A static budget is a financial plan or blueprint that outlines the activities of an organization for a specific period. It serves as an essential tool for financial managers to monitor expenses and generate revenue.
Static budgets are frequently employed by businesses that anticipate a steady annual income and minimal business development. However, they may not be suitable for companies that experience drastic changes to their business model or external circumstances.
Costs
Budgeting is an invaluable tool that businesses use to manage their cash flow, income and expenses. It enables the CFO and other stakeholders to monitor day-to-day activities as well as long-term financial plans for the business. Budgets also serve to maintain monetary controls within an organization while preventing overspending.
Budgets can be tailored to fit a variety of business models and situations. They may be utilized for tracking sales volumes, production costs, as well as planning the allocation of funds.
One of the most commonly used budget types is static budget. This plan focuses on projecting revenue and expenses for a given period, making it ideal for companies that have predictable costs that they can count on. Unfortunately, it does not take into account changes in cyclical demands which makes it less suitable for public institutions that depend on fixed-cost contracts or grant moneys to finance operations.
Static budgets are an invaluable tool for companies to ensure all departments reach their objectives while adhering to a rigid spending plan. For instance, businesses may use the sales team’s quota as the basis for allocating funds, keeping employees motivated towards exceeding quotas.
Static budgets can be beneficial for certain companies and departments, but they have their drawbacks as well. For instance, they may not work well for startups or small businesses since they are too rigid and inflexible to adapt with changes in the environment.
Another disadvantage of static budgets is the cost variance they create. This difference between what you plan to spend and what actually occurs can have a substantial negative impact on your profitability.
To reduce these expenses, companies can create a flexible budget to adjust production levels and sales volumes according to actual production or sales trends. This method enables companies to adjust their numbers accordingly to actual output or sales; additionally, the same percentages can be allocated across various aspects of the business regardless of how many units are produced or sold during any given period.
A static budget is often preferred for businesses that manufacture high-quality goods with steady demand. Furthermore, public institutions that receive grants or contracts to cover operational expenses may benefit from having a static budget in place.
Budgets can have a major effect on a business?s profitability, especially when there are unexpected costs in manufacturing. For instance, companies producing their own goods may discover that raw materials cost more than three times what was initially budgeted – severely decreasing their profit margin.
Flexible budgets are ideal for businesses that require frequent adjustments in their operations, as they can be updated accordingly. This enables a business to react promptly to any shifts in production or sales volumes, ultimately improving its profitability.
Revenue
Static budgets are a popular tool used by organizations with highly predictable sales and expenses. They enable financial leaders to monitor how well a company is doing against its budget, making necessary adjustments as needed.
Static budgets can be an invaluable tool for business owners, but they come with certain drawbacks as well. The primary disadvantage of a static budget is its lack of flexibility; businesses cannot allocate additional revenue or resources to underperforming areas of the company, which could negatively affect both its bottom line and service quality.
Additionally, static budgets can be challenging for newer businesses to create and execute due to their reliance on data that has already been collected, which cannot easily be altered.
Another disadvantage of a static budget is its difficulty in anticipating revenue changes over the long haul. This is because sales volume often fluctuates year to year and many factors can impact a business’ performance.
When creating a static budget for your business, it’s essential to take into account all variables. Make sure your assumptions are accurate and reflect your current goals.
You should also account for variable costs, such as materials and direct labor. These could rise as your business expands or sells more goods. To calculate how much of these items to budget for, use historical information to estimate their average price over time and apply that percentage to your projected period.
Calculating your overall budget for your business and how much money is necessary can be quite complex. Once you’ve calculated it, creating a static budget becomes much simpler.
For instance, if you anticipate making $1,000 worth of product in your first month, construct a static budget based on this amount. However, if sales only total 600 units during that same month, be sure to adjust your budget accordingly.
One way to determine your business’ fixed costs is by dividing them by total revenue. This will give you the percentage of fixed expenses that needs to be budgeted for your venture.
For example, the car wash business must calculate how much money it needs to spend on supplies, cleaning services and other equipment in order to reach its objectives each day of the month. Furthermore, you’ll have an idea of how much money needs to be invested in advertising to promote its services.
These numbers form the basis of your budget, so it’s essential to keep them in mind when making business decisions. A well-crafted static budget will guarantee that your company remains on track towards reaching its financial targets and objectives.
As with any budget, it’s essential to compare your actual results with those projected in your plan. Doing this provides a useful overview of your business performance and helps identify areas for improvement. It may even inform how best to approach budgeting next year.
Life as an entrepreneur can often feel like sailing the ocean without a map. It can be challenging to steer your new business without a clear idea of where you want to go and how to get there. Budgets are valuable business maps.
In your business budgets, you set the direction for your company by projecting your future income and expenses for a given period of time, such as one year.
There are different ways to approach the forecasts that you use in budgets. Specifically, you can choose to do your forecasts before the period begins or continue to update them as you go along.
When you make budget forecasts beforehand, that’s known as a static budget, and it can be a valuable tool for budding entrepreneurs.
What is a static budget?
A static budget is a spending plan for your business that covers a defined period of time. It is made up of financial performance projections that don’t change until the budget period ends.
Typically, static budgets include projections for revenue, fixed expenses, variable expenses, and profit.
Budget forecast numbers are usually based on past data and assumptions about future performance.
For instance, say your revenue has been steadily increasing by $1m each year, and it was $9m last year. You can take that information and project a total revenue of $10m for the upcoming year.
