2.2.4 - Budgets
Budgets matter because businesses have to set targets for spending and revenue before the period begins. In this lesson, you will learn what budgets are for, how historical figures and zero-based budgeting lead to different decisions, how variance analysis helps managers respond when performance changes, and why budgeting can also create problems. That gives you clear AO1 definitions, but also the analysis and judgement needed for explain and assess questions.
Purpose of budgets
Budget
A financial plan of income and expenditure prepared and agreed in advance.
A budget turns a broad business objective into a specific target. If managers want higher profit, they need planned figures for revenue and costs so they can decide what level of spending is acceptable and what performance is expected. In that sense, a budget is not just a spreadsheet; it is a control tool.
The main purpose of budgets is to help a business plan ahead and monitor performance. Managers can estimate how much money should be coming in, how much departments are allowed to spend, and where problems might appear. That matters because once targets are agreed, actual results can be compared with them later, making it easier to see whether the business is on track.
Budgets also improve coordination and communication. Different parts of the business can work from the same set of targets, so one department is less likely to make decisions that clash with another. They can also support delegation and motivation because budget holders know the level of spending or income they are responsible for achieving.
| Purpose | Why it matters |
|---|---|
| Planning | Managers can estimate future spending and revenue before decisions are made |
| Control and monitoring | Actual performance can be checked against the target later |
| Coordination | Departments work to linked targets rather than acting separately |
| Communication and motivation | Staff can see priorities and understand what they are expected to achieve |
Tesco plans major trading periods such as Christmas before customer demand is fully known. A clear budget helps store managers coordinate stock orders, staffing and spending limits, which reduces the risk of rushed decisions or unexpected overspending.
The chain of reasoning is straightforward: if budgets are set clearly, managers can make earlier and better-informed decisions; this improves control and coordination; therefore the business is more likely to use its resources effectively.
Historical figures and zero-based budgets
Businesses do not all build budgets in the same way. One common approach is to start with historical figures from a previous period. Another is to start from zero and justify spending from scratch. The difference matters because each method changes how easy it is to prepare the budget and how likely wasteful spending is to survive.
Historical budgeting
A budget based upon previous financial figures.
Historical budgeting is usually quicker because last year's budget or actual result becomes the starting point for this year's figure. Managers then make small adjustments for expected changes such as inflation or a known rise in demand. This saves time, but it can also roll forward inefficiency because departments may keep receiving money for activities that no longer add much value.
Zero based budget
A type of budget where no money is allocated for spending unless it has firstly been justified.
Zero-based budgeting is more demanding. Budget holders are effectively given a starting point of zero and must explain why each cost should be included. This can reduce unnecessary spending because managers cannot assume that last year's amount will be approved again. However, it is much more time-consuming and can be difficult to carry out across a large business every year.
The contrast is easiest to see side by side:
| Type of budget | Starting point | Main strength | Main limitation |
|---|---|---|---|
| Historical budgeting | Previous figures | Quick and simple to prepare | May allow waste and budget creep to continue |
| Zero-based budgeting | Zero, then justify each cost | Challenges unnecessary spending | Time-consuming and costly to prepare |
A business is not choosing between "easy" and "good". It is choosing between speed and scrutiny. A retailer such as Greggs might find historical figures useful for routine cost areas where spending is fairly predictable, but it may prefer a zero-based review for marketing or administration if managers want to challenge whether each cost still supports the business objective.
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