1 MEANING of MASTER BUDGET: The master budget is the aggregation of all lower-level budgets produced by a company's various functional areas, and also includes budgeted financial statements, cash forecast, and a financing plan. The master budget is typically presented in either a monthly or quarterly format, or usually covers a company's entire fiscal year. An explanatory text may be included with the master budget, which explains the company's strategic direction, how the master budget will assist in accomplishing specific goals, and the management actions needed to achieve the budget. There may also be a discussion of the headcount changes that are required to achieve the budget. A master budget is the central planning tool that a management team uses to direct the activities of a corporation, as well as to judge the performance of its various responsibilities . It is customary for the senior management team to review a number of iterations of the master budget and incorporate modifications until it arrives at a budget that allocates funds to achieve the desired results. Hopefully, a company uses participative to arrive at this final budget, but it may also be imposed on the organization by senior management, with little input from other employees. A master budget is an expensive business strategy that documents expected future sales, productions levels, purchases, future expenses incurred, capital investments, and even loads to be acquired and repaid. In other words, the master budget includes all other financial budgets as wells as a budgeted income statement and balance sheet. The master budget is basically management's strategic plan for the future of the company. Every aspect of the company operations is charted and documented for future predictions. The master
Transcript
1
MEANING of MASTER BUDGET:
The master budget is the aggregation of all lower-level budgets produced by a company's various functional areas, and also includes budgeted financial statements, cash forecast, and a financing plan. The master budget is typically presented in either a monthly or quarterly format, or usually covers a company's entire fiscal year. An explanatory text may be included with the master budget, which explains the company's strategic direction, how the master budget will assist in accomplishing specific goals, and the management actions needed to achieve the budget. There may also be a discussion of the headcount changes that are required to achieve the budget.
A master budget is the central planning tool that a management team uses to direct the activities of a corporation, as well as to judge the performance of its various responsibilities. It is customary for the senior management team to review a number of iterations of the master budget and incorporate modifications until it arrives at a budget that allocates funds to achieve the desired results. Hopefully, a company uses participative to arrive at this final budget, but it may also be imposed on the organization by senior management, with little input from other employees.
A master budget is an expensive business strategy that documents expected future sales,
productions levels, purchases, future expenses incurred, capital investments, and even loads to be
acquired and repaid. In other words, the master budget includes all other financial budgets as
wells as a budgeted income statement and balance sheet.
The master budget is basically management's strategic plan for the future of the company. Every
aspect of the company operations is charted and documented for future predictions. The master
budget is used by the company management and the officers to make strategic "big picture"
decisions about long-term strategy as well as current year forecasting.
A good example of long term planning is a merger or acquisition of another company.
Management must look at what the company can gain by purchasing another company and what
resources would be redundant. For instance, every company has a group of employees in charge
of the administrative duties within the company. If a company was purchased, there would no
need to keep two sets of administrative staff. The management of the acquiring company would
have to make a decision that should be let go.
Management can also use the master budget for expansion planning. For instance, a machine
shop should consider current cash flows, current loan rates, current debt limits, and future
expected sales before management plans a large expansion.
2
DEFINITION of MASTER BUDGET:
“It is an integrated set of operating and
financial projections for a given period (e.g., a forthcoming calendar or fiscal year). A master budget
consists of operating and financial budgets. Operating budgets are budgets for functional areas such
as production, marketing, customer service, human resources, research and development; they
provide the budgeted income statement. The financial budget includes cash budget, capital budget,
budgeted balance sheet, and budgeted cash flows.”
3
MAJOR COMPONENTS of MASTER BUDGET:
A master budget is the financial document used for projecting the income and expenses of a company, as opposed to a division, product, or other area of a business. From the master budget, a small-business owner can develop a variety of reports to help set specific goals for the business. The major components of a master budget include income and expenses, overhead and production costs, and the monthly, annual, average, and projection totals. The following explained are the major components of master budget given below but Master Budget has two types of components i.e. Operational Budget and Financial Budget.
4
EXPENSES:
The other main component of a master budget is expenses. Many small-business owners create sub-components of their master budget expenses to help calculate spending areas they can cut during slow times, or to help calculate production and overhead costs. After you’ve listed all of your expected expenses for the year, label each as a fixed or variable cost. A fixed cost is one you can’t easily change from month to month, such as your rent, insurance premium, loan payment or copier lease. You will be more likely to be able to cut variable expenses if you’re short on cash, because many of these are discretionary. Designate recurring variable expenses you can’t easily cut, such as utilities, phone bills or labor, differently than variable expenses you can’t modify, so you can quickly find places to cut when the need arises. To create a flexible budget, use formulas that change your discretionary spending based on your income.
OVERHEAD AND PRODUCTION:
Once you complete a master budget, break out your production and overhead costs to help with pricing your product or service. Identify costs directly tied to making each unit or delivering each service. Depending on the type of business, these costs might include machinery, materials, extra energy, or labor. Mark these as production costs. Identify non-production costs, such as marketing, phones, office supplies, and general and administrative costs, and mark these as overhead expenses.
