5.5 Budgets
- Syllabus
- 9609–2026–2027
- Topic
- 5.5
- Level
- AS
Learning objectives
5.5.1Budgets• The meaning and purpose of budgets- the measurement of performance- the benefits and drawbacks from the use of budgets- the meaning and use of incremental budgets, flexible budgets and zero budgeting- the uses of budgets for measuring performance, allocating resources, controlling and monitoring a business5.5.2Variances• Variances- the meaning of adverse variances and favourable variances- the calculation and interpretation of variances
Budgets turn objectives into planned resources, targets and control
A budget is a quantified financial plan for expected revenue, costs, profit, cash or resources over a future period. It translates objectives and strategy into departmental/manager commitments that can be compared with actual performance.
Budgeting forms a control loop: set objectives/assumptions → forecast activity/revenue/cost/resource needs → negotiate and allocate budgets → coordinate action and give authority/accountability → record actuals → calculate/investigate variances → correct operations or revise an unrealistic plan.
| Use | Business value |
|---|---|
| Plan and allocate resources | Direct funds/people/capacity to priorities and anticipate finance/cash needs |
| Coordinate and communicate | Align functional plans so marketing demand, operations capacity, HR and finance support one objective |
| Control/monitor | Set spending/revenue limits, expose deviation and enable timely corrective action |
| Measure performance | Compare actual with agreed targets across employees, cost/profit centres, products or periods |
| Motivate/delegate | Give managers authority and clear targets/accountability when targets are accepted and achievable |
| Approach | How it is built | Benefits | Drawbacks/best fit |
|---|---|---|---|
| Incremental | Adjust previous/current budget for expected changes | Quick, simple, consistent, lower conflict; grounded in known operations | Preserves waste/old priorities and weakly challenges assumptions; better for stable activity |
| Flexible | Adjust budgeted revenue/cost to the actual or alternative activity/output level | Fairer performance comparison and what-if planning; separates volume effect | Needs reliable cost behaviour and more data/time; still assumption-dependent |
| Zero budgeting | Start each period/activity from zero; budget holder justifies every resource/activity | Challenges legacy spend, links resource to priority and can release waste | Time-consuming, conflict/political skill, may discourage long-term/intangible activity; useful when priorities/cost base need fundamental review |
| Potential benefit | Paired risk to manage |
|---|---|
| Financial discipline, efficiency and early problem detection | Data/assumption bias gives false precision; unstable markets reduce accuracy |
| Accountability and motivation | Unrealistic imposed targets cause gaming, short-termism, blame and demotivation |
| Coordination/resource prioritisation | Department competition, rigid limits and slow approval can block innovation/opportunity |
| Comparable performance record | Financial targets ignore quality, customer, people, sustainability and external causes |
Budget results should sit beside relevant non-financial measures. A hotel may meet a cost budget by understaffing while service, reviews and repeat bookings deteriorate. Review assumptions and behaviour as well as totals; use flexible budgets where activity differs materially from plan.
Zero budgeting means starting the justification from zero—not spending zero. A budget is a conditional plan, not a guaranteed forecast or a substitute for market/customer/quality judgement.
A variance compares actual with budget, then demands an explanation
A variance is the difference between actual and budgeted performance. Favourable (F) means the result improves the relevant financial outcome versus budget; adverse/unfavourable (A) means it worsens it. Always identify whether the line is revenue, cost or profit before labelling.
| Budget line | Favourable | Adverse |
|---|---|---|
| Revenue/sales | Actual > budget (more revenue) | Actual < budget |
| Cost/expenditure | Actual < budget (less cost) | Actual > budget |
| Profit | Actual > budget | Actual < budget |
Variance amount=∣actual−budget∣then label F or A from the budget line
Budget profit 2,000,000;actual250,000: difference = 1,750,000adverse.Budgetrevenue400m; actual 340m:difference=60m adverse. Budget labour cost 90,000;actual84,000: difference = $6,000 favourable—before judging why. Some schemes calculate actual − budget and others budget − actual; the sign convention may flip, but the F/A economic meaning must not.
| Variance | Possible causes to test |
|---|---|
| Favourable revenue/profit | Higher demand/price/volume, effective promotion, weaker competition, better mix/productivity or lower costs |
| Adverse revenue/profit | Lower demand/price/volume, competition, poor promotion/quality, disruption or higher costs |
| Favourable cost | Lower input price, less waste, efficiency—or lower output, understaffing, deferred maintenance/quality |
| Adverse cost | Higher input/wage/energy price, more output, waste/inefficiency, quality upgrade, emergency or unrealistic budget |
Investigate in order: (1) check data and original assumptions, (2) separate activity/volume from price/efficiency and one-off timing, using a flexible budget where appropriate, (3) judge materiality and whether the manager could control the cause, (4) trace quality/customer/employee/cash consequences and linked departments, (5) correct operations, reallocate resources or revise an unrealistic future budget, then monitor.
Variance analysis highlights exceptions, improves control/accountability, supports manager/centre comparison, reveals overspend/underperformance, guides corrective resource allocation and improves future budget assumptions. Focus attention on material, recurring and decision-relevant causes rather than every small difference.
A favourable variance is not automatically good: lower cost may reflect lower output, unsafe understaffing or lost quality. An adverse variance may fund growth or quality. The number is a signal to investigate—not a verdict on a manager.