A master budget is the overall collection of budget relating to the various operation of the firm. It can also be described as a summary of company’s plans that set specific target of sales, distribution, production and financing activities. The major input to the master budget includes the budgeted balance sheet, budgeted income statement, budgeted cash flow statement and the production budget which comprises of material, labor and overheads.
Budgeted income statement shows the expected income generated by an organization as a result of adopting specific strategies. Budgeted balance sheet is used to show the financial position of the organization at a future date. The budgeted cash flow statement is used to show the cash inflows and outflow and the need of external financing where necessary. The production overhead indicates the final output expected and the financing requirement in production unit.
Benefits And Purposes Of A Master Budget
Integrate and coordinate – the master budget helps to coordinate and integrate the activities of different functional area within the firm. It ensures that all the resources required will be at the right place at the right time. It also ensures that the product mix produced by manufacturing department is the same with which the marketing intend to sell.
Communicate and motivate – it act as a communication device through which staff in each area understand how their effort contribute to the overall goal of the firm and this boost their morale and enhance job satisfaction.
Promote continuous improvement – it encourages the managers to look into various alternatives that might reduce cost and improve customer value.
Guide performance – the master budget becomes the basis for utilization and acquisition of resources needed to accomplish the overall goal.
Facilitate evaluation and control – it provides a benchmark for evaluating actual performance.
Time and cost – it takes much time to complete a master plan and also the cost involved might be difficult to justify in small organization.
Uncertainty – it involves a considerable amount of forecasting and this increases uncertainty particularly the revenue figure due to various external forces which affect sales.
Behavioral bias- it can create behavioral conflict when used as a control device. When the budget is too optimistic it can intimidate rather than motivate.
Revised flexible budget
Cost of goods
Total cost of goods
Total operating exp
E.B.T & Depr
Earning before tax
Risk Associated With Sales Forecast
Sales budget is based on forecast supported by several assumptions relating to the action of Federal Reserve board, economy, fiscal and monetary policy, competitors, customers and supplies. Competitors may change their pricing strategy hence causing current and potential consumers to shift to rivals. Furthermore competitors may develop new product or modify existing one hence causing a reduction of sales therefore action of competitors will determine to a greater extent on quantity sold.
Change in taste and preference on the part of consumer may either increase or decrease sales compared to forecast made. The performance of the economy will also determine whether the budgeted sale will be achieved. Where the economy grows leading to an increase in GDP and per capita income more people will be capable increasing spending due to an increase in purchasing power hence the company may achieve it sales forecast.
On the other hand where the economy shrink or slow down then it is most likely that most people will cut on spending particularly for goods considered as luxury and therefore the expected sales may not be achieved. Government policy both monetary and fiscal affect the economy and ultimately on the spending habit of consumers which will affect sales (Evans, 2000).
The uncertainty relating sales forecast therefore necessitate an annual review of sales budget if the organization is to achieve any benefit from such forecast. In preparing the budget the management should ensure that it is fair and obtainable. A budget which is unfair usually intimidates rather than motivate.
Budgeting should also be participative rather than imposed i.e. all the levels of management should be involved in the budget process. The organization code of ethics requires that any performance tool should be fair and capable of objectively evaluating organization performance. For instance if budget is to be used as a performance tool then it should indicate what was the cause of variance and whether such variance was caused by employee inefficiency or by external forces.
Evans, M.H (2000). Financial Planning and Forecasting, Financial Management
Training Centre, Virginia. Retrieved on 9th July 2009, at http://www.exinfm.com/training/pdfiles/course02.pdf.