COMPONENTS OF THE MASTER BUDGET 1

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1 COMPONENTS OF THE MASTER BUDGET 1 The Strategic Use of Master Budgets: A Strategic Planning Document Anitra N. Reaves Walden University MBA/MGT 6170: Budgeting & Resource Allocation March 22, 2015

2 COMPONENTS OF THE MASTER BUDGET 2 Master Budgets Managerial accounting is the internal planning, forecasting and calculated projections that account for how the business will fund its operations for different budgeted activities within the firm (Heisenger & Hoyle, 2015). Managers from various responsibility centers are tasked with providing key insight from their respective lines of business that contribute to being able to plan a budgeted outlook for the future at the corporate, business and functional level management of the company or organization. Budgets are varied and specific to account for certain categories of business functions and internal business processes. These budgets are amassed together from all functional areas and are used to architect the overall operating and financial budget for the business. This collection of aggregated budget statements represent what is called; the Master Budget; which is a quantifiable expression of management expectations as it pertains to costs, revenue and income for the determined budgeted time frame (Shim, Seigel & Shim, 2012, p.95). The master budget is a planning document for the future and a measurement tool for controlling and managing performance in real time. This enables the business management team to correct any deviations from the overall profit planning objectives and organization wide performance targets; by supplementing, or broadening its flexibility to account for business needs that may change through the planned budget year. The master budget informs management with useful, quantifiable data that is specific, measureable, relevant, and time bound. It provides significant value to the firm in its ability to make strategic decisions and the operational flexibility to continuously improve. This aids in increasing enterprise agility; adjusting its performance along a series of organizational dimensions; and strengthens the firm s knowledge of how effective it is, has been and will be in performing against its goal or plan. In order for managers to confidently account for budgetary expectations, budget exceptions and meet profit planning objectives; it is vital that managers understand not only their responsibility center and

3 COMPONENTS OF THE MASTER BUDGET 3 the management of their centers revenue and expenses; but also understand how their budgets interrelate, intersect and balance or offset other budget centers as well. All information contained in the budgets must make sense to a reasonable degree; to the extent that it is understood that the budget is a planning document that is part of an overall corporate strategic plan and continuous strategic management process. By knowing how each functional budget relates to the overall master budget; managers can empower themselves to communicate more effectively, collaborate better, share information, negotiate their needs more clearly, express their concerns more candidly and extrapolate out key insights that may not be explicitly stated or reflected in the budgeted statements. This provides for a strengthening of data analysis competencies in the management team, and informs their increased capacity to identify trends, patterns and unusual variances in accounting & budgeting reconciliations; which are essential to developing accurate dollar-cost revenues and expenses; and balance sheets for the company (Investopedia.com, n.d). Sales Budgets Sales are the primary sources of information as it relates to products, goods and or services that are marketed and sold by a company. A sales plan is necessary to increase predictability about desired outcomes the business has planned for the next month, quarter or year. The determined idea of a sales plan is to mitigate ambiguity, enhance clarity, increase predictability, synthesize management analysis and decisions; and provide additional knowledge that is germane to profit planning to account for management oversight and control of sales activities, (Shim, Siegel & Shim, 2012, p.97) The sales budget is the foundation to synthesizing all subsequent components to create a master budget. The sales budget provides an outlook of what revenues will be for the business as it relates to its core product, good or service. The sales budget provides an overall framework from which the inventory, production, materials, labor and administrative-operating expenses can be projected for those budget

4 COMPONENTS OF THE MASTER BUDGET 4 centers. The sales budget provides information that is essential in anticipating scenarios and adjusting volume and pricing to predict for higher or lower revenue that can be used to fund other budget centers and analyze the impact on profitability as a whole. Cox (2011) described these scenarios as what-if sales growth assumptions, (p.54). The sales budget can account for sales volume and revenue; by units sold and the unit price point at which they are sold, account for sales volume and revenue by quarter; and inform what can be expected in terms of cash collections on its accounts receivable statement. These collections contribute to proper balance sheet accounting as well. This sales budget can enable managers to perform break even analyses and determine proper resource allocations that are needed to fund other aspects of the businesses operations. The sales budget can add to business intelligence on how much the market for its product is growing or contracting; and lead to questions that will help manager s answers why and how market share is growing or contracting. This knowledge can serve as a useful source of information for adjusting sales strategies in core markets; or for increasing its flexibility in new markets. Sales budgets also provide useful formulas for reasoning out how figures (units or dollars) are derived. For this reason the sales budget must be the first component of the master budget created, because if the premises of sales goals are not realistic then the conclusions of the associated revenues, costs and profits will also be skewed. Production Budget The production budget follows from the sales budget, because it takes the sales volume that managers have projected will be needed to meet sales goals and allows them to properly determine what their production output must be and assess if operational (manufacturing) capacity can support the production unit volume that must be yielded. The production budget accounts for the beginning finished good inventory and the ending finished goods inventory, which is sound management strategy in the event

