Components of a Master Budget

The master budget is the plan of operations for acompany or business unit
over a year, an operating period, or a shorter duration. The master budget sets
quantitative goals for all operations, including detailed plans for raising the
required capital.

The master budget is a map showing where the company is heading. If it is

properly designed, it will show the company heading in the same direction as
thestrategy and the long-term plan. The budget is more precise and of shorter
duration than long-term plans. It
is more focused on responsibility centers than longer-term planning tools. A master budget is broken
down into an operating and a financial budget.

• An operating budget identifies resources that are needed for operations and is concerned
with the acquisition of these resources through purchase or manufacture. Operating budgets include
production budgets, purchasing budgets, sales promotion budgets, and staffing budgets.

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• A financial budget matches sources of funds with uses of funds in order to achieve
the goals of the firm. This includes budgets for cash inflows and outflows, financial
position, operating income, and capital expenditures.

• A capital budget is used to plan how resources will be used to support significant
investments in projects that have long-term implications. These projects could
include thepurchase of new equipment or investment in new facilities.

• A budget manual describes how a budget is to be prepared. Include a budget

planning calendar and distribution instructions for all budget schedules

• Budget planning calendar is the schedule of activities for the development and
adoption the budget, it includes a list of dates indicating when specific information is
to be providingto other.
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Operating budget

Sales Budget
Sales forecasts should use statistical analysis techniques
such as regression analysis and rely on sales managers’
knowledge about their market and customer needs. Once a
company has determined its forecasted sales level, based
on its long and short- term objectives, it forms a sales
budget to accomplish its goals. The two key
components of the sales budget are the projected
number of units of sales and the projected selling
prices for the upcoming periods.

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The first Operating Budget to be prepared is always the Sales Budget, because the
Production Budget and all the other budgets for the company are derived from the Sales
Budget. If sales are expected to be low, the company does not need as much inventory
or as many salespeople, and so on. On the other hand, if sales are expected to be high,
more of each of these resources will be required.
The Sales Budgets should be developed for each responsibility center individually or
possibly for each salesperson, depending on the nature of the business. The Sales
Budget needs to be based on realistic estimates of sales, since the Sales Budget will be
the driver behind all of the remaining budgets.

• If the Sales Budget is too optimistic, production will be too high, inventory will be too high,and problems
such as cash shortfall may result.
• If the Sales Budget is too low, production and inventory will be too low, and sales may
belost because of a lack of product to sell.

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The Sales Budget is probably the most difficult budget to produce because it relies entirely on
information and estimations that are outside of the direct control of the company. The company has
no direct control over the economy as a whole or over competitors and technological advances that
may affect sales of the company’s product.

If demand is greater than the company’s production capacity, the Sales Budget should not
reflect the amount the company could sell if it were able to increase production to meet the
demand. Unless the company has specific plans in its Capital Expenditures Budget to increase
production facilities due to the expected increased demand, the Sales Budget will need to be
adjusted to the quantity that will be available to be sold. Thus, it follows that the Sales Budget will
need to incorporate information about sales revenues expected from any capital projects that are
expected to begin generating sales during the coming year.

Budgeted Production = Budgeted Sales + Desired Ending Inventory – Beginning Inventory

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 Operating budget
For example: The sales budget of Robin Manufacturing Company for the third quarter.

Sales Budget

July August September Quarter

Sales in Units 70,000 72,000 77,000 219,000

Selling Price Per Unit $110.8 $110.8 $112 -

Total Sales $7,756,000 $7,977,600 $8,624,000 $24,357,600

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 Production Budget

July August September Quarter

Budgeted sales in units 70,000 72,000 77,000 219,000
+ Desired ending inventory of finished goods
10,000 11,000 12,000 12,000
(Given )
Total units needed 80,000 83,000 89,000 231,000
- Beginning inventory of finished goods (Given ) 8,000 10,000 11,000 8,000
Budgeted production in units 72,000 73,000 78,000 223,000

Budgeted Production = Budgeted Sales + Desired

Ending Inventory – Beginning Inventory

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 Direct Material Purchase Budget

July August September Quarter

Budgeted Production 72,000 73,000 78,000 223,000
Pounds of resin per unit of 5× 5× 5× 5×
product
needed Total Direct Material 360,000 365,000 390,000 1,115,000
in production
Add: Desired ending 35,000 35,000 40,000 40,000
inventory
Total direct material 395,000 400,000 430,000 1,155,000
required
Less: Direct material 35,000 35,000 35,000 35,000
beginning inventory
Direct material 360,000 365,000 395,000 1,120,000
purchases
Purchase price per pound $13.00 $13.00 $13.00
Total cost for direct $4,680,000 $4,745,000 $5,153,000 $14,560,000
material purchase

