Static budget variances are the differences between what a company or individual thought it would spend in its budget versus what it actually did. In a static budget, a company or individual creates the budget for the entire period -- a year, a quarter, or any other amount of time -- and doesn't change the budget as time moves forward.
To calculate a static budget variance, simply subtract the actual spend from the planned budget for each line item over the given time period. Divide by the original budget to calculate the percentage variance.
Continue Reading Below
An exampleIf a company sets its budget for the year based on revenue of $1 million, but actual revenue comes in at just $500,000, then that company's budget can't simply stay static. It most likely doesn't have the finances to spend the same at $1 million in revenue as it does at $500,000.
With a static budget, the company will keep the original budget figures as is and simply record actual spending separately. The difference between the original budget and the actual spend is the budget variance.
In a flexible budget, the company would adjust the original budget as sales changed, instead of leaving the budget static. Commonly, flexible budgets are set using percentages, allowing these changes to happen without the need for constant tinkering.
In a static budget, marketing expense may be set at $200,000. In a flexible budget, that expense could instead be set to 20% of sales. For a company with $1 million in sales, these budgets start out the year equally. However, over time the static budget will create a variance with actual spending, while the flexible budget will naturally adjust if sales are higher or lower than forecast.
Is there an advantage to using static budget variances instead of a flexible budget?In reality, most companies will use a combination of both a static budget and a flexible budget.
The flexible budget makes it easier for managers to make real-time spending decisions based on the actual performance of the business, while the static budget variance analysis is used as a management tool to better understand why the company performs the way it does.
A flexible budget is most useful for companies with sales and expenses that tend to vary or are hard to predict. Consider a company that gives an operations manager a static budget of $250,000 for her department based on sales of $10 million. Over the year, the manager spends just $200,000, coming in 20% under her budget. That seems great, unless sales were below the forecast by more than 20%. If that happens, then her department would have ended up costing more as a percentage of sales than management intended at the start of the year, despite her cost-cutting efforts.
A flexible budget would ensure that this manager understands how her spending stands in relation to the actual sales of the company, and she can then optimize her spending to real time.
A static budget is useful as well, though, thanks to the variance analysis. Over the short term, a company can forecast results and spending very accurately. Over the long term, though, that task is much more difficult. Think about your own personal budget -- you can probably estimate your total spending this week with pretty close accuracy. But your spending for all of next year? That's a much more difficult estimation.
Understanding the differences between what you thought would happen and what actually occurred can be a powerful learning tool for a company or individual, and the static budget variance analysis provides the data to make that possible.
For a company with very stable numbers, either a static or flexible budget works simply because the numbers don't change much.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in theFoolsaurus. Pop on over there to learn more about our Wiki andhow you can be involvedin helping the world invest, better! If you see any issues with this page, please email us email@example.com. Thanks -- and Fool on!
The article How to Calculate Static Budget Variances originally appeared on Fool.com.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.