TOTALS:
A common component of a master budget is the "Total" function, which shows you how you are doing each month and for the year. You can total your income and expenses by month to show your net income or loss each month. You can also total your income and expense by category to see how a particular area of your company is performing. Using totals to track your monthly income and expenses will help you manage your cash flow better if you prepare a separate budget that shows when bills are due and when income is expected, rather than using monthly averages. For example, instead of dividing your insurance premium costs by 12 and putting the average in each month’s expenses, enter insurance premium payments only in the months they are due.
5
PROJECTIONS:
A helpful component of many budgets is the projection total column, which shows you how you’ll end the year if you continue performing at your current levels of income and spending. These can be skewed if you have large expense or income amounts early in the year. Looking at your performance for a particular month usually isn’t a realistic indicator of your overall performance, because you will have more bills come due in some months. Periods of higher bills can include the beginning of the year when fees are due, dates when quarterly insurance premiums or taxes are due, or times when you have seasonal sales peaks and valleys. Averaging your monthly income and expenses can help you project your annual performance if you don’t have seasonal swings and your expenses are fairly steady.
SALES BUDGET:
Sales budget is the first and basic component of master and it shows the expected number of sales units of a period and the expected price per unit. It also shows total sales which are simply the product of expected sales units and expected price per unit. Sales Budget influences many of the other components of master budget either directly or indirectly. This is due to the reason that the total sales figure provided by sales budget is used as a base figure in other component budgets.
For example the schedule of receipts from customers, the production budget, pro forma income statement, etc.
Due to the fact that many components of master budget rely on sales budget, the estimated sales volume and price must be forecasted with sufficient care and only reliable forecast techniques should be employed. Otherwise the master budget will be rendered ineffective for planning and control.
Format of Sales Budget.
Where the price per unit is expected to remain constant during the period for all units in sales, the sales budget format will be simple as shown below.
Company ASales BudgetFor the Year Ending December 30, 2010
Total Sales $120,120 $87,768 $106,991 $197,792 $51271
However if a business sells more than one product having different prices or the price per unit is expected to change during the period, its sales budget will be detailed.
PRODUCTION BUDGET:
Production budget is a schedule showing planned production in units which must be made by a manufacturer during a specific period to meet the expected demand for sales and the planned finished goods inventory. The required production is determined by subtracting the beginning finished goods inventory from the sum of expected sales and planned ending inventory of the period. Thus:
Planned Production in Units= Expected Sales in Units+ Planned Ending Inventory in Units− Beginning Inventory in UnitsProduction budget is prepared after budget since it needs the expected sales unit’s figure which is provided by the sales budget. It is important to note that only a manufacturing business needs to prepare the production budget.
Format and Example.
The following example illustrates the production budget format. The expected sales units are obtained from the sales budget of Company A. The planned ending units of 1st, 2nd and 3rd period are the beginning units in 2nd, 3rd and 4th period respectively.
Company A
Production Budget
For the Year Ending December 30, 2010
7
1 2 3 4 Year
Budgeted Sales Units 1,320 954 1,103 1,766 5,143
+ Planned Ending Units 210 168 213 225 225
− Beginning Units −196 −210 −168 −213 −196
Planned Production in Units 1,334 912 1,148 1,778 5,172
FACTORY OVERHEAD BUDGET:
The factory overhead budget shows all the planned manufacturing costs which are needed to produce the budgeted production level of a period, other than direct costs which are already covered under direct material budget and direct labor budget. The overhead budget is an operational budget contained in the master budget of a business. It has two sections, one for variable overhead costs and other for fixed overhead costs.Total variable overhead may be calculated as the product of estimated variable cost per unit (also called variable overhead rate) and the budgeted production units (obtained from production budget). However most businesses will prefer to prepare a detailed overhead budget showing individual variable costs such as electricity, fuel, supplies etc.. The fixed overhead costs are calculated as the sum of individual fixed overhead costs for example rent, depreciation, etc. which are planned for the period.
Format and Example.
The following example illustrates the format of a simple overhead budget. The variable overhead per unit of Company A during the first, second, third and fourth quarter is estimated to be $12, $15, $16 and $19 respectively. The production unit’s figures are obtained from the production budget of the company. The company expects to incur monthly depreciation of $3,000 and monthly rent of $2,500. There are no other fixed costs.
Company AFactory Overhead BudgetFor the Year Ending December 30, 2010
Cash Disbursements for FOH $23,508 $21,180 $25,868 $41,282 $111,838
DIRECT LABOUR BUDGET:
Direct labor budget shows the total direct labor cost and number of direct labor hours needed for production. It helps the management to plan its labor force requirements. Direct labor budget is a component of master budget. It is prepared after the preparation of production budget because the budgeted production in units figure provided by the production budget serves as starting point in direct labor budget.
Following are the calculations involved in the direct labor budget:
Planned Production in units× Direct Labor Hours Required per Unit= Budgeted Direct Labor Hours Required× Cost per Direct Labor Hours= Budgeted Direct Labor Cost
Format and Example
Following is an example showing a simple direct labor budget format. The planned production figures are obtained from the production budget of Company A.
