What is the Budget and How is It Useful?

A master budget can be defined as an estimation of the revenue earned or expenses incurred over a specified period of time in the future and it is generally prepared on a periodic basis which can be either monthly, quarterly, half-yearly, or annually. It helps a business, an organization, or even an individual to manage the money effectively. A budget also helps in monitoring the performance of the people in the organization and helps in better decision-making. 

What is a Master Budget?

This is generally prepared by the budget committee for each year under the able guidance of the budget director. The director initially prepares the operating budgets, the information which helps in the preparation of other financial budgets.

A master budget is a complete and thorough financial document that is inclusive of all the lower-level budgets that fall under the category of:

  • Operating budget
  • Financial budget

The Operating budget generally determines how the income is being generated and what are the activities involved in it. It helps an organization in the preparation of budgeted income statements.

The Financial budget on the other hand shows the inflow and outflow of the cash as derived from the cash budget. The cash flows help in the preparation of a budgeted balance sheet.

Major Components of a Master Budget

Sales Budget 

It helps in estimating the sales revenue and sales expenses for a particular period. It prepared with the main motive of better and optimum utilization of the resources, higher profitability, and reducing the wastages during the production process. There are variously internal and external factors that influence the sales budget.

Internal factors 

The internal factors which influence sales budget include the trend of sales made by the business or the organization in the past years, the maximum utilization of a particular plant's production capacity, the changes in the trend of sales during seasonal fluctuations like weekends, festivals, etc., the selling and distribution channel so adopted also affects the forecast of sales in a great way. The change in the price of the product also plays a major role in the preparation of the sales budget. Therefore, the price of the product and also the price of the competitor's product should be taken into consideration while adopting the sales budget.

External factors

The external factors which influence sales budget include government policies and intervention, cutthroat competition in the market, changes in consumer preferences for the product and its demand, and economic condition of the country. The technological advancements also contribute immensely towards bringing about a shift in the sales forecast.

Production Budget

The production budget is considered to be an important component in preparation of the master budget. The preparation of the production budget helps the company to determine the number of sales it can expect to make in the coming years and so it is necessary for the company to make a budget to estimate how many units are to be produced in order to meet the sales and ending inventory requirements.  The production budget is usually based on an estimation that enables a company to make necessary changes in its management if required. The production budget as a component of the master budget helps the top-level personnel to produce a required number of units in the given time frame with utmost efficiency. The companies as a practice keep buffer stocks so that they do not stock out.

Direct Materials, Labor, and Overheads Budget 

The direct materials purchase budget helps in determining the number of raw materials that are to be used in the production process. On the other hand, the direct labor budget helps in estimating how many man-hours and workers would be required to complete the production process. The overheads budget forecasts the fixed and other variable costs incurred during the production.

Finished Goods and Cost of Goods Sold Budget

The finished goods inventory budget helps in assigning value to every unit of goods that are produced. The cost of goods sold budget and the preparation of balance sheet is completed only once the finished goods budget is prepared.

Administrative Budget

The administrative budget also forms an important component of the master budget. The selling and administrative expense budget generally deal with costs that are not associated with the manufacturing of a product such as freight, supplies, etc.

Cash Budget

The cash budget forms a very important component in preparing the master budget. The budget basically estimates the cash flow in a business for a specified period and it determines whether the business entity has sufficient cash balance to continue its operation for the specified time period. The cash budget helps the company to manage its sales and expenses so as to maintain optimum amount of cash flow. There are generally two types of cash budgets which an entity prepares---short-term and long-term cash budgets.

Budgeted Balance Sheet

The budgeted balance sheet as a component of the master budget helps in estimating the value of assets, liabilities, and equity that the company will hold in the future. The budgeted balance sheet is prepared once the budgeted income statement is ready. The budgeted income statement is---budgeted income minus budgeted expenses. The budgeted income statement helps organization to take better decisions and allocate its available resources more efficiently. The budgeted balance sheet is basically a way of checking, whether the budgeted plan will prove to be profitable for the company or not.

Advantages of Master Budget in Accounting

  • The master budget helps the top-level management to have access to all the meaningful information at the same time.
  • The master budget gives an accurate estimation of the profit of an organization.
  • The functional budgets to which the management can have access are available in a single report with the preparation of the master budget.

Disadvantages of Using Master Budget in Accounting

  • The preparation of the master budget makes the organization force its managers and other staff to achieve the desired targets despite the foreseeable difficulties in achieving it, which ultimately leads to lower revenue estimation and higher expense estimation.
  • The master budget is not easy to modify and a small change in it requires a number of steps to be followed. The master budget also cannot be easily understood by a layman because of its complications.

Importance of a Master Budget in Accounting

The master budget serves as an important planning tool for the organization. It helps the top-level management to view the overall financial position of the company while taking important decisions. It also helps in measuring the performance of the organization, thereby, bringing about considerable growth in the accounting patterns, and control and settings of the departments.

Common Mistakes

Care must be taken while preparing the master budget. It should be carefully observed that profits are not overestimated and costs are not underestimated in its preparation. The preparation of cash flow is an important step that must not be ignored and the data should be populated very carefully, so as to ensure proper and better estimation.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

  • B.com (Honors) (Bachelor of Commerce)
  • M.com (Master of Commerce)
  • Chartered Accountants (CA)
  • Company Secretary (CS)
  • MBA (Finance)
  • Budgeting.
  • Capital Budgeting.
  • Financial Budget.
  • Production Budget
  • Limitations of Budgeting.

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