From the course: Accounting Foundations: Budgeting

The master budget

From the course: Accounting Foundations: Budgeting

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The master budget

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- The master budget is the most detailed and most heavily used budget in an organization. This budget is an integrated group of detailed budgets that together constitute the overall operating, investing, and financing plans for a specific time period. The flow of the preparation of the individual budgets within the master budget network looks like this. First the budgeting process should be based on the long-term strategic goals and plans of the company. In fact, if there's no connection between the company's long-term, strategic plans and the company's detailed budgets, then the long-term strategic plans are irrelevant. Another maybe more positive way to say that same thing is that the detailed budgets within the master budget give relevance to the company's long-term, strategic goals. Now in a manufacturing firm, the master budget begins with a forecast of sales. The sales forecast in connection with the long-term strategic plans leads to the capital budget or the plan for the purchase of long-term assets. The label Capital Expenditures or CapEx is given to purchases of long-term operating assets, such as land, buildings, and equipment. These assets are acquired to be used over the course of several years. There are several financial models used to make capital budgeting decisions. Unfortunately for us, a thorough examination of these various models is beyond the scope of this course. Now, the sales forecast also leads to the short-term operational plans established by top management. Once the sales forecast or sales budget is created, the budgeting team in a manufacturing company splits into two subteams. One of the subteams will use the sales forecast to determine the detailed plan for production, the production budget. This team will consider the amount and timing of purchases of raw materials, the hiring needs for the production labor, and the budget for the infrastructure or overhead costs. This collection of production budgets provides a numerical plan for what will happen inside the factory or the production facility. At the same time using the same sales budget, the other subteam constructs a budget for the activities that occur outside the production facility. This selling and administrative expense budget involves the numerical plan for the advertising, payments to the sales team, costs at company headquarters, and so forth. The capital budget, the production budgets, and the selling and administrative expense budgets then come together in the construction of an additional budget, the cash budget, and the budgeted or pro forma financial statements. Preparation of the cash budget is discussed later in this course. The construction of the pro-forma financial statements, unfortunately outside the scope of this course. A formalized budgeting activity forces management to make many important decisions. Those decisions guide a company towards its goals in making decisions involving scheduling, pricing, borrowing, cost control, investing, and other things.

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