Budgets: purposes and types

Types of budget

• Income (revenue) budget: the sales revenue each department or product is expected to earn.
• Expenditure budget: the maximum each department may spend on items such as wages and materials.
• Profit budget: budgeted income minus budgeted expenditure.

Budgets are usually set for a year and broken down by month.

Why budget

• Planning: forces managers to think ahead and set targets that support the firm's objectives.
• Control: spending is limited and actual results compared with the budget (variance analysis).
• Coordination: departments work to consistent plans; production budgets match the sales budget.
• Motivation and responsibility: managers who hold a budget are accountable for it, and agreed targets can motivate.
• Allocating resources: money goes where it supports objectives.

Setting budgets: historical or zero based

• Historical (incremental) budgeting: start from last year's figures and adjust, for example +3% for inflation. Quick, simple and realistic, but repeats past inefficiencies, does not question whether spending is still needed and encourages managers to spend their whole budget so it is not cut next year.
• Zero-based budgeting: every budget starts at zero and each item must be justified from scratch. It removes waste and links spending to current priorities, but it is time-consuming, needs skilled managers and may cause conflict between departments competing for funds.

Worked example

A marketing department spent $80,000 last year. Under historical budgeting with a 5% uplift, what is next year's budget? How would zero-based budgeting differ?

1. Historical: 80,000 x 1.05 = $84,000
2. Zero based: the manager starts from $0 and must justify each campaign, for example $30,000 online advertising and $20,000 for a trade show, with evidence of the return each is expected to bring.

Answer: $84,000 under historical budgeting; under zero-based budgeting the total depends on what can be justified.

Check yourself

1. Last year's staffing budget was $240,000. The new budget allows for a 4% pay rise. Calculate the new budget.
   Show answer

   $249600. 240,000 x 1.04 = $249,600.

2. A store budgets income of $520,000 and expenditure of $465,000. Calculate the budgeted profit.
   Show answer

   $55000. 520,000 - 465,000 = $55,000.

3. A firm's total expenditure budget is $1.2 million. The IT department is allocated $90,000. What percentage of the total is that?
   Show answer

   7.5 %. 90,000 / 1,200,000 x 100 = 7.5%.

4. In zero-based budgeting,
   • the budget is last year's figure plus inflation
   • every item of spending must be justified from scratch
   • no spending is allowed
   • budgets are set by the government
   Show answer

   every item of spending must be justified from scratch. Each item starts at zero.

5. A disadvantage of historical budgeting is that it
   • takes far longer than zero-based budgeting
   • ignores past figures
   • requires every manager to justify every item
   • can repeat past waste because spending is not questioned
   Show answer

   can repeat past waste because spending is not questioned. It builds on last year, inefficiencies included.

6. How can budgets motivate managers?
   • Budgets remove the need for targets
   • Managers who agree their budget feel responsible for meeting it
   • Budgets guarantee bonuses
   • Budgets stop managers making decisions
   Show answer

   Managers who agree their budget feel responsible for meeting it. Ownership of targets encourages effort.

7. Explain one advantage of zero-based budgeting.
   Show answer

   Because every item must be justified, wasteful or unnecessary spending is removed and money is allocated to current priorities.. It removes waste and links spending to current priorities.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.