Direct Materials Purchased =

Direct Materials Used in Production + Desired Ending Inventory of Direct Materials -
Beginning Inventory of Direct Materials
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 Direct Material Budget
Production requirement July August September Quarter
Pounds of resin in beginning inventory 35,000 35,000 35,000 35,000
Cost per pound × $13.00 × $13.00 × $13.00 × $13.00
Total cost of beginning inventory $455,000 $455,000 $455,000 $455,000
Total cost for direct material purchase $4,680,000 $4,745,000 $5,135,000 $14,560,000
Cost of resin available for
$5,135,000 $5,200,000 $5,590,000 $15,015,000
production
Desired ending inventory in pounds 35,000 35,000 40,000 40,000
Cost of desired ending inventory per pound × $13.00 × $13.00 × $13.00 × $13.00
Total cost of desired ending
$455,000 $455,000 $520,000 $520,000
inventory
Cost of resin used in production (cost
Available for Production- Cost of Desired
$4,680,000 $4,745,000 $5,070,000 $14,495,000
Ending Inventory)

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 Direct Labor Budget

July August September Quarter

Budget Production 72,000 73,000 78,000 223,000
DLH required per unit 0.5 0.5 0.5
DLH need 36,000 36,500 39,000 111,500
Hourly rate $15 $15 $15

Total wage for direct labor hour $540,000 $547,500 $585,000 $1,672,500

Direct Labor Requirement = (Expected Production × Direct Labor Hours per Unit)

Budgeted Direct Labor Cost = Direct Labor Requirement × Direct Labor Cost per Hour

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 Overhead Budget (Factory Overhead Budget)

All other production costs that are not in the direct materials and direct labor budgets are in the
overhead budget, sometimes called a fixed costs budget because most of the costs in this category do
not vary with the rise and fall of production. Rent and insurance, for instance, remain stable even if
production goes up or down. However, there are some overhead costs that do vary with
production—variable costs such as batch setup costs or the costs of electricity and other utilities. Fixed
costs are easy to budget,
but variable costs require forecasting the number of units to be produced, the production
methods used, and other external factors.

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 Factory Overhead Budget
Rate per
July August September Quarter
DLH
Total DLHs 36,000 36,500 39,000 111,500
Variable factory overhead
Supplies $0,20 $7,200 $7,300 $7,800 $22,300
Fringe benefits 4,10 147,600 149,650 159,900 457,150
Utilities 1,00 36,000 36,500 39,000 111,500
Maintenance 0,50 18,00 18,250 19,500 55,750
Total variable factory overhead $5,80 $208,800 $211,700 $226,200 $646,700
Fixed factory overhead
Depreciation $20,000 $20,000 $20,000 $60,000
Plant insurance 800 800 800 2,400
Property taxes 1200 1200 1200 3600
Salary supervision 10,000 10,000 10,000 30,000
Indirect labor 72,000 72,000 72,000 216,000
utilities 4,000 4,000 4,000 12,000
maintenance 900 900 900 2,700
Total fixed factory overhead 2.93 $108,900 $108,900 $108,900 $326,700
Total factory overhead $8.73 $317,700 $320,600 $335,100 $973,400

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Standard Cost Sheet Development

A standard cost sheet shows the resources needed and the costs of those
resources to manufacture one unit of a product.
A cost sheet may be used to value inventory, to measure contribution
margin, to set selling prices, and, as will be seen in a later topic, to measure the
performance of departments within the purchasing and production functions.

Resources includes the physical units (such as pounds or linear feet or gallons) of each item of
direct material required to produce one unit of product. The unit of measure used on the standard
cost sheet can vary by industry and/or product.

Product Cost Sheet

Cost Component Units of

Cost/Unit of Cost/Unit of
Resource/Unit of Resource Production
Production
Direct Material lb/unit 5.00 lb/00 .$13 unit/$65.00
Direct labor hr/unit 5 .0 hr/00 .15 50 .7
Variable Overhead hr/unit 5 .0 hr/5.80 2.90
Total Variable Cost unit/$75.40
Fixed Overhead hr/unit 5 .0 hr/$2.93 1.465
Total Cost unit/865 .$76
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The cost sheet shows the product cost is $75.40 per unit in a variable costing income
statement and $76.865 in an absorption costing income statement. Looking ahead to the pro
forma income statement, shows that Robin Manufacturing uses an absorption costing
income statement to conform with GAAP. We know this because the income statement
shows cost of goods sold rather than total variable and total fixed costs.

Cost of Goods Sold Budget

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 Cost of Goods Sold Budget

July August September Quarter

Direct Material used $4,680,000 $4,745,000 $5,070,000 $14,495,000
Direct labor used $540,000 $547,500 $585,000 $1,672,500
Manufacturing Overhead $317,700 $320,600 $335,100 $973,400
Cost of Goods Manufactured
$5,537,000 $5,613,100 $5,990,100 $17,140,900
(COGM)
Add: Beginning finished goodinventory 1 July
(units@$76.865 8,000) $614,920
year 1
Less: Ending finished good inventory1 July year 1 (units@$76.865 12,000) $922,380

Cost of Goods Sold (COGS) $16,833,440

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 Selling and Administrative Expense Budget

July August September Quarter

Research/design $95,000 $95,000 $100,000 $290,000
Marketing 240,000 280,000 290,000 810,000
Shipping 135,000 140,000 150,000 425,000
Product support 90,000 90,000 95,000 275,000
Administration $185,000 190,000 192,000 567,000
Total $745,000 $795,000 $827,000 $2,367,000

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Pro Forma (or Budgeted) Income Statement

For example: the pro forma income statement for Manufacturing Company compiled using
information from the sales budget, the cost of goods sold budget, and the S&A expense budget. In
addition, the company is expected to pay an interest expense of
$140,361 and a tax installment of $1,702,165 for the quarter.

