A fixed budget, also known as a static budget, is a budget that does not change or adjust to the actual volume of output produced or sales levels achieved. Once it’s set, the budgeted amounts for revenues and expenses remain unchanged regardless of actual business performance.
It is usually prepared for a particular period, often one year, based on the estimated level of sales volume and costs. The costs are expected to be incurred and revenues expected to be earned during that period. This type of budget works best in a stable environment where costs, revenues, and market conditions are predictable.
For example, let’s say a company determines it will spend $500,000 on marketing for the year. This amount will remain the same under a fixed budget, whether the company surpasses its sales goals or fails to meet them.
One advantage of a fixed budget is its simplicity, as it can be easier to create and understand. However, a major disadvantage is its lack of flexibility. It doesn’t adjust for changes in sales volume or other business conditions, which can lead to inaccurate performance evaluations and potential misallocation of resources. For this reason, many companies prefer flexible budgets, which adjust to reflect actual business conditions and performance levels.
Example of a Fixed Budget
Let’s consider a simplified example of a fixed budget for a small business, such as a local bakery. The bakery’s budget for the year might look like this:
Fixed Budget for 2023
|Revenues (Sales of baked goods)
|Cost of Goods Sold (Ingredients)
|Salaries and Wages
|Net Income (Revenues – Expenses)
This budget is set at the beginning of the year, and no matter how sales fluctuate throughout the year, the budgeted amounts for revenue and expenses do not change.
For example, if the bakery’s sales exceed expectations and reach $250,000 for the year, the budgeted revenues remain at $200,000. Similarly, if costs for ingredients rise and the actual cost of goods sold is $70,000, the budgeted cost of goods sold still remains at $60,000. The actual results would be compared against the fixed budget for variance analysis and performance evaluation.
While the fixed budget is straightforward and easy to implement, it lacks the ability to adapt to the business’s actual performance or changing market conditions, which can make it less useful for decision-making throughout the year.