Master Budget
The common use of the word budget implies a limit on spending: a spending diet. When we use the term within the context of managerial accounting, it is a quantitative plan of action or formal business plan. Let’s focus on the master budget which is an extensive analysis of the first year of any long range plan. Within the master budget there will be a summary of planned activities for all subunits of the organization. Thus, the master budget is a plan that includes a coordinated set of detailed schedules representing the plan for our organization. The plan is the summary of a number of decisions that will affect the organization for the coming year. Because the elements are interrelated they are completed in coordination and order. So let’s look at the budget process for our company to see how these various elements are prepared.
The Country Store
The owner of the Country Company is eager to prepare a budget for the next quarter, which is typically quite busy. She is most concerned with her cash position because she expects that she will have to borrow to finance purchases of materials and supplies in anticipation of sales and production. She also expects to make a capital addition. She has gathered all the data necessary to prepare the simplified budget. It is important to note that at your firm, some of the budget components may be combined or even look differently than the ones used in this example. This is completely normal.
Budget Process
Managerial accounting is meant to give managers the information they need to make good decisions. It’s much like putting together a puzzle. When all of the pieces of the puzzle are put in their proper place, it should allow them the manager to see what he or she has to do to be successful. Organizations with effective budget systems have specific guidelines for the steps and timing of budget preparation. Although the details differ, the guidelines invariably include the following steps.
The first step in the master budget process for the Country Company involves the sales budget. Please select the sales budget puzzle piece in the container box and drag it into place on the puzzle outline.
Sales Budget
The sales budget is a starting point for budgeting for any organization because inventory levels, purchases, and operating expenses are geared to the expected level of sales. Accurate sales forecasting is essential to effective budgeting. In manufacturing firms, like the candle company, sales drive the production for the coming period for the organization. In non-profit organizations, forecasts of revenue, or some level of services, are also the focal points for budgeting. Examples are patient revenues and government reimbursement expected by hospitals, and donations expected by churches. If an organization generates no revenues, as is the case of municipal fire protection, the sales budget simply specifies a desired level of service.
The next step in the master budget process involves the cash collection schedule. Please select the cash collection schedule puzzle piece in the container box, and drag it into place on the puzzle outline.
Cash Collections Schedule
It is easiest to prepare the cash collection schedule right after we prepare the sales budget. For some organizations, this schedule is actually prepared as part of the sales budget or cash budget. The information for this worksheet is based on what we know about our cash collections from our customers. Typically, we use historical information absent any new information that would cause us to expect a change in payment patterns. Cash collections from customers include the current month’s cash sales plus the collection of previous months’ credits sales.
The next step in the master budget process involves the purchases budget. Please select the purchases budget puzzle piece in the container box, and drag it into place on the puzzle outline.
Purchases Budget
After budgeting sales and cash collections, we need to prepare the purchases budget for the Country Company. The total merchandise needed will be the sum of the desired ending inventory, plus the amount needed to fulfill budgeted sales demand. The total need will be partially met by the beginning inventory. The remainder must come from planned purchases. We can compute these purchases as follows: budgeted purchases equals desired ending inventory plus cost of goods sold minus beginning inventory.
The next step in the master budget process involves the cash disbursements for inventory purchases. Please select the cash disbursements for inventory purchases puzzle piece in the container box, and drag it into place on the puzzle outline.
Cash Disbursements for Inventory Purchases
We next use the purchases budget to develop disbursements for purchases. This information will come from both the purchases budget and our accounts payable department. We have relationships and agreements with many of our vendors that affect the timing of payment.
The next step in the master budget process involves the operating and admin budgets. Please select the operating and admin budgets puzzle piece in the container box, and drag it into place on the puzzle outline.
Operating and Administrative 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. Examples of expenses driven by sales volume include sales commissions and many delivery expenses. Other expenses, such as rent, insurance, depreciation and salaries are not influenced by sales, within appropriate relevant ranges, and we regard them as fixed.
