Updated July 10, 2023
Definition of Master Budget
A master Budget is the aggregation of all divisional budgets prepared by various functional divisions of the entity into one large budget, which provides a comprehensive view of the company’s finance.
It mainly includes sales, production, capital, Office expense, budgeted cash flow statement, profit and loss statement, and budgeted statement of financial position, which is the entity’s balance sheet.
Explanation
All the divisional heads of the company prepare a budget for their particular division. These small budgets are compiled and converted into a large company budget known as the master budget. It is a futuristic plan or strategy the company’s management makes to ascertain the level a company wants to reach. This includes expected sales made in the future, production to be done, purchases to be made, expenses to be incurred, capital investments to be made by the company in the future, etc. It also included Budgeted financial statements like a profit and loss statement and a projected balance sheet.
Example of Master Budget
Below are some examples of master budgets:
For Example, The Budgeted activity of ABC Inc for Nov2020 is as follows:
| Cost of sales = | $750,000 |
| Provision for doubtful debts = | 1% of sales |
| Inventory on 31st Oct 2020 = | $100,000 |
| All goods are marked up to be sold at cost plus 20% | |
| Estimated administrative and selling expenses = | $115,000 |
| Projected Depreciation For the month = | $16,000 |
Calculate the projected operating income statement (part of the master budget) of ABC Inc. for November 2020.
Solution:
ABC Inc.
Projected statement of operating income
For the month ended November 2020
| Particulars | Amount (In $) |
| Budgeted sales | $900,000 |
| (-) cost of sales | $750,000 |
| (-) Provision for bad debts | $9,000 |
| (-) Administrative and selling expenses | $115,000 |
| (-) Depreciation | $16,000 |
| Operating Income | $10,000 |
The cost of Sales calculates as
Cost of Sales = Budgeted Sales / 120 *100
- Cost of Sales = $900,000 / 120 *100
- Cost of Sales = $750,000
Components of Master Budget
Below are some of the components:
- Income: It is a major component of the master budget. It includes income generated from sales operations and other income like interest income, dividends, and capital gain earned by the company. Sometimes, the company’s other income is not used in running its operation. So, these incomes can exclude from the master budget to make it an operational budget.
- Expenses: It is also a major component of the master budget. Here, the expenses are divided into fixed and variable expenses. Fixed expenses are incurred by the company irrespective of the production level, like rent, insurance, etc. Variable expenses are an expense that varies according to the level of production. The company can cut down its variable expenses if it runs short in cash, as some are discretionary expenses.
- Cost of Overhead and Production: After completing the master budget, the cost of overhead and production calculate, which helps the company decide the price for its product. Production costs include raw materials, direct labor, machinery, etc.; overhead costs include general and administrative expenses, selling expenses, etc.
- Net Profit or Loss: A common component shows the net result of the company’s operations.
- Projected Annual Performance: This is a very helpful component that helps forecast the company’s future performance if a company continues to operate at its current level.
Applications of Master Budget
- It is a planning tool in an entity. With the help of a master budget, management assesses the profitability of the company and the position of its assets and liabilities and makes plans accordingly.
- It is also used as a performance-measuring tool for an organization. A Master budget is an aggregation of all divisional budgets where all the divisions are accountable and responsible for controlling the expenses in their departments. This will also improve the efficiency of various departments.
- It facilitates interdivisional coordination among different divisions within the company.
Advantages of Master Budget
Below are some of the advantages :
- Management can compare the actual and budgeted performance of employees with the help of a master budget. This will motivate the employees to do their work in a better manner.
- It provides a summarized view of the income earned and expenses incurred by each company division to the owners or the management.
- With the help of the master budget, unusual problems like non-profitable departments are identified in advance and fixed by the management on time.
- The management uses it to achieve an organization’s long-term goals by allocating the resources in the right area and controlling the expenses to get the desired profit.
- The company prepares it annually. This budget is compared with the actual performance of the divisions, and corrective actions are taken to mitigate the variances. So, this is a continuous process the company performs for better results.
Disadvantages of Master Budget
Below are some of the disadvantages :
- The top management pressures the departmental staff to achieve the predefined targets per the master budget. This leads to higher expenses and low revenue estimates.
- It is rigid. It is hard to update or alter the master budget as it involves various steps.
Conclusion
Thus, a large budget provides a summarized view of various divisional budgets. The company prepares This budget monthly, quarterly, or yearly based on its discretion. It includes forecasting cash flows, a budgeted statement of profit and loss, and the projected balance sheet of an entity. It is also referred to as a continuous planning tool where the actual performances of various divisions are compared with the budgeted one, and variances are identified. Then, corrective measures are taken by the management to improve the differences and their efficiency. This will motivate the employees to perform properly. For example, suppose an organization has a division that is not profitable, so with the help of a master budget. In that case, management ascertains this problem and fixes it on time. Thus, it facilitates planning in an organization.
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