These projections are made beforehand, and then compared with your actual performance. To create a static budget for 2023, you would make your projections in 2022, then compare them with the actual results at the end of 2023.
Static budget vs. flexible budget
In a static budget, the projected numbers don’t change during the covered period. In contrast, a flexible budget allows for changes to projections based on new information and assumptions.
For instance, take the revenue prediction of $10m from the previous example and say that it breaks down into $2.5m revenue per quarter. If you use a flexible budget, you could change your numbers based on what happens during the year.
If your actual performance is higher and you bring in $3m in Q1 and Q2, you can use that information to create a new projection. You might assume you’ll earn $3m each quarter, which changes your annual revenue projection to $12m.
In a static budget, you would keep your initial projections and compare them to your actual results after the year ends by analyzing budget variance.
Understanding static budget variance
Factors such as consumer preferences, competitor performance, and economic trends can impact your business’s sales and costs.
Given that, your business’s actual revenue and cost numbers often diverge from projections in the budget. This difference between your static budget and your actual performance is known as a static budget variance.
To get a better idea of how static budget variance works, say you have a business with the following budget projections and actual performance:
The actual performance is different from what you predicted — that difference is the budget variance.
Budget variances can be favorable or unfavorable.
Favorable results are those that end up with more money than expected — such as earning more or spending less than expected. Unfavorable variances result in less money in your accounts and happen when your revenue is lower or your costs are higher than projected.
In this example, the business had a favorable revenue variance because sales generated $0.5m more than predicted. But there was an unfavorable expense variance because actual costs were $1m higher than the budgeted costs.
All in all, this led to the business falling $0.5m short of its net profit projection.
Once you know where budget variance occurred, you can perform a budget variance analysis to understand why your actual numbers differed from the predicted amounts. The analysis can help you identify opportunities to increase revenue, lower costs, and make more accurate projections.
For instance, if the source of your increased costs was unexpected shipping rates, you can either adjust your predictions for next year or look for a cheaper shipping partner.
How to build a static budget
Here’s how to create a basic static budget in five steps.
1. Estimate revenue
The first thing to do when creating a static budget is to forecast sales revenue for the upcoming year. You can use the following formula to estimate revenue:
Estimated Revenue = Estimated Sales Volume x Projected Price Per Unit
To estimate your sales volume and price per unit, start with your most recent numbers, and then make an assumption about how they will change in the next year.
Say you sold 1m units last year. That number will either increase, decrease, or stay the same in the upcoming year.
If you expect to expand and sell more, you would assume that sales volume and revenue will increase.
You can look at your growth trends to estimate how much more you’ll sell. If your sales volume has been growing by 10% each year, you might assume you’ll sell 1.1m units in the next year.
You can make similar assumptions about sales prices depending on whether you plan to raise prices, keep them steady, or lower them.
For startup founders who don’t have a lot of historical data, Aaron Jerez, founder of culinary and entertainment brand Home Bar Select, recommends “creating a budget based on industry averages and trends or using data points from a similar business in your field” to get started.
2. Estimate variable expenses
Next, estimate your variable expenses, which are the costs that change based on your sales volume or production levels. These are also known as your cost of goods sold (COGS). Variable expenses include items like raw materials, sales commissions, packaging costs, and delivery costs.
Divide last year’s variable costs by last year’s revenue to determine how much your variable costs are as a percentage of revenue. Then, multiply that number by your revenue projection for the upcoming year to estimate variable expenses.
3. Calculate gross margin estimate
Use revenue and COGS estimates to calculate your projected gross margin (or contribution margin).
Estimated Gross Margin = (Estimated Revenue – Estimated COGS) / Estimated Revenue
This number predicts how much money you have left to pay for fixed expenses. That being said, you don’t want to spend all of this money on fixed expenses. Ideally, you want some money leftover as net profit.
4. Estimate fixed expenses
The next step is to estimate your fixed costs for the year. These costs don’t change based on your sales volume or production levels and typically include rent, payroll, business insurance, and interest payments.
You can use past data to predict your fixed expenses. For instance, if you know that your rent payments will stay the same, you can carry over that cost from the previous year.
You can also adjust your budget based on anticipated growth. If you want to hire another team member, you can budget a fixed amount for their annual salary.
5. Calculate net profit estimate
Finally, estimate your net profit by subtracting your total expected expenses from your total expected revenue.
Estimated Net Profit = Estimated Revenue – (Estimated Variable Costs + Estimated Fixed Costs)
Estimated net profit can also be calculated as:
Estimated Net Profit = Estimated Gross Margin – Estimated Fixed Costs
By estimating your net profit, you can see how your revenue and expense plans will affect your bottom line.
Should you use a static budget?
Is a static budget the right type of budget for your business? Here are some pros and cons to consider.
Benefits of a static budget
Static budgets don’t change throughout the year, so they’re helpful as financial road maps that keep the company on track. Business owners often use their ideal scenario for static budget projections, which helps them avoid overspending, stay focused on revenue goals, and achieve optimal performance.
Lilian Chen, co-founder of virtual team-building startup Bar None Games, explains that “[static budgets] are easier to maintain than flexible budgets, which is beneficial for small businesses and startups that don’t have the resources to regularly adjust their budgets.”
Limitations of a static budget
The most significant limitation of a static budget is its lack of adaptability, since the budget can’t change for the year. The budget can become less relevant if your company’s performance varies drastically from your predictions.
This may not be a huge concern for companies with more predictable sales and expenses. However, if your business is in a dynamic or high-growth industry, a fixed budget may not give you the flexibility you need to reallocate resources and respond to significant changes in the market.
