Master Budget is a collection of all lower level budgets and provides a great route to the management to plan for the future. The main purpose of the master budget is to make sure that at the end of the time period for which the budget was made; the actual results do not deviate too much. If the actual results have deviated a lot, then management will input certain controls over the processes and procedures to keep the thing on the right track. So, it also works as a control tool to keep the things under control.
Master budget can be made for a month, a quarter or for the whole year. It all depends over the management’s working style and decision making process. Usually, following lower level budgets make up the master budget:
- Sales budget – this is the starting point in the preparation of master budget.
- Direct material budget
- Direct labor budget
- Production budget
- Selling & administrative expense budget
- Cost of goods manufactured Budget
- Cash budget
- Budgeted income statement
- Budgeted balance sheet
If the organization is a large one, then management can make separate master budget for each of its strategic business unit (SBU) so that each SBU adheres to the overall organization’s objectives, goals and mission. In today’s modern accounting and ERP (Enterprise resource planning) software, this is very easy to integrate budgets for each unit and head which helps a lot in the creation of various types of reports at the disposal. The usage of financial ratios with budgets helps the decision makers in developing a reasonable budgets because budgets which does not follow past trends often provides no value to the decision makers and serve just as a piece of paper.
How to prepare master budget
Aero is a shoe manufacturing company. The management wants to prepare a master budget for each quarter of the year. You as a finance manager has discussed with various departmental budgets and gathered following information:
Sales Budget
Sale price per unit is expected to be $ 10 which is expected to increase by 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} every quarter. In Quarter 02, special festival is coming, that is why the sale volume in this quarter is expected to be much high than that of rest of the quarters.
- Quarter 01 2000 units
- Quarter 02 4000 units
- Quarter 03 1500 units
- Quarter 04 1800 units
| Quarter | Units | Per Unit Price | Sales for the Quarter |
| 01
02 03 04 |
2000
4000 1500 1800 |
10
10 x 1.20 = 12 12 x 1.20 = 14.4 14.4 x 1.20 = 17.28 |
20,000
48,000 21,600 31,104 |
Production Budget
The ending inventory would be 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} of the next quarter sales unit. The opening inventory at the beginning of the first quarter is 150 units. We will add closing inventory with sales units and then deduct opening stock to find out the finished goods produced in the quarter.
| Quarter | Opening stock | sales | Ending Stock | Finished Goods Production |
| 01
02 03 04 |
150
400 150 180 |
2000
4000 1500 1800 |
400
150 180 150 |
2250
3750 1530 1770 |
Direct Material Purchases Budget
Raw material is needed in the production. It can be direct and in-direct. When a raw material could be specifically identified for a product, it should be treated as direct material. Othwerwise, we will take it as in-direct. If the entity is doing job order costing, direct materials are charged to work in process account while indirect materials are charged to FOH account.
