A standard budget contains fixed revenue and expense budget information. It does not provide for any variability in the amount of units sold, price points, activity levels, and so forth. As such, a standard budget represents a single best estimate of the future performance of a business through the budgeting period. This approach works best when the business model is relatively simple, revenues rarely deviate from expectations, and expenses are highly predictable. Conversely, it functions poorly in a more fluid business environment that is more difficult to predict.
A standard budget is usually accompanied by variance analysis, which measures the differences in actual revenues and expenses from expectations. These variances may be used as the foundation for a system of performance bonuses. If bonuses are based on variances, this tends to force employees to follow the budget, even if subsequent changes in the market make it obvious that the company really should be diverging from the plan to follow new opportunities as they arise. The linkage of bonuses to the budget also means that employees are more likely to pad their budgets to make them easier to achieve. Padding means that revenue targets are set artificially low, while expense targets are set too high.
The standard budget is commonly used in a centralized command-and-control environment, since it allows senior management to judge the performance of the organization in comparison to a single forecast of future results.
Though the standard budget concept is extremely wide-spread, it suffers from the singular failing of only planning for a single outlook on the future, which any business is extremely unlikely to precisely reach. There are several viable alternatives to this type of budget that avoid the single option approach, such as:
- Continuous budgeting. The budget is revised each month to add a new month to replace the one that has just been completed. This is a time-consuming approach, but does allow for incremental changes to the budget.
- Flex budgeting. The flex budget alters expense levels automatically, depending upon the actual revenues achieved.
- Rolling forecast. Rather than using a budget at all, consider revising a high-level forecast at frequent intervals. Doing so requires little labor, and more accurately reflects short-term expectations.
In short, the standard budget is the traditional method for deriving a budget, but it is severely limited, and if followed too rigorously, does not allow a business to take advantage of new opportunities on short notice.
A standard budget is also known as a static budget.