9
Company A
Direct Material Purchases Budget
For the Year Ending December 30, 2010
1 2 3 4 Year
Planned Production in Units 1,334 912 1,148 1,778 5,172
× Direct Labor Hours per Unit 3.5 3.5 3.5 3.5 3.5
Budgeted Direct Labor Hours 4,669 3,192 4,018 6,223 18,102
× Cost per Direct Labor Hour $4 $5 $5 $5
Budgeted Direct Labor Cost $18,676 $15,960 $20,090 $31,115 $85,841
COST OF GOODS MANUFACTURED BUDGET:
Cost of goods manufactured budget is an operational component of master budget. It is prepared to calculate the manufacturing costs that are expected to be incurred on budgeted finished goods. The cost of goods manufactured budget is based on direct material purchases budget, direct labor cost budget and factory overhead budget. The figures from direct labor budget and overhead budget are directly used in the preparation of cost of goods manufactured budget but the direct material purchase cost needs to be adjusted as shown below:
Direct Material Purchases+ Direct Material Beginning Inventory− Direct Material Ending Inventory= Cost of Direct Material Used in Production
The next step is to calculate the budgeted cost of goods manufactured as follows:
Cost of Direct Material used in Production+ Direct Labor Cost+ Factory Overhead Cost= Manufacturing Cost+ Beginning Work in Process− Ending Work in Process= Cost of Goods Manufactured.
SELLING AND ADMINISTRATIVE EXPENCE BUDGET:
10
Selling and administrative expense budget is a schedule of planned operating expenses other than manufacturing costs. It is a component of master and it is prepared by all types of businesses (i.e. manufacturers, retailers and service providers) before the preparation of budgeted income statement. Usually it is divided in two sections: the selling expenses and the administrative expenses.
Both selling expenses and administrative expense may be fixed or variable (see cost behavior). For example sales commission and freight cost on sales are variable selling expenses where as sales salaries are fixed selling expenses. Similarly depreciation and rent on office building are fixed administrative expenses whereas office supplies and utilities expense are variable administrative expenses.
Different variable selling and administrative expenses vary with different types activities. For example sales commission vary with number of units sold, entertainment expenses with number of employees in the organization etc., therefore an accurate selling and administrative expenses budget can be made by using activity based costing.
Format and Example.
The following example illustrates the format of a typical selling and administrative expense budget:
Company ASelling and Administrative Expense BudgetFor the Year Ending December 30, 2010
SCHEDULE for EXPECTED CASH COLLECTIONS: Schedule of expected cash collections from customers shows the budgeted cash collections on sales during a period. It is a component of master budget and it is prepared after the preparation of sales budget and before the preparation of cash budget.
The calculation of expected cash collections is based on the total sales figure obtained from sales budget. The management estimates the proportion in which sales are expected to be collected in the current and following periods. This is used to determine how much sales are expected to be collected during a period.
Format and Example
The master budget of Company A continues here with the preparation of schedule of expected cash collections. The sales figures are obtained from the sales budget of the company. 70% of sales are expected to be collected in the quarter in which sales are made and the rest are expected to be collected in the next period. Bad debts are negligible.
a) Q1 Sales = $120,120
Collections in Q1 = $120,120 × 70% = $84,084; Collections in Q2 = $120,120 × 30% = $36,036
b) Q2 Sales = $87,768
Collections in Q2 = $87,768 × 70% = $61,438; Collections in Q3 = $87,768 × 30% = $26,330
c) Q3 Sales = $106,991
Collections in Q3 = $106,991 × 70% = $74,894; Collections in Q4 = $106,991 × 30% = $32,097
d) Q4 Sales = $197,792
Collections in Q4 = $197,792 × 70% = $138,454.
12
Company A
Schedule of Expected Cash Collections
For the Year Ending December 30, 2010
1 2 3 4 Year
Beginning AR $62,130 $62,130
Quarter 1 Sales (a) 84,084 $36,036 120,120
Quarter 2 Sales (b) 61,438 $26,330 87,768
Quarter 3 Sales (c) 74,894 $32,097 106,991
Quarter 4 Sales (d) 138,454 138,454
Total Collections $146,214 $97,474 $101,224 $170,551 $515,463
BUDGETED INCOME STATEMENT: The budgeted income statement contains all of the line items found in a normal income statement, except that it is a projection of what the income statement will look like during future budget periods. It is compiled from a number of other budgets, the accuracy of which may vary based on the realism of the inputs to the budget model. The budgeted income statement is extremely useful for testing whether the projected financial results of a company appear to be reasonable. When used in combination with the budgeted balance sheet, it also reveals scenarios that are not financially supportable (such as requiring large amounts of debt), which management can remedy by altering the underlying budget assumptions.
