Business Courses/Introduction to Business: Homework Help ResourceCourse
- AuthorPeter Crain
Peter works as a franchise and business consultant, and has a background of diverse business experience before that. He holds an MBA in Pharmaceutical and Healthcare Business from University of the Sciences in Philadelphia as well as a Bachelor of Music from West Chester University.
View bio - InstructorAnthony Aparicio
Tony taught Business and Aeronautics courses for eight years; he holds a Master's degree in Management and is completing a PhD in Organizational Psychology
View bio
Learn about master budgets. Understand what a master budget is, learn how to prepare it and identify its components, and see examples of a master budget.Updated: 11/21/2023
Table of Contents
- What is a Master Budget?
- How to Prepare a Master Budget
- Master Budget Example
- Lesson Summary
Frequently Asked Questions
What are the three main components of the master budget?
There are three main components to a master budget. Operating budgets cover the general company expenses and income. Capital expenditure budget covers longer term asset and project costs. Financial budgets deal with cash flows and company financial data.
What is master budget and how it is prepared?
A master budget is the overarching budget for a company. It is a combination of many departmental budgets that help to determine a company's goals and direction for the designated period.
Table of Contents
- What is a Master Budget?
- How to Prepare a Master Budget
- Master Budget Example
- Lesson Summary
Any company that wants to run effectively and efficiently prepares budgets for each fiscal year. This allows for an overarching view of how the finances will look for that specific period. When companies have several departments, the need for a master budget arises. A master budget is the central financial planning document that includes how a company will spend and how much it expects to earn in a fiscal year. A master budget contains budgets of departments within the organization and projections that allow for management to plan for the upcoming year.
The master budget covers all of the company's anticipated income and costs for the fiscal period. It breaks down various operating budgets for the departments of a company, as well as the planned financial budgets involving spending on company growth and cash flow. It is important to know all of these different factors as it not only gives the company a plan for how to move through the year but also ensures any variations or deviations from the budget can be quickly analyzed.
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To explore how to prepare a master budget, first, a look must be taken at the master budget components. The three major components that will be explained in more detail are the operating budgets, capital expenditures budgets, and financial budgets. To form these budgets and the master budget, there needs to be an analysis of what the company income could look like for the coming year as this will dictate where that revenue is allocated in the rest of the budgets.
Operating Budgets
The operating budget is a very important part of the master budget. This contains the budgets for what will be coming into the company from an income perspective, and how it will be used to support the business's operation. There are a few important budgets in this category to note:
- Sales Budget: This is the first budget that will be developed before all other budgets. It is based on the forecasting of how the company feels sales will go for the period of budgeting and will influence all other budgets because it will determine how much money will be made in that period.
- Selling Expense Budget: As suggested by the name, this budget estimates the cost of doing business. Money must be spent to be made and this will show where there are fixed costs to that as well as variable costs. In a manufacturing setting, this would also be paired with a production budget, which details the cost of producing the product being sold.
- General and Administrative Budget: All other expenses needed to keep a business running fall under this budget. Payroll, equipment depreciation, taxes, ongoing maintenance, and other expenses will be factored into this budget.
Capital Expenditures Budgets
A capital expenditure involves the money used to buy or upgrade fixed assets such as property and equipment. The best way to think of capital expenditures compared to operating expenses is if the money being spent will benefit the company for longer than a year. A capital expenditure budget will have information regarding the purchase or sale of any large assets. Companies plan their capital expenditures out well in advance due to the sheer amount of money and or time that projects in this category tend to involve.
Financial Budgets
Financial budgets involve the cash, financing, and balance sheet side of running a company. Three budgets typically make up this section of the master budget.
- Cash Budget - A cash budget tracks the cash flows of a business. Items it will track include cash receipts, cash disbursem*nt, and financing. Cash receipts will track the incoming cash from revenue generation as well as any interest or dividends from investments and other assets. Cash disbursem*nt will cover all cash being paid out to various items in the budget. Financing tracks any borrowed cash and the repayment of those loans.
- Budgeted Income Statement - This is a projection that is a result of all of the operating budgets' numbers. It allows a company to project how the company will perform over the budget period.
- Budgeted Balance Sheet - This also uses data from the operating budgets to create the future financial picture for the company. This also takes data from the previous year's balance sheet as well as the current budget data to form the information.
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For a master budget example, say that ACME Tool Company needs to plan for the coming year. Being a tool manufacturer is a fairly regular business, but to know how to calibrate their business for expanding growth, a master budget must be made.
