A master budget consists of a set of interrelated but independent budgets that articulate the organization’s sales, production, profit, and financial position for a specified time period. Manufacturing overhead is projected to be $0.50 per unit variable and fixed overhead $45,000 per quarter. Assume that each units of Water Wiz requires $0.10 of variable manufacturing overhead per unit produced and total fixed manufacturing overhead is $41,000 per quarter. As demonstrated in Exhibit 6-1, the budgets are interrelated with some budgets feeding into other budgets. While the Master Budget is a powerful tool for comprehensive financial planning and control, it is important to be aware of its limitations. Organizations should use the Master Budget in conjunction with other management tools and remain flexible to adapt to changing circumstances.

The Role of Operating Budgets

The finance department is responsible for creating a master budget because they are the ones who have access to financial data and are familiar with the financial operations of the business. The finance team typically consists of financial analysts, accountants, and other professionals with a finance and accounting background. Lord’s firm helps venture-backed startups create financial plans and master budgets. Indirect labor costs are manufacturing labor costs that cannot be easily and economically traced to the production of the product, e.g. the production supervisor’s salary or quality control.

The Role of Financial Budgets

• The remainder of this section describes how a company prepares the operating budget portion of the master budget.
• To avoid this mistake, businesses should involve stakeholders in the budgeting process and ensure they are aware of the assumptions and projections that underpin the budget.
• Budgeting helps plan for those times when cash is in short supply and bills need to be paid.
• A flexible budget, on the other hand, separates fixed and variable costs and can adjust based on different production outputs.
• Incorrect sales projections can lead to an imbalance in the budget, with the potential for overspending or underproduction.

Because of this problem, it may be better to employ the master budget as just a rough guideline for management’s near-term expectations for the business. The selling and administrative expense budget may be further subdivided into budgets for individual departments, such as the accounting, engineering, facilities, and marketing departments. Altogether, the Operating, Cash Flow, and Capital Budgets depict a company’s expected financial performance. Essentially, viewed from a different angle, the Master Budget consists of the firm’s projected Income Statement, Balance Sheet, and Cash Flow Statement for the upcoming years.

Video Illustration 6-2: Preparing the production budget

Businesses should also communicate any changes to the budget to all relevant stakeholders to ensure everyone is on the same page. They must also have the ability to use budgeting software and tools effectively. With these skills, the finance team can create an accurate and reliable master budget to guide the business’s financial activities and decision-making process. Third, they must have excellent communication skills to work with other departments and stakeholders.

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If this is your first time creating a budget, cut yourself some slack, and learn from your mistakes. If you run a one- or two-person business, it’s likely you’ll be doing most of the prep work yourself. However, if you have sales or production managers, be sure to get them involved in the budget creation process as well.

Inaccurate Sales Projections

Businesses should ensure that the budgeting process is fair to all stakeholders. This includes treating employees and suppliers fairly and not exploiting them. Metrics should be developed to measure progress toward achieving the strategic goals.

2 Master Budgets

Preparing a master budget involves several steps, such as creating the sales forecast, production plan, and marketing budget. The finance team must ensure that all these steps are completed accurately and on time. Variable manufacturing overhead costs are the same per unit, but total costs depend on the quantity produced. Fixed manufacturing overhead costs are the same in total regardless of the quantity produced. The figure below lays out how operating budgets and financial budgets are related within a master budget. We encourage you to evaluate your business environment, consider your industry-specific requirements, and assess the size and complexity of your operations.

Existing information regarding fixed manufacturing costs are combined with variable manufacturing costs to determine the manufacturing overhead budget. The information from the sales budget is used to determine the sales and administrative budget. Finally, the sales, direct materials, direct labor, fixed manufacturing overhead budget, and sales and administrative budgets are used to develop a pro-forma income statement. The same is true for direct labour, as management knows how many units will be manufactured and how many hours of direct labour are needed. The necessary hours of direct labour and the estimated labour rate are used to develop the direct labour budget. While the materials and labour are determined from the production budget, only the variable overhead can be determined from the production budget.

Once completed, these smaller budgets are rolled up into a budgeted income statement format, while the financial budget consists of a projected balance sheet and statement of cash flow. Combining an operating budget with a financial budget, a master budget is typically master budget prepared for the upcoming year, and it can also be a useful tool when creating a strategic plan for your business. The budget committee usually develops the master budget for each year, guided by the budget director, who is usually the controller of the company.