Table of Contents
- 1 What is Master Budget?
- 2 Steps to Prepare Master Budget
- 3 Applications of Master Budget
- 4 Advantages of Master Budget
- 5 Disadvantages of Master Budget
What is Master Budget?
All the functional division of the organization prepares the budget for the particular division. The master budget is the sum total of all the divisional budgets that is prepared by all the divisions. Further, it also includes the financial planning, cash-flow forecast and budgeted profit and loss account and balance sheet of the organization. It is the goal of the organization to reach a level in a particular period. Normally master budget is prepared for a year.
Sometimes, it may be misunderstood that master budget is one large budget of the organization. However, it is not the case. Master Budget is the summary of the divisional budget. It is a continuous financial plan.
Steps to Prepare Master Budget
The sales budget is the foundation of the master budget. All the procurements, staff requirements and administration cost are based on the sales. First and foremost, the number of units to be sold and price per unit are derived. On the basis of that, the value of sales is calculated.
The sales budget is prepared based on considering the following factors:
- Market demand estimation
- Production capacity or an infrastructure facility
- Current supply facility
- Industry analysis
Market demand and production capacity are determined with the help of Marketing division and production division respectively.
The production budget is mainly based on the sales budget. However, following factors shall be considered;
- Inventory at the beginning of the year
- Inventory to be maintained at the end of the year
- Number of units manufactured
- Buffer stock to be maintained throughout the year
The production budget is divided into further three parts:
- Direct material budget
- Direct labor budget
- Manufacturing overhead budget
If the company is not having manufacturing unit, we require a number of units to purchase instead of the production budget.
Capital Asset Acquisition Budget
The plant, machinery, and equipment require periodical maintenance and replacement. If the sales target is higher than the previous period, new plant and machinery also need to be introduced. Therefore, careful planning of the capital asset has to be done. A financial budget is an integral part of Master Budget.
For all the divisional budgets, the organization requires cash. It needs to ensure that during the year it does not run out of the cash due to poor planning in preparation for the budget.
On the basis of the sales and production budget, it is derived that what is the expected receipts and what are the expected payment. Receipt and payment cycle of the customer and supplier need to be analyzed. At this stage, the organization decides whether the external borrowing is required or not.
All the administration expenses such as interest on borrowing, staff cost, office rent, legal expenses, office supplies etc are to be considered while preparing cash budget. Some factors also are dependent on the sales budget such as CEO’s salary based on performance or the performance bonus to sales staff.
Budgeted Income Statement
On the basis of the above budgets, the budgeted income statement is prepared. Budgeted Income statement includes following;
|Less: Budgeted Expenses||(XXX)|
Budgeted Balance Sheet
The budgeted balance sheet is prepared once the Budgeted Income Statement is prepared. Budgeted balance sheet indicates following:
|Plants & Machinery||XXX|
|Income tax payable||XXX|
|Short term loans||XXX|
All the divisional budgets are interrelated. A mistake in preparation for any budget leads to a mistake in the master budget. Hence, it is recommended to prepare the budget which is ambitious but achievable and not a fairy tale.
Applications of Master Budget
Important Planning Tool
The master budget is considered one of the most important planning tools for an organization. While planning, top-level management discusses the overall profitability and the asset and liability position of the company. For which, the master budget is being used.
Master budget measures the performance of the organization as a whole. It helps in departmental control and setting in departmental accountability. It helps in improving the efficiency.
The master budget is used for the interdivisional coordination amongst the divisions of the organization. It helps and ensures that coordination with the other divisions is properly made.
Advantages of Master Budget
Motivation to Staff
The master budget serves as a motivation tool on the basis of which the employees can compare the actual performance with the budgeted performance. The Master Budget helps staff in getting job satisfaction as well as a good contribution to the growth of the business.
Summary of the Divisional Budget
Master budget works as a summary budget for the overview of the business owners and the management. The master budget indicates how much the organization is earning and what the expenses are incurred as a whole.
Planning in Advance
The master budget identifies the unusual problems in advance and fixes the same. For instance, one of the company divisions is not performing well and the expenses incurred are exceeding the set budget limit. This results in the lower profitability of the company.
Helps in the Achievement of Goal
The organization has short, medium and long-term goals. A master budget helps in achieving the long-term goal of the organization. All the resources of the organization are channelized and controlled for optimization of the profit.
The master budget is a continuous process. Each year the organization prepares the master budget and it works as a tool of analytics. The variances are identified and the worked upon for better results on a continuous basis.
Disadvantages of Master Budget
The divisional staff is forced for the achievement of the target despite having practical difficulties in achieving the same. It is because of the pressure from the top management. This leads to low revenue estimates and higher expense estimates. Managers may not consider the new opportunities for the growth of the organization.
Difficult to Update
The master budget is not easy to modify. To add, alter or delete small change requires a lot of steps in the entire budget. It includes lengthy descriptions and charts. Hence, a master budget cannot be easily understood as a layman.
Chartered Accountancy Final course – Chapter: Financial ManagementLast updated on : September 22nd, 2018