| to provide a framework for decision-making and communication |
| and performance management which can be used by managers to across the organisation acting as a to the managers who control them |
Types of Budgets
- Budgets are usually set annually and then monitored on a monthly basis
- Businesses may set budgets to monitor the financial performance of any aspect of the business
Historical figure budgets
- Zero based budgeting
- Budgets are usually based on historical data (e.g sales and costs data from previous years) and allow for factors such as Inflation and other relevant economic indicators (e.g. e xchange rate variations)
Zero based budgeting
- This is particularly useful where a business needs to control costs closely (e.g. to improve profitability)
- It can be time-consuming as evidence to support spending decisions needs to be collected and presented
- Zero budgeting also requires skilled and confident employees to make a persuasive case to convince those making purchasing decisions
Variance Analysis
- A budget variance is a difference between a figure budgeted and the actual figure achieved by the end of the budgetary period (e.g. twelve months)
- Variance analysis seeks to determine the reasons for the differences in the actual figures and budgeted figures
- A favourable variance in a revenue or profit budget is where the actual figure is higher than the budgeted figure
- A favourable variance in a costs budget is where the actual figure is lower than the budgeted figure
- An adverse variance in a revenue or profit budget is where the actual figure is lower than the budgeted figure
- An adverse variance in a costs budget is where the actual figure is higher than the budgeted figure
Worked example
Selected financial information for Bunsens PLC 2022
| £m |
Budgeted sales revenue | 12,460 |
Actual sales revenue | 13,718 |
Budgeted total costs | 8,420 |
Actual total costs | 10,627 |
Using the data, calculate the total profit variance for Bunsen PLC in 2022. You are advised to show your working (4)
Step 1 - Calculate the budgeted profit for 2022
£12,460 - £8,420
= £ 4,040 (1 mark)
Step 2 - Calculate the actual profit for 2022
£13,718 - £10,627
= £3,091 (1 mark)
Step 3 - Subtract the budgeted profit from the actual profit for 2022
£3,091 - £4,040
= £949 (1 mark)
Step 4 - Identify the nature of the variance
In this case, the variance is adverse because the actual profit for 2022 is lower than the budgeted profit for 2022
The correct answer is £949 A (1 mark)
Although the Bunsen Plc example shows an adverse profit variance, it is worth noting that the company’s actual sales revenue was higher than budgeted. There could be some sales executives in the business that deserve some sincere congratulation!
You may recommend that the business should investigate the reasons for the adverse profit variance. The focus of the examination must be on the higher than budgeted costs rather than this seemingly positive sales performance. You may recommend that Bunsen reviews its supply agreements or that it adopts a zero budgeting approach.
- Where adverse cost variances are identified a business may seek alternative suppliers or investigate ways to improve efficiency
- Where adverse sales variances are identified a business may review its marketing activities to improve their effectiveness
- Where favourable cost variances are identified a business may review key quality indicators such as the volume of returns or wastage levels to ensure that output standards are being met
- Where favourable sales variances occur a business may reward client-facing staff with performance based incentives
Difficulties of Budgeting
- Budgeting requires significant expertise to be of genuine use to a business and there are several difficulties associated with their construction
![business plan revision questions 2-2-4-the-difficulties-of-budgeting](https://cdn.savemyexams.com/cdn-cgi/image/f=auto,width=1920/uploads/2023/03/2-2-4-the-difficulties-of-budgeting.png)
The difficulties of budgeting
- Sources of data must be selected carefully and used with care to ensure the most appropriate assumptions are made
- Those constructing budgets will require skills and relevant experience to do so effectively
- This may involve training or the recruitment of specialist staff
- Unrealistic budgets (over or under) can lead to a lack of motivation amongst those tasked to achieve the financial plan
- The conflict between budget holders may arise, reducing the effectiveness of the business as a whole
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Author: Lisa Eades
Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.
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Selected financial information for Bunsens PLC 2022. Using the data, calculate the total profit variance for Bunsen PLC in 2022. You are advised to show your working (4) Step 1 - Calculate the budgeted profit for 2022. £12,460 - £8,420. = £ 4,040 (1 mark) Step 2 - Calculate the actual profit for 2022.