Master Budget

• The master budget consists of a number of separate but interdependent budgets

that formally lay out the company’s sales, production, and financial goals.
• The master budget culminates in a cash budget, a budgeted income statement,
and a budgeted balance sheet.
• The first step in the budgeting process is preparing a sales budget, which is a
detailed schedule showing the expected sales for the budget period.
• An accurate sales budget is the key to the entire budgeting process. All other parts
of the master budget depend on the sales budget.
• The sales budget influences the variable portion of the selling and administrative
expense budget and it feeds into the production budget, which defines how many
units need to be produced during the budget period.
• The production budget in turn is used to determine the direct materials, direct labor,
and manufacturing overhead budgets. Once a company has prepared these three
manufacturing cost budgets, it can prepare the ending finished goods inventory
budget.
• The master budget concludes with the preparation of a cash budget, income
statement, and balance sheet.
• Information from the sales budget, selling and administrative expense budget, and
the manufacturing cost budgets all influence the preparation of the cash budget.
A cash budget is a detailed plan showing how cash resources will be acquired and
used.
• The budgeted income statement provides an estimate of net income for the budget
period and it relies on information from the sales budget, ending finished goods
inventory budget, selling and administrative expense budget, and the cash budget.
• The final schedule of the master budget is the balance sheet, which estimates a
company’s assets, liabilities, and stockholders’ equity at the end of a budget
period.

A master budget for a manufacturing company is designed to answer 10

key questions as follows:
1. How much sales will we earn?
2. How much cash will we collect from customers?
3. How much raw material will we need to purchase?
4. How much manufacturing cost (including direct materials, direct labor, and
manufacturing overhead) will we incur?
5. How much cash will we pay to our suppliers and our direct laborers, and how
much will we pay for manufacturing overhead resources?
6. What is the total cost that will be transferred from finished goods inventory to
cost of goods sold?
 7. How much selling and administrative expense will we incur and how much cash
will we pay related to those expenses?
8. How much money will we borrow from or repay to lenders—including interest?
9. How much net operating income will we earn?
10. What will our balance sheet look like at the end of the budget period?

Estimates and Assumptions for a Master Budget

Sales budget:
1. What are the budgeted unit sales?
2. What is the budgeted selling price per unit?
3. What percentage of accounts receivable will be collected in the current and
subsequent periods?
Production budget:
1. What percentage of next period’s unit sales needs to be maintained in ending
finished goods inventory?
Direct materials budget:
1. How many units of raw material are needed to make one unit of finished goods?
2. What is the budgeted cost for one unit of raw material?
3. What percentage of next period’s production needs should be maintained in
ending raw materials inventory?
4. What percentage of raw material purchases will be paid in the current and
subsequent periods?
Direct labor budget:
1. How many direct labor-hours are required per unit of finished goods?
2. What is the budgeted direct labor wage rate per hour?
Manufacturing overhead budget:
1. What is the budgeted variable overhead cost per unit of the allocation base?
2. What is the total budgeted fixed overhead cost per period?
3. What is the budgeted depreciation expense on factory assets per period?
Selling and administrative expense budget:
1. What is the budgeted variable selling and administrative expense per unit sold?
2. What is the total budgeted fixed selling and administrative expense per period?
3. What is the budgeted depreciation expense on non-factory assets per period?
Cash budget:
1. What is the budgeted minimum cash balance?
2. What are our estimated expenditures for noncurrent asset purchases and
dividends?
3. What is the estimated interest rate on borrowed funds?
List of documents that would be a part of the master budget:
1) A sales budget, including a schedule of expected cash collections.
2) A production budget (a merchandise purchases budget would be used in a
merchandising company).
3) A direct materials budget, including a schedule of expected cash
disbursements for purchases of materials.
4) A direct labor budget.
5) A manufacturing overhead budget.
6) An ending finished goods inventory budget.
7) A selling and administrative expense budget.
8) A cash budget.
9) A budgeted income statement.
10) A budgeted balance sheet.
The production budget is prepared after the sales budget. The production budget lists
the number of units that must be produced to satisfy sales needs and to provide for
the desired ending finished goods inventory.

A merchandising company would prepare a merchandise purchases budget, instead

of a production budget. A merchandise purchases budget is usually accompanied by
a schedule of expected cash disbursements for merchandise purchases.

A direct materials budget is prepared after the production requirements have been
computed. The direct materials budget details the raw materials that must be
purchased to fulfill the production budget and to provide for adequate inventories.

The direct labor budget shows the direct labor-hours required to satisfy the production
budget.
The manufacturing overhead budget lists all costs of production other than direct
materials and direct labor.
The cost of unsold units is computed on the ending finished goods inventory budget.
The selling and administrative expense budget lists the budgeted expenses for areas
other than manufacturing.
The cash budget is composed of four main sections:
1. The cash receipts section.
2. The cash disbursements section.
3. The cash excess or deficiency section.
4. The financing section.
The receipts section lists all of the cash inflows, except from financing, expected
during the budget period. Generally, the major source of receipts is from sales. The
disbursements section summarizes all cash payments that are planned for the budget
period. These payments include raw materials purchases, direct labor payments,
manufacturing overhead costs, and so on, as contained in their respective budgets. In
addition, other cash disbursements such as equipment purchases and dividends are
listed. If a cash deficiency exists during any budget period or if there is a cash excess
during any budget period that is less than the minimum required cash balance, the
company will need to borrow money. Conversely, if there is a cash excess during any
budget period that is greater than the minimum required cash balance, the company
can invest the excess funds or repay principal and interest to lenders.

The financing section of the cash budget details the borrowings and principal and
interest repayments projected to take place during the budget period. To calculate
borrowings and interest payments, pay attention to the company’s desired minimum
cash balance and to the terms of the company’s loan agreement with the bank. The
cash balances at both the beginning and end of the year may be adequate even though
a serious cash deficit occurs at some point during the year. Consequently, the cash
budget should be broken down into time periods that are short enough to capture
major fluctuations in cash balances. In any period where a company’s excess of cash
available over disbursements is greater than its desired minimum cash balance, the
company will not need to borrow money during that period. The ending cash balance
for each period is computed by taking the excess (deficiency) of cash available over
disbursements plus the total financing.
The budgeted income statement is one of the key schedules in the budget process. It
shows the company’s planned profit and serves as a benchmark against which
subsequent company performance can be measured.
The budgeted balance sheet is developed using data from the balance sheet from the
beginning of the budget period (see Exhibit 8–3) and data contained in the various
schedules.

This chapter describes the budgeting process and shows how the various
operating budgets relate to each other. The sales budget is the foundation for a
master budget. Once the sales budget has been set, the production budget and
the selling and administrative expense budget can be prepared because they
depend on how many units are to be sold. The production budget determines
how many units are to be produced, so after it is prepared, the various
manufacturing cost budgets can be prepared. All of these budgets feed into the
cash budget and the budgeted income statement and balance sheet.