We will use the above data of production units in the example above to prepare direct material budget. For each unit of production, 3 Kg of direct materials needed. Cost per unit of raw material purchases is $ 2 per Kg. Budgeted opening and closing inventory of direct materials are follows:
| Description | Quarter 01 | Quarter 02 | Quarter 03 | Quarter 04 |
| Budgeted production units | 2250 | 3750 | 1530 | 1770 |
| Raw material required | 2250 x 3 = 6,750 | 3750 x 3 = 11,250 | 1530 x 3 = 4,590 | 1770 x 3 = 5,310 |
| Closing Inventory – Direct materials | 400 | 350 | 370 | 470 |
| Opening inventory – direct materials | (470) | (400) | (350) | (370) |
| Direct material purchases – budgeted | 6,680 | 11,200 | 4,610 | 5,410 |
| Direct materials – Cost per Kg | 2 | 2 | 2 | 2 |
| Budgeted direct materials purchases $ | 13,360 | 22,400 | 9,220 | 10,820 |
Direct Labour Cost Budget
Direct labor cost is the key ingredient of the total cost of manufacturing goods. If it is added to direct material cost, we get the figure of prime cost. We will use the above data of production units in the example above to prepare direct material budget. In order to produce a single unit of finished goods, following types of labor required with their rate of working as follows:
- Unskilled labor 1 hour per unit ($ 1 per hour)
- Semi-skilled labor 2 hours per unit ($ 2 per hour)
- Skilled labor 3 hours per unit ($ 3 per hour)
| Quarter 01 | Quarter 02 | Quarter 03 | Quarter 04 | |
| Budgeted production units | 2250 | 3750 | 1530 | 1770 |
| Direct Labour hours:
Unskilled Semi-skilled Skilled |
2250X1=2250
2250X2=4500 2250X3=6750 |
3750X1=3750
3750X2=7500 3750X3=11250 |
1530X1=1530
1530X2=3060 1530X3=4590 |
1770X1=1770
1770X2=3540 1770X3=5310 |
| Direct Labour Cost
Unskilled Semi-skilled Skilled |
2250×1=2250
4500×2=9000 6750×3=20250 |
3750×1=3750
7500×2=15000 11250×3=33750 |
1530×1=1530
3060×2=6120 4590×3=13770 |
1770×1=1770
3540×2=7080 5310×3=15930 |
| Budgeted Direct Labour Cost | 31,500 | 52,500 | 21,420 | 24,780 |
Factory Overhead Budget
Factory overhead comprises of two elements, one is variable and the second is fixed over head. When we make Factory Overhead Budget, we need to take account both types of overheads. Here, accountant needs to set a proper pre-determined overhead absorption rate well in advance so that it can reliably included in the FOH Budget. Now, let move forward to develop a factory overhead budget using the information given below:
| Quarter 01 | Quarter 02 | Quarter 03 | Quarter 04 | |
| Variable factory overhead per unit | $ 10 | 12 | 13 | 15 |
When it comes to fixed factory overhead, there are two heads which are depreciation and monthly rent of the factory. Both of these expenses/ overheads are estimated to be 2500 each per month.
| Quarter 01 | Quarter 02 | Quarter 03 | Quarter 04 | |
| Budgeted production units | 2250 | 3750 | 1530 | 1770 |
| Variable overheads | 2250×10=22500 | 3750×12=45000 | 1530×13=19890 | 1770×15=26550 |
| Fixed overheads 5000/month | 15000 | 15000 | 15000 | 15000 |
| Budgeted FOH Cost | 37,500 | 60,000 | 34,890 | 41,550 |
Budgeted Admin & Selling Expenses
The important part of an income statement is the admin & selling expenses. These are the expenses which must be deducted from the gross profit figure to arrive at the net income. In order to prepare the budget for admin & selling expenses, we need to identify the heads and estimate the figures based on some appropriate technique. Normally, admin expenses include office staff salaries, office rent, utilities, insurance expenses and miscellaneous expenses. On the other hand, when we look over selling expenses, it normally includes commission and transportation charges to deliver the goods to the customers. A specimen format of this type of budget is given below:
| Quarter 01 | Quarter 02 | Quarter 03 | Quarter 04 | |
| Budgeted production units | 2250 | 3750 | 1530 | 1770 |
| Variable overheads | 2250×10=22500 | 3750×12=45000 | 1530×13=19890 | 1770×15=26550 |
| Fixed overheads 5000/month | 15000 | 15000 | 15000 | 15000 |
| Budgeted FOH Cost | 37,500 | 60,000 | 34,890 | 41,550 |
In the above example, we have separately calculated variable factory overhead and as you can see it varies with the level of production. However, fixed overhead do not change with the level of production. No matter, entity produces 4000 units or no units at all , it has to incur these fixed overhead expenses.