Pro Forma Income Statement

Sales $24,357,600
Less: Cost of goods sold 16,833,400
Gross margin $7,524,200
Less: S&A expenses 2,367,000
Operating income $5,157,200
Less: Interest expenses 140,361
Earnings before taxes $5,015,839
Less: Taxes 1,702,165
Net income $3,314,674

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Pro forma statements represent a company’s projected financial statements. They are
useful in the company’s planning process because these statements support three major
functions. They help a company to:

1. Assess whether its anticipated performance is in line with its established targets.
2. Anticipate the amount of funding needed to achieve its forecasted sales growth.
3. Estimate the effects of changes in assumptions of key numbers by performing
Sensitivityanalysis.

Sensitivity analysis (i.e., what-if analysis) helps to identify potential

conditions that could lead to major problems for the company. This enables the
company to plan for appropriate actions in case such an event should occur. In
addition, sensitivity analysis also provides the company with the opportunity to
analyze the impact of changing its operating plans.

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The Cash Budget

Maintaining adequate liquidity is a requirement for staying in

business, and a cash budget is a plan to ensure liquidity. Because cash is
needed in all areas of operations, the cash budget gets data from all parts
of the master budget. A cash budget is divided into Five sections: the cash
receipt section, the cash disbursement section, the cash excess or
deficiency section, the financing section and Desired Ending cash balance.

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 Cash Budget form
Quarters Total Year
Q1 Q2 Q3 Q4
Beginning Cash Balance
Add: Collection from Customer
Add: Sale of capital Equipment
1-Total Cash Available
Minus: Disbursement
Direct Material
Payroll
Manufacturing Overhead (exclude Depreciation)
S, G&A (exclude Depreciation)
Equipment Purchase (Capital Expenditure)
Cash Dividends
Interest
Income Taxes
2-Total Disbursement
3-Cash Excess (Deficit)
Financing:
Borrowing
Repayment
Investment
5-Total Effect of Financing
4-Desired Ending Cash Balance

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 Case (1): (Sales collection Budget)
Greenup, Inc., produces a product which has peak sales in March of each year. The
company’s budgeted sales for the first quarter of 2019 are given below:
January February March Total

Budget Sales $50,000 $65,000 $75,000 $190,000

In order to have data available for preparing a Cash Budget, the company is anxious to determine the
budgeted cash collections from sales. To this end, the following information hasbeen gathered:

Collections on Sales:
60% in month of sales
30% in month following sale
8% in second month following sale2% uncollectible

The company gives a 2 percent cash discount for payments made by customers during the month of sales.
The Accounts Receivable Balance to start the year is $22,000 of which
$4,000 represents uncollected November sales and $18,000 represents uncollected
December sales.

Required:
1) What were the total sales for November? For December?
2) Prepare a schedule showing the budgeted cash collections from sales, by month and total,for the
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 Answer

Cash Inflows for Month

= (Month zero % Collected × Sales Current Month)
+ (Month one % Collected × Sales Last Month)
+ (Month two % Collected × Sales Two Months Ago)
+ (Month three % Collected × Sales Three Months Ago)

January February March Total

(60% × 98% × S) (60% × 98% × S) (60% × 98% × S)

Sales 29,400 38,220 44,100 111,72
First Month 13,500 15,000 19,500 48,000
Second Month 3,200 3,600 4,000 10,800
Total cash collection 46,100 56,820 67,600 170,520

Note:

1 From December >> 18,000 uncollectible

So, December sales = 18,000 ÷ 40% = $45,000

2 From November >> 4,000 uncollectible

So, November sales = 4,000 ÷10% = $40,000

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Case : (2)

A cash budget by Quarter is given below. Fill in the missing amounts. The company
requires a minimum cash balance of at least $5,000 to start each quarter.
Quarter Year
1 2 3 4
Beginning Cash balance $6 ? ? ? ?
+ collection from customers ? ? 96 ? 323
Total Cash available 71 ? ? ? ?
Disbursements:
Purchase of inventory 35 45 ? 35 ?
Operating expenses ? 30 30 ? 113
Equipment purchase 8 8 10 ? 36
Cash Dividends 2 2 2 2 ?
Total Disbursements ? ? ? ? ?
Excess (Deficiency) of Cash (2) ? 11 ? ?
Financing:
Borrowing ? 15 - - ?
Repayments - - (?) (17) ?
Total financing ? ? ? ? ?
Cash Balance Ending ? ? ? ? ?

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Once a company creates its pro forma financial statements, the statements need to be
analyzedto determine if the company is meeting its predetermined financial targets.
This can be

accomplished by calculating a variety of financial ratios and comparing them

to predeterminedtargets and Industry averages

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