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Budgeting
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Teaching Business
Budgeting
A complete guide to budgeting — covering budget setting, budgeted and actual figures, favourable and adverse variances, cost control and how businesses use budgets to support planning.
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Created by an experienced Head of Business and examiner
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AQA | Edexcel | Cambridge | Eduqas | WJEC | OCR | GCSE
KEY POINTS
A budget is a financial plan that sets expected income, costs or spending over a future period.
Budgets help businesses plan ahead and allocate resources more effectively.
Budgeting allows managers to compare expected performance with actual results.
A variance is the difference between a budgeted figure and an actual figure.
A favourable variance improves the financial position of the business.
An adverse variance worsens the financial position of the business.
Budgets can help control costs, improve accountability and support decision-making.
Budgets may become less useful if they are based on inaccurate forecasts or if market conditions change.
KEY DEFINITION
Budgeting
Budgeting is the process of setting financial targets for future income, costs or spending and then comparing actual performance against those targets.
Main Explanation
A budget is a financial plan that estimates future income, costs or spending. Businesses use budgets to help plan ahead, control costs and make better financial decisions. For example, a business may set a sales budget, marketing budget, production budget or labour cost budget.
Budgeting is important because it gives managers a clear target to work towards. If a department is given a budget, managers can monitor whether spending is staying under control. This can help the business avoid unnecessary costs and make better use of limited resources.
A key part of budgeting is comparing budgeted figures with actual results. The difference between the two is called a variance. Variance analysis helps managers identify where performance is better or worse than expected. For example, if actual sales revenue is higher than budgeted revenue, this is usually favourable. If actual costs are higher than budgeted costs, this is usually adverse.
Budgets can also improve accountability. Managers may be responsible for keeping their department within budget, which can encourage more careful spending. However, budgets are only useful if they are realistic. If a budget is based on inaccurate forecasts, outdated information or unrealistic assumptions, it may lead to poor decisions.
Budgeting is closely linked to business planning and control. It helps businesses prepare for the future, but managers must regularly review budgets and adjust them when conditions change.
✎ EXAMINER TIP
Students often confuse favourable and adverse variances. Always consider whether the variance improves or worsens the financial position of the business. Higher revenue than budgeted is favourable, but higher costs than budgeted are adverse.
KEY FORMULAS(s)
Profit and Profitability Formulas
These key formulas help you calculate different profit measures and profitability ratios used in business.
Gross Profit
Gross profit = Revenue − Cost of sales
The profit made after deducting direct costs.
!
Remember: profit shows how much money has been made, while profitability shows how efficiently revenue is being turned into profit.
DATA TABLE
Income Statement for North Coast Coffee Ltd
This statement shows how revenue is converted into gross profit, operating profit and net profit.
Revenue
£250,000
Output
Fixed Costs
Variable Costs
Total Costs
Revenue
Profit / Loss
0 candles £1,200 £0 £1,200 £0 -£1,200
Net profit is the final profit remaining after all costs and expenses have been deducted from revenue.
WORKED EXAMPLE
Worked Example: North Coast Coffee
How many coffees must be sold to break even?
Fixed Costs
£1,800
equity + long-term debt
Break-even output = Fixed costs ÷ Contribution per unit
Contribution per unit = Selling price − Variable cost
£3.50 − £1.10 = £2.40
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Step 1: Calculate contribution
£3.50 − £1.10 = £2.40
Contribution per unit is the amount each coffee contributes towards fixed costs.
BREAK-EVEN OUTPUT:
750 coffees per month
EXAM TIP
Always explain what the number means for the business. Do not just calculate the break-even point.
The Typical Budgeting Cycle
APPLICATION
Gymshark
Gymshark is a UK fitness clothing brand that sells gym wear and activewear to customers in the UK and overseas. The business needs to budget carefully for stock, marketing, staff, website operations, warehouses and retail stores.
If Gymshark launches a new clothing range, managers may set a budget for production, advertising and influencer promotion. At the end of the campaign, they can compare the budgeted figures with the actual results. If marketing spending was higher than planned, managers would need to decide whether the extra cost helped increase sales enough to justify the variance.
This makes budgeting useful because it helps Gymshark plan ahead, control spending and judge whether business decisions have improved performance.
This independent educational case study is not affiliated with, endorsed by or sponsored by Greggs plc. Any financial figures used alongside this example should be treated as simplified or hypothetical estimates created for teaching purposes.
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ANALYSIS
EXAM FOCUS
Analysis questions require you to examine a business concept or issue in detail, breaking it down into its component parts. You should explain how and why something happens and consider its impact on the business.
How to Approach Analysis Questions
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Identify the key issue or concept
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Break it down
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Explain how and why
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Reach a reasoned conclusion
Read the question carefully and highlight the focus of the analysis.
Consider the different factors, causes or impacts related to the issue.
Provide clear explanations using business terms and links points to context.
Evaluate the overall implications for the business.
Example Analysis Question
North Coast Coffee is considering using break-even analysis before opening a second café.
Advantages
• Sales forecasts may be inaccurate.
• Assumes costs and revenue remain constant.
• External factors may reduce reliability.
• Ignores qualitative business factors.
Disadvantages
• Sales forecasts may be inaccurate.
• Assumes costs and revenue remain constant.
• External factors may reduce reliability.
• Ignores qualitative business factors.
Key Exam Tip
If you find it difficult to expand your answer and show the type of depth that an examiner is looking for in a top response, consider using the 'so what' approach.
Tesco carry out market research - so what? - this allows them to better understand customer needs - so what? as a result Tesco can provide goods more likely to sell - so what? - this will increase Tesco profit and ensure higher levels of customer satisfaction - so what? this means that customers are likely to become more loyal to Tesco.
Avoid These Exam Traps
Students often lose marks on calculation and analysis questions by making these mistakes. Watch out for them in your exam!
1
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Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
2
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
3
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Tip:
Helvetica Light is an easy-to-read font, with tall and narrow letters, that works well on almost every site.
Be precise. Read the question carefully. Show your working.
Small mistakes can cost big marks.
EXAM PRACTICE
Practice Question
Apply your knowledge of profit and profitability to answer this exam-style question.
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MINI CASE STUDY
North Coast Coffee Ltd is a premium coffee business which sells freshly roasted coffee beans through its online store and a small chain of independent cafés. The business has experienced strong sales growth due to increasing demand for high-quality speciality coffee products.
The business generates annual revenue of £250,000. Its cost of sales, including coffee beans, packaging and direct production costs, totals £100,000. North Coast Coffee Ltd also faces operating expenses of £80,000, including marketing, employee wages, rent and administration costs. In addition, the business pays £20,000 in interest and taxation each year.
The owner, Mia Thompson, is reviewing the company’s profitability because rising wage costs and increased competition in the premium coffee market have started to place pressure on operating profit margins. She is considering increasing prices slightly in order to protect profitability while still maintaining customer demand.
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EXAM QUESTION
Analyse the possible reasons for BrightBite’s falling profit margins and evaluate strategies it could use to improve profitability.
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HOW TO ANSWER
P
Point
E
Explain
A
Apply
C
Consequence
H
However...
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MODEL ANSWER
P
Point
Increasing prices could improve the profitability of North Coast Coffee Ltd because each sale would generate a larger amount of revenue and potentially increase profit margins.
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EXAMINER TIP
For full marks, make sure you analyse causes rather than just listing them, and evaluate realistic strategies with clear judgement. THINK: Which strategy would have the biggest impact and why?
CALCULATOR
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Budgeting
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