Master Budget

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:

  1. Sales budget - this is the starting point in the preparation of master budget.
  2. Direct material budget
  3. Direct labor budget
  4. Production budget
  5. Selling & administrative expense budget
  6. Cost of goods manufactured Budget
  7. Cash budget
  8. Budgeted income statement
  9. 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 % 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 % 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

2250x1=2250

4500x2=9000

6750x3=20250

3750x1=3750

7500x2=15000

11250x3=33750

1530x1=1530

3060x2=6120

4590x3=13770

1770x1=1770

3540x2=7080

5310x3=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

2250x10=22500

3750x12=45000

1530x13=19890

1770x15=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

2250x10=22500

3750x12=45000

1530x13=19890

1770x15=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