This document discusses budgets and variance analysis for managing a business. It defines a budget as a financial plan covering income and expenses. Variance analysis is the process of comparing actual budget outcomes to planned figures to identify favorable and unfavorable variances. The document provides examples of calculating variances for income, expenses, and profit budgets and interpreting the variances to understand factors that led to differences from the planned budget.

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.