Example of the Budgeted Income Statement
The following is an example of a budgeted income statement:
13
Very Large CorporationBudgeted Income Statement for the Year Ended December 31, 20XX
Line Item Source Budget Amount
Net sales Sales budget $10,000,000
Less: cost of goods sold(Cost in the ending F/G* inventory budget)
BUDGETED BALANCE SHEET STATEMENT: The budgeted balance sheet contains all of the line items found in a normal balance sheet, except that it is a projection of what the balance sheet will look like during future budget periods. It is compiled from a number of supporting calculations, the accuracy of which may vary based on the realism of the inputs to the budget model.The budgeted balance sheet is extremely useful for testing whether the projected financial position of a company appears to be reasonable. It also reveals scenarios that are not financially supportable (such as requiring large amounts of debt), which management can remedy by altering the underlying budget model.
A budgeted balance sheet should be constructed for each period spanned by the budget model, rather than just for the ending period, so that the budget analyst can determine whether the cash flows estimated to be generated will be sufficient to provide adequate funding for the company throughout the budget period.
14
Example of the Budgeted Balance Sheet
The following is an example of a budgeted balance sheet:
Very Large CorporationBudgeted Balance Sheet
as of Year December 31, 20XX
Current Assets
Cash (1) $1,500,000
Accounts receivable (2) 4,200,000
Raw materials inventory (3) 3,500,000
Finished goods inventory (4) 6,800,000
Total Current Assets $16,000,000
Fixed Assets
Office equipment (5) 500,000
Machinery (6) 9,200,000
Accumulated depreciation (7) -2,700,000
Net Fixed Assets 7,000,000
Total Assets $23,000,000
Current Liabilities
Accounts payable (8) $2,100,000
Notes payable (9) 5,900,000
Total Current Liabilities 8,000,000
Shareholders' Equity (10) 15,000,000
Total Liabilities & Equity $23,000,000
As we said earlier, the components of master budget are interconnected, which means that numbers from one component budget flow to another one. For example sales budget numbers are used in schedule of cash receipts from customers and unless the sales budget is prepared we are unable to prepare schedule of receipts from customers because of lack of information. This means that components of master budget must be prepared in a specific order. We have ordered the above list in such a way that the necessary information needed by any component budget is provided by a preceding component.
15
A master budget contains all of the other budgets within a business. A successful budget depends on accurate predictions of future activity within each department or division. While companies with multiple divisions have a more complex master budget, all businesses share the same major components. The two main parts are the operational budget and the financial budget. There is a specific order of completion when preparing a master budget.
OPERATIONAL BUDGET: The operational budget comprises sales, production, direct material costs, and direct labor costs, overhead, administrative and cost of goods manufactured. Some industries use these categories differently. For example, while a manufacturer has a production budget for making goods, a department store has a merchandising budget to buy from its suppliers. Each of these categories has its own budget, with sales being the most important component. An operating budget is the annual budget of an activity stated in terms of Budget Classification Code, functional sub functional categories and cost accounts. It contains estimates of the total value of resources required for the performance of the operation including reimbursable work or services for others. It also includes estimates of workload in terms of total work units identified by cost accounts.
COMPONENTS of OPERATIONAL BUDGET:
16
Following are the components of Operational Budget.
INCOME STATEMENTS:
An operating budget presents all of the money coming into the business, whether through investors, sales or a combination of both. This is often presented by income statements and sales reports. If the operational budget is for a small business, the income may solely be the income from products and services. The income section may be broken down in terms of products sold so the business owner can see how the products are selling. For example, if the business has 10 products for sale, the income section may show that the business has sold three copies of one product, six of another and two of a third. The money earned from each product is added up as an income lump sum.
OFFICE EXPENCES:
Another component that is part of the operating budget is a list of the items the business needs in order to operate the office or administrate part of the company. This may change month to month, so the office expenses are often classified as flexible or variable expenses. Examples of office expenses can include computers, printers, technological repairs or add-ons, paper, pens, office furniture, business cards and telephone utility bills. Some businesses will also classify customer dining and travel expenses under the administrative expense section of the operational budget.
PRODUCT EXPENCES:
In order for a business to operate effectively, the business needs to produce products or services. While some services may be created using limited expenses or costs, such as Web design or writing services, products that need to be manually built or created may require additional production costs, such as tools and supplies. For example, if the business is selling wooden furniture, production expenses would include woodworking tools, different types of wood, screws, paint, stain and paintbrushes.
ADDITIONAL FUNDS:
17
The operating budget is constructed using the income of the business and the costs required to keep it running. If the income of the business is more than its operating costs, the operational budget will have additional funds left over. This specific amount may vary each month, depending on the overall income and production expenses. These additional funds can be used for other business expenses, such as marketing or employee salaries. Otherwise, the additional funds can be put away as profit.
PREPARATION:
The company creates the operating budget by assigning each component to an individual manager. The budget coordinator provides each manager with historical reports that detail the actual expenses for the prior and current period. Each manager knows the activities in her individual area and combines this knowledge with the historical data to create a new budget for their area. The budget coordinator combines each of the individual budgets into a final operating budget.
EVALUATION:
The operating budget is used to evaluate the performance of each individual manager during the period the budget applies. Actual performance is compared to the operating budget. The difference between the actual and budget amounts is a variance. Each manager must explain why the variance exists.
