1. Unit 2: Managing a business
Finance
What is a budget?
A financial plan covering income and expense
This unit is about using budgets is studied.
How can budgeting help the business to improve its performance?

2. Unit 2: Managing a business
Finance
Benefits and drawbacks
of using budgets
Benefits
• They provide direction and coordination.
• They can motivate staff.
• They improve efficiency.
• They encourage careful planning.
Drawbacks
• They are difficult to monitor fairly.
• Allocations may be incorrect and unfair.
• Savings may be sought that are not in the interests of the firm.
• They may be inflexible.

3. Unit 2: Managing a business
Finance
Features of good budgeting
A good budget should:
• be consistent with the aims of the business
• be based on the opinions of as many people as possible
• set challenging but realistic targets (be SMARTA)
• be monitored at regular intervals
• be flexible

4. Unit 2: Managing a business
Finance
Variance analysis
variance analysis: the process by which the outcomes of budgets are examined
and then compared to the budgeted figures. The reasons for any differences
(variances) are then found.
favourable variance: when costs are lower than expected or revenue is higher
than expected.
adverse (unfavourable) variance: when costs are higher than expected or
revenue is lower than expected.

5. Unit 2: Managing a business
Finance
Calculating variances
A variance is calculated by the following formula:
variance = budget figure – actual figure
For variance analysis, use ‘F’ for favourable variances and ‘A’ for adverse variances,
rather than positive or negative numbers.
A favourable variance would happen when:
• actual income is greater than budgeted income
• actual costs are below budgeted costs
An adverse (or unfavourable) variance would be shown when:
• actual income is less than budgeted income
• actual costs are above budgeted costs

6. Unit 2: Managing a business
Finance
Calculating variances: the golden rule
The golden rule: knowing the effect a variance has on profit tells you whether it is
favourable or adverse.
A favourable variance will mean more profit than expected.
An adverse variance will mean less profit than expected.

7. Unit 2: Managing a business
Finance
Example variance calculation:
income budget
Income budget for XYZ Ltd, April 2009
Source of
income
Budgeted
income (£)
Actual income
(£)
Variance (£) F/A
Product A 7,500 7,600 100 F
Product B 6,000 5,700 300 A
Total income 13,500 13,300 200 A

8. Unit 2: Managing a business
Finance
Example variance calculation:
expenditure budget
Expenditure budget for XYZ Ltd, April 2009
Item of
expenditure
Budgeted
expenditure
(£)
Actual
expenditure
(£)
Variance (£) F/A
Raw materials 2,700 2,500 200 F
Labour costs 2,400 2,450 50 A
Administration
and other costs
4,500 4,500 0 –
Total
expenditure
9,600 9,450 150 F

9. Unit 2: Managing a business
Finance
Example variance calcualtion:
profit budget
Profit budget for XYZ Ltd, April 2009
Item of
income/
expenditure
Budgeted
profit (£)
Actual profit
(£)
Variance (£) F/A
Total income 13,500 13,300 200 A
Total
expenditure
9,600 9,450 150 F
Budgeted profit 3,900 3,850 50 A

10. Unit 2: Managing a business
Finance
Interpreting the variances
1 What factors might have caused the variances for XYZ Ltd?
In small groups find:
a Two factors WITHIN the business that might have led to the variances in
the INCOME budget.
b One factor OUTSIDE the business that might have led to the variances in
the INCOME budget.
c Two factors WITHIN the business that might have led to the variances in
the EXPENDITURE budget.
d One factor OUTSIDE the business that might have led to the variances in
the EXPENDITURE budget.
2 Suggest two actions the business might take to improve matters.

11. Unit 2: Managing a business
Finance
Interpreting the variances:
answers
Possible answers include:
1a
• Successful marketing of product A.
• Low-quality production of product B.
1b
• Adverse media publicity concerning product B.
1c
• Efficient production methods, leading to lower wastage of raw materials.
• Workers being given a wage rise that was higher than expected.
1d
An unexpected shortage of raw materials, leading to higher prices being charged by suppliers.
2
• Introduce new quality assurance measures for product B.
• Investigate alternative suppliers or different raw materials.

12. Unit 2: Managing a business
Finance
Calculating variance: income budget
Complete the variance analysis for XYZ Ltd’s income budget.
The budgeted income column has been provided.
Actual income for XYZ’s two products were:
• product A: 3,000 units were sold at a price of £2.70
• product B: 6,400 units were sold at a price of £1.25
Income budget for XYZ Ltd, May 2009
Source of income Budgeted
income (£)
Actual income
(£)
Variance (£) F/A
Product A (3,200 x £2.50) 8,000
Product B (6,000 x £1.30) 7,800
Total income 15,800

13. Unit 2: Managing a business
Finance
Calculating variance:
expenditure budget
Complete the variance analysis for XYZ Ltd’s expenditure budget.
The budgeted expenditure column has been provided.
Actual expenditure was as follows:
• Raw materials were 25% of the actual income.
• Labour costs were 25p per unit (9,400 × 25p).
• Administration and other costs were £4,200.

14. Unit 2: Managing a business
Finance
Expenditure budget for XYZ Ltd, May 2009
Item of expenditure Budgeted
expenditure
(£)
Actual
expenditure
(£)
Variance (£) F/A
Raw materials (25% of
£15,800)
3,950
Labour costs (9,200 x 25p) 2,300
Administration and other
costs
4,600
Total expenditure 10,850

15. Unit 2: Managing a business
Finance
Calculating variance: profit budget
Complete the variances for XYZ Ltd’s profit budget, based on your variances
for the income and expenditure budgets.
Profit budget for XYZ Ltd, May 2009
Item of
income/
expenditure
Budgeted
profit (£)
Actual profit
(£)
Variance (£) F/A
Total income 15,800
Total
expenditure
10,850
Budgeted profit 4,950

16. Unit 2: Managing a business
Finance
Income budget: answers
Income budget for XYZ Ltd, May 2009
Source of income Budgeted
income (£)
Actual income
(£)
Variance (£) F/A
Product A (3,200 x £25) 8,000 8,100 100 F
Product B (6,000 x £13) 7,800 8,000 200 F
Total income 15,800 16,100 300 F

17. Unit 2: Managing a business
Finance
Expenditure budget: answers
Expenditure budget for XYZ Ltd, May 2009
Item of expenditure Budgeted
expenditure
(£)
Actual
expenditure
(£)
Variance (£) F/A
Raw materials (25% of
£15,800)
3,950 4,025 75 A
Labour costs (9,200 x 25p) 2,300 2,350 50 A
Administration and other
costs
4,600 4,200 400 F
Total expenditure 10,850 10,575 275 F

18. Unit 2: Managing a business
Finance
Profit budget: answers
Profit budget for XYZ Ltd, May 2009
Item of
income/
expenditure
Budgeted
profit (£)
Actual profit
(£)
Variance (£) F/A
Total income 15,800 16,100 300 F
Total
expenditure
10,850 10,575 275 F
Budgeted profit 4,950 5,525 575 F

19. Unit 2: Managing a business
Finance
Interpreting the variances
What were the main factors that led to the variance in XYZ’s profit for May
2009?
Possible answers are:
• The price increase for product A led to a small fall in demand, which led to sales
revenue increasing. (Lower volume would also have saved on variable costs.)
• The price cut for product B led to a significant rise in demand and an increase in
income (but a rise in variable costs too).
• There was a major cut in administration costs of almost 10%.
• Although variable costs rose per unit produced, they were the same as the
budget.
Conclusion: the main reason for the favourable variance in profit was the significant
saving in administration and other costs. The price changes of both products also
helped to boost income.