What is a Standard Budget?

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. 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.

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 forces 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.

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Variations on the Standard Budget

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, which are noted below:

Continuous budgeting. The continuous 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. This actually means that any fixed expenses are not altered in the budget, while expenses considered to be variable will adjust in the budget, based on the actual sales generated within a budget period. The budget model may also contain some mixed costs, which contain a fixed element and a variable element; in this case, only the variable element is altered in accordance with sales levels.
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.

Problems with the Standard Budget

There are several significant issues associated with standard budgets, which are as follows:

Inflexibility. Standard budgets often rely on static assumptions that may not account for unexpected changes in circumstances, such as market conditions, inflation, or supply chain disruptions.
Over-emphasis on cost control. Budgets focused solely on cost control can discourage creativity and risk-taking, which may hinder innovation.
Time-consuming preparation. Preparing a standard budget often involves gathering extensive data and input, which can be time-intensive.
Limited accuracy. Budgets are based on predictions that can be inaccurate, particularly in dynamic industries or volatile economic environments.
Neglects long-term strategy. A standard budget may prioritize short-term cost savings over long-term investments and strategic growth.
Rigid performance metrics. Standard budgets often set fixed goals, which can be demotivating if they are too ambitious or perceived as unfair.
End-of-year waste. Departments may rush to spend remaining budgeted funds to avoid reductions in future allocations, leading to inefficient use of resources.
No continuous improvement mechanism. Standard budgets don’t inherently promote regular review, feedback, and optimization.
System gaming. Teams may manipulate figures or underreport their needs in order to secure easier targets.

Addressing these issues often involves adopting more flexible, dynamic budgeting approaches such as rolling budgets, zero-based budgeting, or activity-based budgeting, which are better suited to handle changing business environments.