fixed budget may serve to pinpoint average cost of running business when all factors are held constant. However, as the business expands, it becomes necessary to adopt a static budget for considerate allocation of funds to the functional business activities. Non-profit organizations and public institutions will find a static budget useful and reliable. The financial performance of a company will always depend on strategic financial planning with the aid of a reliable budget.

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