In this complex world of corporate finance today, a vision without an actionable plan is simply hoping for the best. For an organization to remain sustainable overall and increase shareholder value, it needs one cohesive map that aligns all departments with a common financial goal. That is the purpose of the Master Budget.
An expert budget represents the umbrella budget of an organization that links all departmental budgets into one high-level vision of the future. It is, after all, the “budget of budgets,” making sure sales, production, and finance act like a seamlessly functioning, integrated machine.
What is a Master Budget?
A Master Budget is one single comprehensive financial plan that encapsulates the organization-wide plan for a particular time (usually a few months or a fiscal year). It encompasses every expected dollar that it earns sales dollars to every expected dollar that it spends on operating expenses until the last dollar lands in its bank account.
The master budget, in general, is divided into two parts:
- Operating Budgets: This relates to the day-to-day, income-generating activities of the firm,e.g., sales, production, and administrative costs.
- Financial Budgets: These relate to the company’s need of capital, cash flow, and financial position at the end of the period.
Master Budget Structure: Basic Elements
A master budget is done in a stepwise manner. Since each department needs to build its budget based on others which output is going to be used as an input, the budget order is established in a certain way to secure data consistency and operational alignment.
Operating Budgets
This process always starts with Sales Budget. This is the very foundation that the entire organizational plan is laid over. An incorrect sales forecast will result in an incorrect budget, from production to cash flow.
- Sales Budget: Assesses the number of units that will be sold and how much revenue can be expected, based on market analysis and historical records.
- Production Budget: After the sales target has been determined, the production budget estimates how many units must be produced to satisfy the sales target and meet desired ending inventory.
- Direct Materials Budget: Specifies the raw materials needed in production and when they should be bought so that the factory never must sit idle.
- Direct Labor Budget — Estimates the workforce requirements and labor costs to fulfill the production schedules.
Manufacturing Overhead Budget: All costs of production other than direct labor and materials, including factory rent, utilities, and equipment depreciation.
Selling and Administrative (S&A) Expense Budget: A budget addressing the non-manufacturing side of the business including marketing, executive salaries, corporate rent, and legal fees.
Financial Budgets
After setting the operating goals the company must decide how it will finance these activities and what it wants the company’s balance sheet to look.
- Cash Budget: This is probably the single most vital component that everyone needs to survive. It monitors cash receipts (collections from customers) and cash disbursements (payments to vendors and employees). It warns the management of shortage of cash so that they can arrange financing beforehand.
- Budgeted Income Statement — Projects profit or loss for the period by subtracting budgeted expenses from budgeted revenue.
- Projected Balance sheet: This is a summary of what you expect your Assets, Liabilities, and Equity to be at the end of the budget period, considering the effects of all planned activities.
Master Budget Example
Many budgets at the lower levels use specific formats in order to achieve certain outcomes. For example, the cost of finished goods inventories that have been fully absorbed or the total number of units manufactured.
A master budget looks a lot like a set of standard financial statements.
The format of the balance sheet and income statement will be dictated by Generally Accepted Financial Reporting Standards or International Financial Reporting Standards.
Cash budgets are the most important distinctions, because they do not appear in the usual format of a statement of cash flow.
It is instead used to determine the precise inflows of cash and outflows that are generated by other parts of the budget.
Master Budgets: Static Vs. Flexible: A Strategic Comparison
The master budget gives an accounting blueprint, but most business environments are anything but stable. If managers want to keep that “award-winning” control of finances, they will need to learn the difference between a static plan and a flexible one.
| Feature | Static Master Budget | Flexible Master Budget |
| Adaptability | Remains fixed regardless of actual volume levels. | Adjusts automatically based on various levels of activity. |
| Primary Use | High-level planning and setting annual goals. | Performance evaluation and variance analysis. |
| Complexity | Simpler to create; based on a single forecast. | More complex; it requires separating fixed and variable costs. |
| Accuracy | It can become obsolete if sales differ from the forecast. | Highly accurate for comparing actual results to what “should have been. |
Why Corporate Use the Master Budget
The master budget is far more than a compilation of spreadsheets; it is a vehicle for communication and coordination. Without it, however, a company will face “internal friction”—the sales team will make promises of orders that the production team cannot fulfill or the production team will build inventory with no demand from the sales team, leaving the finance team to pick up the bill for storing it.
Performance Evaluation
Variance Analysis : By analyzing actual performance against the master budget, management can pinpoint precisely where the company is over performing or under performing. This enables speedy pivoting.
Resource Allocation
An effective master budget can allocate key resources—limited cash, labor, and materials—toward the highest-margin, most strategically-important areas of the business.
Goal Congruence
It achieves the alignment of individual managers with the goals of the company. And since each department can view how its budget plays into the overall “Budgeted Income Statement,” it encourages a sense of shared accountability.
Best Practices fora Master Budget That Deploys Effectively
Instead, you can have an “award-winning” budget that really moves the dial by doing the following:
- Participative Budgeting: Have department heads involved in the creation process, instead of top-down dictating numbers This improves accuracy and it provides the manager “buy-in”.
- Rolling Budgets: Rather than just creating a single budget a year, roll a new month onto the end of the budget every time a month passes. This maintains the current and topical nature of the plan.
- Zero-Based Budgeting:Occasionally, force managers to justify each expense from ground zero (0) instead of simply changing the prior year’s digit. It helps to reduce “budget slack” and reduce wasteful spending.
Conclusion
The expert budget is the upper echelon of organizational alignment to financial health. Combining the operational and financial world in one document, it presents the clarity required to make it through difficult market environments. No matter if it is a budding company in your garage or a giant company in your backyard, the expert budget is how dollars should be directed to be put to work today so that it will benefit tomorrow.