Cost of Goods Manufactured Budget – Standard Format
It is the most important portion of master budget as here accountant has to estimate the figures for raw materials, work in process, direct labor, factory overheads. Seasonal variations are also considered here because if you ignore the seasonal effects on the values of sales and expenses, your budget would be totally wrong and the purpose of developing the budget will be compromised.
| Raw material consumed
Raw material opening Add: raw material purchases Add: transportation-in/ freight in Add: import duty Less: purchase return/ discount allowed Net raw material purchases Raw material available to use Raw material – closing inventory Raw material used/ consumed Add: direct labor used Prime cost Add: factory overheads Indirect raw materials Indirect labors Factory rent Factory utilities Depreciation Foreman salary Factory stores and spares Oil Machine fuel Factory tools Other manufacturing expenses Total factory overheads Manufacturing cost Add: work in process – opening Total manufacturing cost Less: work in process – closing Cost of goods manufactured |
xxx xxx xxx (xx)
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx |
xxx
xxx xxx (xx) xxx xxx xxx
xxx xxx xxx xxx (xx) xxx |
Cash Budget
Cash budget is an important tool for effective controlling and planning. It is a key tool in keeping the overall working capital management in strict control. In order to continue as a going concern, an entity has to make sure it has sufficient amount of cash available to meet its current liabilities. In order to prepare the cash budget, we need to estimate cash inflows and outflows. Normally, cash budget is prepared for each month of the year and following common items make up the inflows and outflows:
Inflows – cash from cash sales, recoveries from credit sales, cash received from sale of short term investments, short term loans, and long term loans and proceed from issue of shares etc.
Outflows – cash payment to vendors or suppliers of raw materials, cash payment to labors and staff, capital and revenue expenditure on plant, machinery and equipment, interest paid on loan amount, debt retirement and dividend paid on shareholders.
Budgeted Income Statement
This is invaluable tool to predict the future performance of the entity. This budget helps the organization to take corrective and preventive measures so that the organization could make up the profit in the coming period. Normally, this type of statement is made for each month comprising report for the whole twelve months. It is also known as Pro forma income statement. It can help the organization in achieving the desired results and provide a great opportunity to check whether the desired plans are still feasible to achieve the objectives. After the end of each month or period, budgeted figures of the income statement are compared with the actual results and if any variations are found, appropriate actions are taken.
Specimen Format of Budgeted Income Statement/ Pro Forma Income Statement
| Sales revenue | xxxx | |
| Cost of goods sold | (xxx) | |
| Gross Profit | xxx | |
| Operating expenses | ||
| Admin expenses | xxx | |
| Selling expenses | xxx | |
| Total operating expense | xxx | |
| Operating profit | xxx | |
| Finance charges | (xxx) | |
| Income before tax – PBT | xxx | |
| Income tax | (xxx) | |
| Profit after tax – PAT | xxx |
As you can see there are numerous items in the above budgeted income statement. These are obtained from the other budgets that we discussed in above lines. This can be done easily by interlinking the budgets in MS Excel. The financial modeling is a fantastic method to make easy the entire process of budgets preparation.
Budgeted Balance Sheet
This is the last step in the making of a master budget. In this report, balance of each items of assets, liabilities and equities are estimated. This is perfect tool to see the effect of long term finance on the financial position and performance of the company. If the loan or debt affects the profitability of the company, then corrective actions can be taken to eliminate the causes of the problems. Normally, Budgeted Balance Sheet is prepared for a entire twelve months.
| Current Assets | |||
| Cash & bank | xxx | ||
| Accounts receivable | xxx | ||
| Raw materials inventory
Work in Process inventory |
xxx
xxx |
||
| Finished goods inventory | xxx | ||
| Total Current Assets | xxx | ||
| Non Current Assets | |||
| Office equipment | xxx | ||
| Plant & Machinery
Vehicles Computers & Electronic Items |
xxx
xxx xxx |
||
| Accumulated depreciation | -xxx | ||
| Net Non Current Assets | xxx | ||
| Total Assets | xxx | ||
| Current Liabilities | |||
| Accounts payable
Bank Overdraft |
xxx
xxx |
||
| Notes payable | xxx | ||
| Total Current Liabilities
Long Term Liabilities Loan Payable Lease Obligation under finance lease Total Long Term Liabilities |
xxx
xxx |
xxx
xxx |
|
| Shareholders’ Equity | xxx | ||
| Total Liabilities & Equity | xxx |