FOCUS:
The operating budget focuses on the activities involved with the company's daily activities. These activities include selling the product or service to customers, producing the product or performing the service and managing the corporate office activities which support the daily operation of the company. While activities outside of the daily operation occur and must be planned for, they are not included in the operation budget.
18
19
BENEFITS of OPERATIONAL BUDGET:
The lists discussed below are the advantages of Operational Budget.
TRACKING:
A benefit of an operating budget is keeping track of the entire business. Operating budgets indicate both money that is spent and money that is projected to come in. By checking the operating budget, a business owner or manager can see if the business is on track or is experiencing problems. By noting any deviation from the operating budget, the manager or owner can examine those issues to determine what changes, if any, might need to be made to either the current budget or future budgets.
PREPARATION:
Benefit of an operating budget is being prepared for financial responsibilities. When an operating budget indicates the monthly expenses of a business, a manager or owner has the opportunity to put money aside to cover those expenses. Knowing beforehand what the expenses are, rather than waiting until the last minute, allows a business to flow smoothly. In addition, factoring in such expenses as salaries ensure that both management and labor get paid on a regular basis, assuming that money has been set aside each month to cover those expenses.
BUILDING RESERVES:
An operating budget should be liberating instead of restricting. It can help you reduce debt as you work toward a goal of building financial reserves. Saving, investing and planning for unforeseen circumstances are solid benefits of a successful operating budget. Sometimes your income may be unexpectedly reduced, although your operating costs remain the same, when contracts fall through or inventory doesn’t move as expected. If you’ve built your budget around being able to keep some cash reserves, your business can more easily endure temporary setbacks.
20
FINANCIAL BUDGET:
The financial budget has five parts. The schedule of expected cash receipts is based on predicted future sales revenues during each period. The amount for each month or quarter will vary in small businesses that are cyclical in nature. The schedule of expected cash payments reflects the amount of money your business plans to spend on purchases during each financial period. The cash budget, income statement and balance sheet all reflect budgeted amounts. If you compare them with the actual numbers at the completion of each quarter, then you can make any necessary adjustments.
ELEMENTS of FINACIAL BUDGET:
Following are the elements of Financial Budget.
INCOME:
Determining how much income a person brings in a month is the first step to creating a successful financial budget. To determine how much income you have, calculate the net proceeds you make from any source of income. Sources of income include any money you receive on a regular basis, such as paychecks, child support, alimony payments or rental income. Income you receive infrequently, such as an employee bonus, may be too unreliable to include as a monthly source of income.
FIXED EXPENSES:
Fixed expenses are recurring expenses that cost the same each month. Typically, these are the necessary expenses required to cover the cost of living, such as mortgage or rent payments or insurance premiums. Fixed expenses can also include recurring expenses, such as auto loan payments or telephone bills. Every fixed expense you pay each month should be written down and deducted from your monthly income.
21
VARIABLE EXPENCES:
Variable Expenses include any living expense that varies from month to month. For example utility bills, car maintenance, groceries, credit card payments and pet food all count as a variable expense. Many people choose to estimate the cost of these expenses when creating a budget. However, you can adjust the total to a more accurate estimation by tracking your spending in these categories.
DISCRETIONARY EXPENCES:
Discretionary expenses are not necessary expenses and include purchases you make for entertainment purposes. For example, the cost of Internet fees or cable television, going out to eat, purchasing concert tickets or buying a cup of coffee at a coffee shop counts as discretionary expenses. Many people spend more on discretionary expenses than they think they do. You can track your expenses in this category for a few months to see where you spend the most and make adjustments if necessary.
GOALS:
One of the main objects of creating and maintaining a budget is to meet financial goals. A goal can include anything you want to spend your money on. For example, you can build up an emergency fund by saving a portion of your income each month. You can pay down credit card debt with excess income you have after paying for your living expenses. You can also set short term goals like buying a new piece of furniture or taking a weekend vacation. By deducting your monthly expenses from your income, you can determine how much excess income you have left over to put toward your goal each month.
22
23
BENEFITS of FINANCIAL BUDGET :
The given below are the benefits of Financial Budget.
FINANCIAL AWARENESS:
Creating a financial budget will provide financial awareness of the spending and earnings of the business. The budget will outline exactly how much the business is earning each month from sales and additional income. It will also show much the business is spending on operational expenses like office supplies and fixed utility bills. The operational budget should also show the company's given assets and liabilities at the current time. This will reveal whether the business is in positive financial standing or negative. It will also briefly reveal the direction of the financial standing, as the budget will show whether the business has a monthly profit or is continuously creating debt.
BUSINESS OPPORTUNITIES:
One benefit of having a financial budget for a business is to recognize opportunities that can help market and expand the business. The budget will reveal the amount of profit the business can put aside each month. This means the business owner can use the profit to expand the business and market it in new ways by attending conferences and joining marketing campaigns with larger businesses. Knowing the funding available can help the business owner plan ahead and market the business in new and creative ways.