The first step is to have the sales team develop their budget in anticipation of the sales they will accomplish that year. They believe that with the rise in houses being built, there will be a need for increased tool sales and predict a fairly favorable income number. They also then put together an estimate of what they believe it will cost to achieve the sales they are budgeting due to advertising, commissions, and other sales needs. The production side submits their budget as well for the cost of manufacturing the tools to be sold. All other costs related to the staff in the office as well as paying regular bills are figured out by the operations team.
The finance department then puts together a capital expenditure budget as the company will need to acquire more space and new machinery to help manufacture to meet the rising demand. It has been a while since expansion and they plan on this project taking a couple of years so they adjust the budget accordingly.
A summation of all the department's budgets is submitted for review, as well as information that will help to summarize the cash flow, income, and balance sheet for the company. The combination of all of this information is presented to executives who then use the information to determine if money is being properly allocated to the growth of the company. They feel good about their profitability based on the report at hand but are ready to make adjustments if there is slowing demand.
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A master budget is a total budget composed of budgets from various departments in a company to help determine a company's financial direction for some time. It is composed of three categories: operating budgets, financial budgets, and capital expenditures budgets. A financial budget determines the levels of cash a company intends to receive and spend. This budget also includes the budgeted balance sheet which is one of the last items to be created. The first item that is usually created is a sales budget to help determine income for the budget period. This is included in the operating budget, which covers all of the items necessary to run a company and not the capital expenditures.
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Video Transcript
What is a Master Budget in Accounting?
When you think of a budget, you probably picture a list of numbers that show your income (from work or an allowance) and all of your expenses (such as car payments, rent, or even video game subscriptions). Like a household, a company must also have a budget. Companies cannot grow without closely following a budget that accounts for expected income and expenses and helps them plan for the future. A master budget in accounting refers to a specific type of document, based upon other specialized, individual budgets. Individual budgets within a firm can change depending on the type of business. However, they frequently fall under one of the three main categories:
- Operating budgets
- Capital expenditures budgets
- Financial budgets
Operating Budgets
Operating budgets contain a sales, selling expense, and general and administrative budget. Companies that manufacture goods also have production and manufacturing budgets that include the number of units to be made and the costs associated with production. By comparison, companies that only sell products manufactured by others use a merchandise purchases budget to track the number of units it needs to purchase over time to cover expected sales.
The sales budget includes the expected number of sales and projected income for the upcoming period in months, quarters, or years. Companies typically complete this budget first, as it allows them to estimate how much income is available to meet corporate goals.
The selling expense budget commonly follows the sales budget. It records the estimated income and predicts expenses directly related to the sale of goods. Examples of direct sales expenses include sales commissions, sales managers' salaries, and advertising expenses.
Expenses not directly related to the sale of particular items are accounted for in the general and administrative budget. Costs such as facility rentals, administrative personnel salaries, depreciation expenses, and shared utilities can be found in this budget.
Capital Expenditures Budgets
Capital expenditures budgets track any money that a business receives from selling large plant assets and buying new equipment to carry out production schedules. Typically, companies try not to keep a lot of cash in their accounts because it doesn't generate a lot, if any, revenue. Planning for large expenditures helps firms decide how they will pay for major equipment upgrades, additional facilities, or other related expenses. This budgetary section may be left out if the company does not have any income or expected expenses related to capital expenditures.
Financial Budgets
Financial budgets include the cash budget, budgeted income statement, and budgeted balance sheet.
Cash budgets track the expected income and spending of cash over an upcoming period of time to ensure that a company has enough cash on hand to meet future needs. As previously stated, companies do not like to keep too much cash on hand, especially when the money could be better spent by expanding products, services, and/or a customer base.
Budgeted income statements attempt to predict how much a company will earn from sales and how much it will pay in expenses related to those sales. The development of a budgeted income statement is one of the last steps in the master budget process because it incorporates the other budgets.
Budgeted balance sheets constitute the final part of a master budget and provide a summary of the company's expected financial status at a future date. Like the budgeted income statement, the budgeted balance sheet uses information from the other budget components.
Lesson Summary
A master budget is actually a combination of many other budgets developed by different departments across an organization. Master budgets typically fall into one of three categories: operating budgets, capital expenditures budgets, and financial budgets. Operating budgets include a general and administrative budget, sales budget, and selling budget. Financial budgets include the cash budget, budgeted income statements, and budgeted balance sheets. The capital expenditures budgets track any money that a business receives and may not be included in every budget. The results show a financial picture of what a company expects to achieve over the course of an upcoming period of time, information of great use to managers making both long-term and short-term corporate decisions.
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