The Master Budget

What is the Master Budget?

The master budget is a one-year budget planning document for the

firm encompassing all other budgets. It coincides with the fiscal
year of the firm and may be broken down into quarters and, further,
into months.

If the firm plans for the master budget to be an ongoing document,

rolling from year to year, then normally a month is added to the
end of the budget to facilitate planning. This is called continuous
budgeting.
 Objective 1

Explain the major features

and advantages of a
master budget.
Advantages of Budgets

Goals and
Budgets
objectives

A budget allows systematic rather

than chaotic reaction to change.
Advantages of Budgets

Compels
managers
to think Provides definite
ahead expectations that
are the best framework
to evaluate performance

Aids managers in
coordinating their efforts
 Types of Budgets

Strategic plan Long-range plan

Capital budget Master budget

Continuous budget
 Strategic Plan

The most forward-looking budget is the

strategic plan, which sets the overall
goals and objectives of the organization.
Long-Range Plan

The strategic plan leads to long-range

planning, which produces
forecasted financial statements
for five- to ten-year periods.
Capital Budget

Long-range plans…

are coordinated with capital budgets,

which detail the planned expenditures
for facilities, equipment, new products,
and other long-term investments.
 Master Budget

Sales
The master budget
summarizes the Production
planned activities
of all subunits of Distribution
an organization.
Finance
 Continuous Budget

are a common form of

master budgets that
Rolling budgets... add a month in the
future as the month
just ended is dropped.
 Components of Master Budget

Operating budget

Financial budget
 Objective 2

Follow the principal steps in

preparing a master budget.
 Steps in Preparing the
Master Budget
The principal steps in preparing
the master budget are:

1. Basic data
a. Sales budget
b. Cash collections from customers
c. Purchases budget
d. Disbursements for purchases
e. Operating expense budget
f. Disbursements for operating expenses
Steps in Preparing the
Master Budget

1. Basic data

2. Operating budget

3. Financial budget
 Objective 3

Prepare the operating budget

and the supporting schedules.
 Operating Budget

Sales Cash collections

budget from customers

Purchases Disbursements
budget for purchases

Operating expenses Disbursements for

budget operating expenses
Cash Collections

It is easiest to prepare budgeted

cash collections at the same
time as the sales budget.

Cash collections include the current

month’s cash sales plus the
previous month’s credit sales.
Purchases Budget

Budgeted purchases
= Desired ending inventory
+ Cost of goods sold
– Beginning inventory
 Disbursements for Purchases

For example, 50% of the current month’s

purchases and 50% of the previous
month’s purchases may be included.

The total disbursements are then

used in preparing the cash budget.
 Operating Expense Budget

The budgeting of operating expenses

depends on several factors.

Month-to-month changes in sales

volume and other cost-driver activities
directly influence many operating expenses.
Operating Expense Budget

Expenses driven by sales volume

include sales commissions
and many delivery expenses.
 Operating Expense Budget

Other expenses are not influenced by sales

or other cost-driver activity and are regarded
as fixed, within appropriate relevant ranges.

Rent Depreciation

Insurance Salaries
 Operating Expense
Disbursements

Disbursements for operating expenses are

based on the operating expense budget.
 Operating Expense
Disbursements

For example, 50% of last month’s

and this month’s wages and
commissions plus miscellaneous
and rent expenses may be included.

The total of these disbursements is then

used in preparing the cash budget.
Budgeted Income Statement

The income statement will be complete

after addition of the interest expense,
which is computed after the cash
budget has been prepared.

Budgeted income from operations

is often a benchmark for judging
management performance.
 Objective 4

Prepare the financial budget.

 Cash Budget

The cash budget has the following major sections:

 available cash balance
 cash receipts disbursements
 cash needed from (or used for) financing
 ending cash balance
 Cash Budget

Available cash balance

= Beginning cash balance
– Minimum cash balance desired.

Cash receipts depend on collections from

customers’ accounts receivable, cash sales,
and on other operating income sources.
 Cash Budget

Cash disbursements for purchases depend

on the credit terms extended by suppliers
and the bill-paying habits of the buyer.

Payroll depends on wage, salary, and

commission terms and on payroll dates.
 Cash Budget

Disbursements for some costs and expenses

depend on contractual terms for installment
payments, mortgage payments, rents,
leases, and miscellaneous items.

Other disbursements include outlays for

fixed assets, long-term investments,
dividends, and the like.
Cash Budget

Management determines the minimum

cash balance desired depending
on the nature of the business
and credit arrangements.
 Cash Budget

Financing requirements depend on how

the total cash available compares
with the total cash needed.

Needs include the disbursements plus

the desired ending cash balance.
Cash Budget

Ending cash balance

= Beginning cash balance
+ Receipts – Disbursements
+ Cash from financing

The cash from financing can be

either positive (borrowing)
or negative (repayment).
 Budgeted Balance Sheet

The final step in preparing the master budget

is to construct the budgeted balance sheet
that projects each balance sheet item in
accordance with the business plan.
Objective 5

Explain the difficulties

of sales forecasting.
 Sales Forecast

A sales forecast is a prediction of sales

under a given set of conditions.

Sales forecasts are usually prepared under

the direction of the top sales executive.
Factors to Consider When
Forecasting Sales

Past patterns of sales

Estimates made by the sales force

General economic conditions

Competitors’ actions
Factors to Consider When
Forecasting Sales

Changes in the firm’s prices

Changes in product mix

Market research studies

Advertising and sales promotion plans

 Objective 6

Anticipate possible human

relations problems caused
by budgets.
Getting Employees to Accept
the Budget

To fully benefit from budgets, an

organization needs the support
of all the firm’s employees.

The attitude of top management will

heavily influence lower-level
workers’ and managers’ attitudes.
 Getting Employees to Accept
the Budget

Another problem that can negate the benefits

of budgeting arises if budgets stress one set
of performance goals, but employees and
managers are rewarded for different
performance measures.
 Participative Budgeting

Budgets created with the active participation

of all affected employees are generally more
effective than budgets imposed on subordinates.
Functional Budgeting

The budgeting focus is on preparing

budgets for various functions
such as production, selling,
and administrative support.
Activity-Based Master Budgets

This budgetary system emphasizes

the planning and control purpose
of cost management.
Objective 7

Use a spreadsheet to
develop a budget.
(Appendix 7)
 Spreadsheets

Spreadsheet software for personal computers

is a powerful and flexible tool for budgeting.

Arithmetic errors are virtually nonexistent.

Spreadsheets can be used to make a

mathematical model of the organization.
End of Chapter 7