COMMUNICATION TOOL:
Having a monthly financial budget can highly improve the procedure of creating annual reports. Annual reports are collections of the business's financial information over an annual period. This information is not only useful for a business owner but also for investors who may be interested in the company. A financial budget is essentially a communication tool, as it shows how the business operates internally and how wise the money is spent within.
24
FUNCTIONS of MASTER BUDGET:
Following are the functions of Master Budget explained in detail below.
SUM of ALL WHOLES:
A master budget must add all the budgets together to get one bottom line. This master budget, in turn, is used to determine the overall revenue and expenses of an organization and its profitability. This helps the higher-ups know exactly how much they are spending on running the business.
DIVISIONS:
A master budget must also list all separate budgets. Just having one big total is not enough. A master budget must also list each department’s budget for the year. This way, the company can know what divisions are profitable and what divisions are under-performing. Basically, this is a way to keep track of spending on a more micro-level.
HISTORY:
A master budget must keep a thorough history. On an even smaller scale, the master budget must keep track of all major spending in each division. That way, the company is able to determine how resources are being spent. The master budget must keep track of production costs, sales costs and maintenance costs past, future and projected.
CONCISE:
A master budget must be comprehensible and concise. The master budget has to be an all-inclusive, one-stop listing of the business’s expenses and revenue in general. It does not have to keep track of the smaller expenditures, but it should delegate capital for the larger necessities to make the business run like salaries, taxes and property payment.
25
BUDGET INTERDEPENDENCY:
The master budget's outline of the interdependency of sub-budgets allows company management to see how the actions of different departments feed throughout the organization. This flowchart of budget flow can help management control the organization by being able to see how non-optimal results move throughout the rest of the organization.
DEPARTMENTAL CONTROL:
Breaking the master budget into sub-budgets gives full responsibility for departmental budgets over to the appropriate departments. The idea of responsibility accounting -- which asserts that individuals should only be held accountable for results that they can control -- allows managers to control employees that feel reasonable for their actions. According to the textbook "Managerial Accounting," this could lead to increased productivity.
BUDGETED FINANCIAL STATEMENT:
The final output of the master budget is a set of budgeted financial statements. Because the output of the master budgeting process is a report that is familiar to top management, company decision-makers can determine how the company's financials would look if the budget objectives were attained. Company control and processes can then be changed and updated to ensure that financial objectives are achieved.
SALES AWARENESS:
The master budget begins with sales forecasts, which reinforces the idea that without customers a business will have a difficult time succeeding, regardless of what happens down the production line. For employees that are far removed from the sales function, this is a relevant reminder of how customers affect the business
26
SECTIONS:
The master budget is broken down in terms of the departments, so the reader can look at specific departments for financial information, if required. Under each department, there will be common headings, such as operational budgets, production fees, total sales or earnings for the department, cash flow statements and income statements for the department and a full balance sheet that presents the department's earnings and spending for a given period.
LIMITATIONS of MASTER BUDGET:
There are several limitations and problems associated with the master budget that need to be considered by management. These problems involve uncertainty, behavioral bias and costs.
UNCERTAINTY:
Budgeting includes a considerable amount of forecasting and this activity involves a considerable amount of uncertainty. Uncertainty affects both sides of the financial performance dichotomy, (see Exhibit 9-1) but uncertainty on the revenue side presents a more serious limitation for planning. The sales budget is frequently based on a forecast supported by a variety of assumptions about the economy, the actions of the Federal Reserve board and congress in implementing monetary and fiscal policy, and the actions of competitors, suppliers, and customers.
The uncertainty associated with sales forecasting creates a greater problem than uncertainty on the cost side because the other parts of the budget are derived from the sales forecast. This forces management to constantly monitor and analyze changes in the economic environment. From the planning perspective, the inability to accurately forecast the future reduces the usefulness of the original budget estimates for materials requirements planning (MRP) and planning for other resource needs. Uncertainty on the cost side tends to be less of a problem because management has more influence over the quantities of resources consumed than over the quantities of their own products purchased by customers. From a performance evaluation and control perspective, uncertainty on both sides of the financial performance dichotomy is not as much of a problem because flexible budgets are used to fine tune the original budget to reflect expectations at the current level of activity.
27
BEHAVIORAL BIAS:
A second problem involves a variety of behavioral conflicts that are created when the budget is used as a control device. To be effective, the budget must be used by the managers it is designed to help. Thus, it must be acceptable to all levels of management. The behavioral literature on budgeting supports the view that the budget should reflect what is most likely to occur under efficient operating conditions. If a budget is to be used as an effective planning and monitoring device, it should encourage a high level of performance and efficiency, but at the same time, it should be fair and obtainable. If the budget is viewed by managers as unfair, (too optimistic) it may intimidate rather than motivate. One way to gain acceptance is referred to as participative (rather than imposed) budgeting. The idea is to include all levels of management in the budget preparation process. Of course this process must be coordinated by a budget director to ensure that a fair budget is obtained that will help achieve the goals of the total organization.