5 COMPONENTS OF THE MASTER BUDGET 5 more units are needed to meet and unexpected increase in demand during the sales period for that product or good, or decrease excess that may lead to loss or unpurchased goods at the end of a period. Costs are undefined as the production is specific to units needed to be produced only (Shim, Siegel & Shim, 2012, p.101). Direct Material Budget Materials that will be needed to meet production goals are assessed relative to the amount of materials that will be consumed in production of the units to be sold and the cost associated with those material purchases. Materials in in the Direct Materials budget are accounted for in actual units produced to be sold in sales projections; and for the ending and finished inventory levels determined by the company s inventory policy (Shim, Siegel & Shim, 2012, p.103). The direct materials budget must be quantified in what will be needed to cover materials expenses. It follows logically that the direct materials budget would follow the units determined reflected in the production budget. Managers cannot effectively plan for materials based on a production volume that has not been planned for in the sales plan and production budget. If materials are purchased prior to receiving information from production, the material the company has on hand may be less or more than is needed to be sold; or less or more than is needed to cover standing inventory. This could inflate budget resource allocations, or underfund needed resource allocations. These decisions could ultimately affect the company s variable or mixed costs; and profitability / income against the plan. Direct Labor Budget The labor that will be needed is directly informed by what production goals are. A sufficient operational workforce will be needed to cover all the production hours that it will take to produce the sales volume determined. A series of computations are needed to determine what the direct labor costs will be and involve-- accounting for, the expected production volume for each period multiplied by the direct

6 COMPONENTS OF THE MASTER BUDGET 6 labors required to meet production of each unit to be sold, (Shim, Siegel & Shim, 2012, p.104). For example in our analysis of Arrowdale manufacturing; our production volume of 605,000 thermos units was multiplied by.5 hours totaling 302,000 labor hours. This was then multiplied by the hourly rate of $12.00 which gave us a total of $3,630,000 direct labor hours needed to meet our determined production volume at Arrowdale. The following of direct labor after production makes sense because managers need to be able to determine if have sufficient manpower to meet production goals, which contribute to meeting sales goals. Ending Finished Goods Inventory & Factory Overhead, Cost of Goods Sold and Admin and Selling Budget The ending inventory that production has on hand aids in reconciling the company balance sheet. The previous budgets provide for managers to know how much costs were incurred manufacturing the product unit to include the factory overhead which includes manufacturing expenses not accounted for in the direct labor and materials statements. This reconciliation is essential for the developing and communicating a rationale for; determining the cost of the product, and how much money the product represents in the finished inventory; which allows managers to populate budgeted financial statements, i.e. the budgeted income statement and the budgeted balance sheet (Shim, Siegel & Shim). The costs of goods sold assist managers in determining what their cost of goods available for sale are and what the company s gross margin is. It is important that these budgets proceed from the following because it reconciles the budgeted income statement in a sequential order so that managers can see where additions and subtractions will be from the total sales revenue gained. Once Managers know and can communicate these facts to the business and functional levels management teams; they are now in a position to account for their administrative and selling expenses which will show what their total operating income will be to cover things like compensation and taxes, for example. The administrative and selling expense budgets

7 COMPONENTS OF THE MASTER BUDGET 7 apprise managers of the costs associated with manufacturing products and managing the firms business activities and can be separated by mixed costs (Shim, Siegel & Shim, 2012). Cash Budget Cash budgets are necessary to reconcile receipts, disbursements surplus and deficits as they show the sources of cash coming into the business and the cash flowing out of the company and any money received from investments made, or cash collected from customer credit accounts. Cash must be sufficient to cover quarterly ending cash balances and also account for and variances that result in a cash shortage. A company may have available credit resources from which it may borrow against to cover these situations. The company may use any surplus money repay the bank for credit used. A Cash budget is important because it ensures that enough money is on hand to allocate to the different budget centers; for materials, labor factory overhead and selling and administrative expenses, as well as financing and repayment obligations (Shim, Siegel & Shim).

8 COMPONENTS OF THE MASTER BUDGET 8 References Heisinger, K., & Hoyle, J. (2015). Managerial accounting: Characteristics of managerial accounting. In Flat World Education. Retrieved March 22, 2015, from Flat World Education.com website: ch09_s03#heisinger_1.0-ch01_s01 Reconciliation. (n.d.). In Investopedia. Retrieved March 22, 2015, from Investopedia, LLC website: Shim, J. K., Siegel, J. G., & Shim, A. I. (2012). Master budget. In Budgeting Basics and Beyond (Fourth, pp ). Hoboken, NJ: John Wiley & Sons, Inc.