Budgets and Variances (Edexcel 9BS0 2.2.3)
A budget is a financial plan that sets targets for revenue and costs over a defined period. This topic asks you to calculate adverse and favourable variances, compare historical budgeting with zero-based budgeting, and judge whether budgets help or hinder a business — a favourite Paper 2 assessment angle.
Why businesses budget, and how budgets are set
Budgets turn strategy into numbers. They force managers to plan ahead, allocate scarce cash between departments, set targets that can motivate staff, and create accountability because a named budget holder answers for each figure. Delegating budgets to branch or department level can also speed up decisions and develop junior managers.
Edexcel expects two methods of setting them:
- Historical budgeting takes last year’s figure and adjusts it, often for inflation. It is quick and cheap but rolls forward old inefficiencies — a department that overspent last year is rewarded with a bigger allowance.
- Zero-based budgeting starts every line at zero and makes managers justify each pound from scratch. It exposes waste and suits fast-changing markets, but it eats management time and can trigger internal battles over resources.
Most large UK firms mix the two: zero-based reviews every few years, historical adjustment in between.
Variance analysis: the calculations
A variance is the difference between a budgeted figure and the actual outcome. It is adverse when the difference reduces profit and favourable when it increases profit — the labels describe the effect on profit, not whether the number went up or down.
Worked example for one quarter:
| Item | Budget | Actual | Variance |
|---|---|---|---|
| Revenue | £80,000 | £74,000 | £6,000 adverse |
| Total costs | £50,000 | £47,500 | £2,500 favourable |
| Profit | £30,000 | £26,500 | £3,500 adverse |
The profit variance is the two effects combined: £6,000 adverse less £2,500 favourable = £3,500 adverse. Real firms live this constantly — B&M, the discount retailer, trimmed its 2024/25 profit guidance to £605m–£625m in February 2025 after trading came in below budget, and its share price fell sharply on the day of the announcement — a reminder that investors read variances as a signal of management control.
Interpreting variances and the limits of budgeting
Calculating a variance earns low-level marks; explaining it earns the rest. An adverse revenue variance might reflect a competitor’s price cut, poor weather or an over-optimistic budget in the first place. A favourable cost variance is not automatically good news — it may mean cheaper ingredients that damage quality, or an understaffed shop floor that drives customers away.
Budgets themselves carry drawbacks worth using in evaluation:
- They date quickly: energy and wage costs moved so fast in 2024–25 that annual budgets needed mid-year rewrites.
- Unrealistic targets demotivate rather than motivate staff.
- Managers may spend an unused allowance in March simply to protect next year’s budget.
- Rigid adherence can starve a sudden opportunity of funds.
The examined judgement is usually the same: budgets are valuable as a planning and control discipline, provided they are revised when conditions change and variances trigger questions rather than blame.
Key terms
Practice questions
A firm budgeted revenue of £80,000 and costs of £50,000. Actual revenue was £74,000 and actual costs £47,500. Calculate the profit variance and state whether it is adverse or favourable. [4 marks]
Model answer guidance: Budgeted profit = £80,000 − £50,000 = £30,000. Actual profit = £74,000 − £47,500 = £26,500. Profit variance = £3,500 adverse. Alternatively: £6,000 adverse revenue variance less £2,500 favourable cost variance = £3,500 adverse. State the label — a number alone is incomplete.
Explain one benefit of zero-based budgeting for a business operating in a fast-changing market. [4 marks]
Model answer guidance: Identify that every line must be justified from scratch, then develop: spending that made sense last year — for example printed catalogues — is challenged rather than rolled forward, so cash is redirected to what the market now rewards, keeping the cost base matched to current demand rather than history.
Discuss whether a favourable cost variance is always good news for a retailer. [8 marks]
Model answer guidance: For: costs below budget lift profit directly and may show efficient buying or lower wastage. Against: the saving may come from cheaper stock that raises returns and complaints, understaffing that lengthens queues, or postponed maintenance that stores up bigger bills. Conclude that the source of the variance decides its meaning, so managers must investigate before celebrating.
Assess the value of variance analysis to a UK retailer facing rising labour costs. [10 marks]
Model answer guidance: Value: monthly variances reveal quickly where wage inflation is biting, letting managers adjust rotas, prices or targets before year-end, and giving evidence for revising budgets. Limits: variance analysis reports the past, cannot itself control an economy-wide wage rise, and an adverse variance caused by the National Living Wage is outside a branch manager's control, so blaming budget holders would demotivate. Judgement: useful as an early-warning system, weak as a cure.
Assess whether the benefits of setting budgets outweigh the drawbacks for a rapidly growing private limited company. [12 marks]
Model answer guidance: Benefits: growth burns cash, so budgets ration it between competing projects, impose discipline on new hires and reassure lenders. Drawbacks: forecasts date fast when revenue doubles, rigid budgets can choke the very opportunities driving growth, and founders' time spent budgeting has a high opportunity cost. A balanced judgement: budgets outweigh their drawbacks if reviewed frequently — quarterly rolling budgets suit fast growth better than a fixed annual plan.
Examiner tips
- Label every variance adverse or favourable by its effect on profit — costs below budget are favourable even though the number fell.
- When a case study shows an adverse variance, offer two possible causes and say which the evidence supports; single-cause answers stay mid-level.
- Know one real example of a company revising guidance against budget (B&M in February 2025) to add weight to evaluation on why budgets must be updated.
In The Business School simulation your students make these exact decisions in a live market against rival firms — every choice mapped to the specification. Free teacher demo, no installs, students join with a PIN.