Another way to reduce the behavioral bias against budgeting is to recognize the concepts of variation and interdependence when using the budget to evaluate performance. Recall from our discussion of the statistical control concept in that there is variation in all performance and most of this variation is caused by the system, (i.e., common causes) not the people working in the system. The concept of interdependence refers to the fact that the various segments of a company are part of a system. Inevitably, these segments, or subsystems influence each other. Failure to adequately recognize the interdependencies within an organization tends to cause behavioral conflicts and motivate participants to optimize the performance of the various segments rather than to optimize the performance of the overall system.
Finally, the behavioral conflicts associated with budgeting are reduced by using flexible budgets when evaluating performance.
COSTS:
A third problem or limitation is that budgeting requires a considerable amount of time and effort. Many companies maintain a twelve month budget on a continuous basis by adding a future month as the current month expires.4 While this does not create a major expenditure for large or medium sized organizations, smaller companies may find it difficult to justify the costs involved. Many small, potentially profitable firms do not plan effectively and eventually fail as a result. Cash flow problems are common, e.g., not having enough cash available (or accessible through a line of credit with a bank) to pay for merchandise or raw materials or to meet the payroll. Many of these problems can be avoided by preparing a cash budget on a regular basis.
Another disadvantage of a master budget is it's difficult to update. This is because of the many categories and numbers that are included in the budget. Due to the extensive descriptions and charts, a master budget can also be difficult to read and understand. Keep in mind that the master budget includes all expenses and income statements of the entire business, so this can be rather extensive if the business is a corporation or has hundreds of employees in many departments.
LACK of SPECIFICITY:
One of the disadvantages of having a master budget is its lack of specificity. The dollar amounts and numbers written on the master budget are a collective sum of all of the departments' expenses and earnings. For example, the reader would not be able to determine how much the marketing department is spending on a monthly basis as the amount will be added to all of the other departments' spending as one sum.
BUDGETING DRAWBACKS:
Limited spontaneity is a burden for some people who budget. Because budgeting emphasizes disciplined spending, it precludes spontaneous, emotional purchases. For adventure seekers, this restriction is significant. The time required to develop and manage a budget is inhibiting as well. For people with more laissez-faire personalities, the time demand is a natural deterrent. Rigid adherence to a budget may also prevent you from taking advantage of limited time discounts, promotions and buying opportunities.
29
30
31
STEPS to PREPARE MASTER BUDGET:
A master budget helps you to plan and coordinate all of the different budgets needed to run an enterprise. It includes budgets for sales, production or purchases, selling and administrative expenses, an income statement, a cash flows statement and a balance sheet.
In the budgeting process, the master budget provides a single map explaining how the company intends to earn profits and positive cash flow for the coming period. It also helps different parts of a business to coordinate their activities so that together they can meet the overall goals of the business.
Step 1. Project Sales
Start the budgeting process by estimating sales. Go to the sales or marketing department and request anticipated sales for the coming period. This estimate could be based on economic projections, consultants' reports, or a simple analysis of trends in prior years.
Step 2. Plan Production
Figure out the number of units of each product that you need to produce, using the following formula:
Expected sales (in units) + Desired ending inventory (in units) - Beginning inventory (in units) = Units to be produced.
This assumes that you're a manufacturer. If you're a retailer that doesn't produce its goods, then use a similar formula to estimate the number of units that need to be purchased:
Expected units to be sold + Desired units of ending inventory - Units of beginning inventory = Units to be purchased.
32
Multiply the number of units to be produced (or purchased) by the cost per unit to figure out the total cost of units to be produced (or purchased). Manufacturers can skip to Step 6.
Step 4. Design Labor Budget The direct labor budget estimates how much work must be done to meet your production plans, and the number of employees needed. To figure out the direct labor budget, ascertain (1) how many hours of direct labor are needed to produce each unit and (2) the average direct labor rate. Multiply both these factors by the number of Units to be produced that you estimated in the Step 2 Production budget:
Hours needed to produce each unit x Average direct labor rate x Units to be produced = Total direct labor costs
To figure out the number of employees needed, divide total hours to be worked by the number of hours worked per week:
(Hours needed to produce each unit x Units to be produced) Average number of hours worked per week by each employee = Number of employees needed for production.
Step 5. Plot Overhead To prepare the Overhead budget, multiply the number of Units to be produced by the Variable overhead cost per unit. Then add Total fixed overhead cost:
(Units to be produced x Variable overhead cost per unit) + Total fixed overhead = Total overhead.
To estimate the Variable overhead cost per unit and Total fixed overhead, account analysis, a scatter graph of overhead, the high-low method, or regression analysis will help you understand the relationship between overhead costs and volume.
\
33
Step 6. Estimate Selling and Administrative Expenses Sales don't happen automatically. You need to pay for sales agents, advertising, and other marketing costs. All of these estimated costs are tabulated in the Selling and administrative expense budget.
Step 7. Layout a Capital Acquisitions Budget Factory equipment requires careful maintenance and occasionally replacement. You may also need to add more equipment to make the needed number of Units to be produced. Therefore, set up a capital acquisitions budget that includes the cost of any new equipment or property that needs to be purchased during the coming period.
