Question

Respond to the following in a minimum of 175 words:

What is a master budget? What are some of the underlying budgets that form the master budget? What is the budgeting process at your organization? Is it effective? Why or why not?

Answer 1

A master budget is a summary budget of functional budgets, which is finally approved, adopted and employed. It consists of a projected income statement (planned operating budget) and a projected balance sheet (financial budget) showing the organization’s objectives for the coming fiscal, and proposed ways of attaining them. It is the aggregation of all lower-level budgets produced by a company's various functional areas, and also includes budgeted financial statements, cash forecast, and a financing plan. The master usually covers a company's entire fiscal year. A master budget acts as a working plan for the year at the beginning of the year, and also as a yardstick for measuring performance at the end of the year. Also, noteworthy is the fact that all functional budgets are inter-linked, for e.g., production budget depends on sales budget and capex budget is interlinked to cash budget.

The master budget includes three main parts: the operating budget, capital expenditures budget, and financial budget.

Operational Budget

It is a budget of the operating activities of the business for the coming year. It comprises of:

1. Sales Budget – Sales Budget contains the budgeted sales for the coming year based on past data and projections, market trend,etc. The annual sales budget can be further broken down into monthly, quarterly, semi-annually Sales Budget to ensure its achievement.
2. Production Budget – The sales budget forms basis for production budget as production needs to be planned based on projected sales.
3. Direct Material Purchases Budget – Once the production budget is finalized, materials procurement budget needs to be put in place to ensure seamless production as per schedule.
4. Direct Labor Budget – It is prepared based on production budget to account for required manhours and associated costs.
5. Overhead Budget – It is a budget of the overheads in production – both fixed and variable.
6. Selling and Administrative Expenses Budget – This covers the selling and administrative expenses and may be prepared individually for various selling and administrative departments including accounts office, sales office, advertising, payrolls, etc.
7. Cost of Goods Manufactured Budget – It is budgeted total cost of production, required to ascertain estimated profitability or to fix appropriate selling price.

Capital Expenditure Budget

Every organization invests in capital expenditure from time to time for expansion purposes. Same needs to be presented in the form of budget as to which asset is to be purchased when, what will be the expenditure, how will the expenditure be funded,etc.

Financial Budget

It is a budget of the financial activities to be undertaken during the year and a budget of the expected financial position at the end of the fiscal. It further comprises of:

1. Schedule of Expected Cash Receipts from Customers – to record the cash inflows during the year.
2. Schedule of Expected Cash Payments to Suppliers – to record the cash outflows during the year.
3. Cash Budget – to budget the cash position at all times during the year. Can be further broken down to monthly, quarterly, semi-annual for better monitoring.
4. Budgeted Income Statement – It is basically projected income statement for the coming year.
5. Budgeted Balance Sheet – It is basically projected balance sheet for the coming year.

I have worked in a Bank, wherein the budgeting process at the beginning of the financial year, usually started off with a meet of business heads where previous year performance (vs budgeted) was discussed and, basis that, Annual Operating Plan (AOP) used to be brainstormed. With such feedback from business heads, the proposed budget would be formalized after taking into account the feasibility of suggestions, the required growth rate considering market conditions, etc. This Master budget was usually built up on past year’s performance as the base and communicated top-down format. Once formalized, departmental budgets were communicated, which would further be communicated down by these department Heads. The annual budget was always broken down into semi-annual, quarterly and monthly budgets, to ensure minimum variance.

The process was effective since employees had to adhere to budget formalized by management considering numerous factors. It was a top-down approach but with feedback from mid-management, which ensured that budgets are set high enough (avoiding complacency in bottom-up approach) but not unachievable high (to maintain its sanctity). Further, since it was monitored every month, then every Quarter (Q1,Q2,Q3,Q4 nos.), then half-yearly (H1,H2 nos.) and finally annually with previous nos. and also y-o-y basis, it ensured that the budget was actually achieved with least variance.