The master budget is a single financial plan that aggregates all other budgets for a company’s fiscal year. It is composed of operating budgets, which detail revenues and expenses, and financial budgets, which show how cash is expected to flow in and out of the company. The result is a budgeted balance sheet, the financial statement that breaks down how the company projects its assets to compare to its debts in the coming fiscal year. Developing a master budget helps a company plan its business activities for the year, and forecast what growth or contraction is ahead. It also provides a frame of reference to compare actual future performance to expectations.
Timing and Process
Completing the master budget requires that all constituent budgets be finished. These include operating budgets such as the sales budget that projects revenues from selling goods or services, the production budget that calculates how many units are expected to be produced and at what cost, the labor and materials budgets that estimate the company’s costs of paying employees and purchasing materials, the administrative budget that projects the costs incurred by non-production departments, such as accounting and human resources, and financial budgets, most notably the cash budget. The operating budgets must be completed and aggregated before the financial budgets can be finalized, and both sets of budgets must be finished to begin work on the master budget. The assembly of the master budget’s components replicates the flow of information from the income statement and statement of cash flows to the balance sheet. The master budget coincides with the company’s fiscal year but frequently breaks that year down into quarters or months.
Master Budget Uses
The master budget is useful for business expansion, cash flow management, product development, and future opportunities. Companies can minimize the risk of investing in growth initiatives when they have an accurate idea of the revenues and expenses they’ll face in the near future. Budgeting for future cash flows helps to plan future activities while ensuring the business remains cash flow positive. Comparing certain budget components, such as the production budget, with the master budget itself provides insight into the appropriate investment amount for new product development, while such a comprehensive budgeting strategy can shed light on where the best future opportunities for expansion lie.
Master Budget Dangers
While the master budget is an essential tool for business planning, using it improperly can result in negative outcomes. Perhaps the biggest misuse of the master budget is tying employee compensation to meeting or exceeding budgeted results. Doing so creates a hefty incentive for employees to undershoot on revenues and overestimate expenses during the budgeting process. This way, achieving even pedestrian performance numbers results in coming in over budget, which prompts higher compensation for employees. To ensure accuracy and honesty in the budget creation process, compensation and bonuses should be tied to metrics held separate from the master budget. Used properly, the master budget is one of the best tools businesses have to plan for the future. It should be a part of any business’s growth strategy.