Step 8. Budget an Income Statement Based on all of the information in the prior steps, you should be able to project an income statement for the coming period. This will follow the basic formula for net income:
Sales - Cost of goods sold - Other expenses = Net income
A sale comes from the Sales budget (Step 1). To estimate cost of goods sold, multiply the number of units expected to be sold (see Step 1) by the estimated cost per unit (a sum of Steps 3, 4, and 5). Other expenses include Selling and administrative expenses (see Step 6), general expenses, depreciation expenses, and also income tax expenses.
When complete, the budgeted income statement answers a critically important question: Will your company be profitable next year? If you're dissatisfied with the estimated profits, then you may need to go back to Step 1 and rework your numbers.
Step 9. Formulate a Budgeted Cash Flows Statement A budgeted cash flows statement adds all of the expected cash receipts and subtracts the disbursements for the coming period. Cash receipts come from sales - but be careful! Don't list the sales themselves, but the cash flows from sales. This means adjusting for the rate at which you collect payment for your sales. Cash disbursements need to be made for purchases of raw materials (Step 3), direct labor (Step 4), overhead costs (Step 5), selling and administrative expenses (Step 6), and capital acquisitions (Step 7).
34
Step 10. Bring Down a Budgeted Balance Sheet The budgeted balance sheet is based on the following formula:
Assets = Liabilities + Stockholders' Equity
It explains how the business plan for the coming period will affect the company's finance position at the end of that period.
35
BENEFITS of MASTER BUDGET:
There are a variety of purposes and benefits obtained from budgeting. Consider the following:
INTEGRATES and CORDINATES:
The master budget is the major planning device for an organization. Thus, it is used to integrate and coordinate the activities of the various functional areas within the organization. For example, a comprehensive plan helps ensure that all the needed inputs (equipment, materials, labor, supplies, etc.) will be at the right place at the right time when needed, just-in-time if possible. It also helps insure that manufacturing is planning to produce the same mix of products that marketing is planning to sell. The idea is that the products should be pulled through the system on the basis of the sales budget, rather than produced speculatively and pushed on the sales force.
As discussed in excess inventory and other resources hide problems and add unnecessary costs. The integrative nature of the budget provides a way to implement the lean enterprise concepts of just-in-time and the theory of constraints where the emphasis is placed on the performance of the total system (organization) rather than the various subsystems or functional areas.
MOTIVATION:
Another purpose and benefit of the master budget is to provide a communication device through which the company’s employees in each functional area can see how their efforts contribute to the overall goals of the organization. This communication tends to be good for morale and enhance jobs satisfaction. People need to know how their efforts add value to the organization and its' products and services. The behavioral aspects of budgeting are extremely important.
OVERALL BUSINESS BUDGET:
One of the main reasons why a master budget is created is to give the business owner and company executives an overview of the company's budget. Since smaller budgets for each department only cover the expenses and earnings for each individual area of the business, a company executive would have to add all of the departments' budgets up to get one large budget to determine the overall earnings and spending of the company. The master budget reveals how much the company is earning and spending as a whole and shows whether the business is in good or negative financial standing.
36
PLANNING AHEAD:
Another advantage of having a master budget is the ability to identify problems and plan ahead. For example, the master budget can reveal if one department is spending beyond its limit, causing the company to spend more than it is earning each month. In order to repair this budget issue, company executives can identify which department is spending excessively by looking at individual department budgets and plan ahead, either by cutting the department's expenses or by making other budget cuts in other departments for additional spending. It is more difficult to spot budget issues by only looking at individual department budgets.
GOAL ACHIEVEMENT:
In a thorough budgeting system, you set short-term, medium-term and long-term financial goals. Your goals direct you in allocating portions of income to paying off debt and putting money away for savings or retirement. Using accurate numbers to reflect cash inflows and required expenses allows for greater understanding of the time required to meet financial milestones. In theory, accurate accounting and disciplined focus should propel you toward each financial goal you set.
PLANNING for UNEXPECTED:
Budgeting puts great emphasis on the known factors of income and typical expenses. However, a primary benefit of budgeting is that you can equip yourself to deal with unexpected expenses. The ideal budget allows you to set some money aside each month in a rainy-day savings fund. Building such a fund is essential after you meet monthly bill obligations. When you need a new set of tires or a home appliance breaks down, the rainy-day fund is your way to pay for these unplanned events without taking on debt.
SIMPLICITY:
Cash budgets are relatively easy to use. Once you have established the total amount of cash available for spending and decided how to allocate it, you can look at the cash left in your wallet and see at a glance when you are reaching your spending limit. To see where your money is going, all you have to do is track your receipts.
37
CONCLUSION:
I want to conclude my project by saying that a master budget
is only a tool. It does not mean that if the company has an excellent strategic tool, everything will
work out right. Nothing cans substitute for teamwork in the organization. Everyone should be
united in achieving the goals and leading the race in this competitive world of business.
REFERENCES:
Following are the references from where the information is been collected.
