Advancing Business Ability: How To Prepare A Master Budget
The master budget is a business management tool used to project operating and financial performance
. The budgeting processing can be overwhelming. But with a little coaching, preparation and effort the capable executive can create a budget that will keep your business on track during the year. Here is how to prepare a master budget and use the data to make strategic business adjustments.
Overview of budgeting
The first known use of the word budget is from the 15th century. Countries, businesses and households have been doing budgets for a long time. Still the budgeting process remains a mystery of complexity to many people and becomes nothing more than a platform for their desk paperweight. Budgets are a business tool that can power operating results and improve financial durability.
How are budgets used and developed?
Budgets are prepared with a collaborative effort from cross-functional business teams. Gather financial and operating data from the prior year to aid your budgeting process. Budgets are forward looking and prepared for internal use only. Enlist the help of staffers from accounting, marketing, finance, operations, engineering, information technology and other business functions. The budget process can take weeks but the well constructed budget is used by the entire company to stay on track and make strategic business adjustments throughout the year. Begin the budget process well before the beginning of the fiscal year.
What is a master budget?
A master budget rolls up financial and operating projections from various departments within the company. Some companies use sophisticated spreadsheets or budgeting software to drill down into the data when evaluating budget variances during the year. Your business budget can be as simple or complex as your situation and resources dictate.
How are operating budgets prepared?
A company operating budget is prepared using input from the departments that drive revenue or use cash. The examples below are related to a manufacturing business. A service or merchandising business will use some but not all of these budgets:
Sales budget: The projected sales come from the quantity of product that will be sold times the estimated selling price. These numbers come from historical results and forecast adjustments for inflation and market conditions. Estimate cash and credit sales to prepare the bad debt expense estimate in the budgeted income statement.
Production budget: The amount of product to manufacture is derived from the sales budget with allowances for the desired ending inventory of finished goods each month. Companies usually want some inventory on hand to meet unexpected demand.
Direct materials budget: The purchasing manager uses the production budget to budget for materials to meet production each month. An allowance for stock inventory of raw materials is usually made so the production line can keep rolling without delays for out of stock conditions.
Manufacturing Overhead (MOH) budget: The plant manager estimates overhead costs using the production budget. MOH includes variable costs such as indirect labor and materials which fluctuate based on production volume. Fixed MOH includes costs that are incurred whether or not any products are manufactured. The costs include plant depreciation, property taxes and insurance, indirect labor related to fixed overhead and some of the plant utilities.
Operating expenses budget: These expenses are not related to what happens inside the manufacturing plant but are necessary costs of doing business. Variable operating expenses include shipping costs, bad debt and marketing costs. Fixed operating expenses include depreciation on the office building, advertising, utilities for the office space and non-manufacturing payroll costs.
Calculate the budgeted manufacturing costs per unit: The company can prepare the expected cost per unit of product after all of the estimates are in from the manufacturing budgets. Direct materials, direct labor, fixed and variable manufacturing overhead are used to estimate the manufacturing cost per unit.
Prepare a budgeted income statement: The budgeted income statement is prepared using the production budgets and the operating expenses budget. Projected sales, cost of goods sold, gross profit operating expenses, interest income or expense, and income taxes are the primary line items that give the business executive an estimate of net income for the budget period.
Now you know why you need a master business budget and how it is prepared. Increase your financial durability by spending quality time preparing the sales, production, materials, overhead, and operating expense budgets.
by: Michael Shelton
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