The next step in the master budget process involves the cash budget. Please select the cash budget puzzle piece in the container box, and drag it into place on the puzzle outline.
Cash Budget
The cash budget is a statement of planned cash receipts and disbursements. The cash budget is heavily affected by the level of operations summarized in the operating and administrative budget. The cash budget has the following major sections: the available cash balance equals the beginning cash balance, less the minimum cash balance desired, cash receipts and disbursements. Cash receipts depend on collections from customers’ account receivable, cash sales, and on other operating cash income sources, such as interest received on notes receivable. Disbursements for purchases depend on the credit terms extended by suppliers, and the bill-paying habits of the buyer. Cash budgets help management to avoid having unnecessary idle cash and unnecessary cash deficiencies. The finance team becomes aware of financing needs for operations from this schedule. A well-managed financing program keeps cash balances from becoming too large or too small.
The next step in the master budget process involves two parts, the operating and admin budget and the budgeted income statement. One at a time, please select both puzzle pieces in the container box, and drag it into place on the puzzle outline.
Budgeted Income Statement
The operating and administration budget, along with other information, gives us enough information to prepare the budgeted income statement to a point. The income statement will be complete after the addition of the interest expense, which we can compute only after we prepare the cash budget and budgeted balance sheet. Budgeted income from operations is often a benchmark for judging management performance.
The next step in the master budget process involves the capital budget. Please select the capital budget puzzle piece in the container box, and drag it into place on the puzzle outline.
Capital Budget
This schedule summarizes all of the approved capital and investment projects undertaken by the organization. Because these projects affect results over a period longer than just a year, this information will be integrated into other areas of the business plan, as well as the financing schedule.
The next step in the master budget process involves the financing budget. Please select the financing budget puzzle piece in the container box, and drag it into place on the puzzle outline.
Financing Budget
The cash needed or available from financing depends on large part on the results of the cash budget. This schedule will not only consider the results from the cash budget, but other types of cash outlays and inflows, such as needs suggested by the capital budget. If cash from operations will not cover all of the needs of the organization, then our company will borrow funds. These activities will result in both cash inflows and outflows; inflows from the borrowings and outflows for repayment and interest charges. Note in this example, the financing budget is imbedded within the cash budget. Again, in your company the financing budget may be a separate statement.
The last step in the master budget process involves the budgeted balance sheet. Please select the budgeted balance sheet puzzle piece in the container box, and drag it into place on the puzzle outline.
Budgeted Balance Sheet
The final step in preparing the master budget is to construct the budgeted balance sheet. It is a projection of the financial position of the company at the end of the budget period. Each balance sheet item is projected in accordance with the business plan as expressed in the previous schedules. Specifically, the beginning balances would be increases or decreased in light of the expected cash receipts, cash disbursements and inventory levels. The effects of non-cash items appearing on the income statement would also be considered. In preparing the balance sheet, not only are the sales, production and income statement budgets needed, but we also must take into consideration the cash, capital and financing budgets. Again, please note that this process may be slightly different at your company. Some of the schedules may be combined or have a different appearance.
When management has completed the master budget, it can consider all the major financial statements as a basis for changing the course of events. For example, the initial formulation of the financial statements may prompt management to try new sales strategies to generate more demand. Alternatively, management may explore the effects of various adjustments in the timing of receipts and disbursements. As managers re-work it, the budgeting process becomes an integral part of the management process itself. Budgeting is planning and communicating. When the budget is prepared in a spreadsheet or budgeting software, proposed changes may be completed easily, with the resulting effect available immediately. This sort of analysis, assessing the effects of varying one of the budget inputs up or down, is sensitivity analysis. Sensitivity analysis for budgeting is the systematic varying of budget data input to determine the effects of each change on the budget. This type of what-if analysis is one of the most powerful uses of spreadsheets for financial planning models.
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