What is a Master Budget? Steps in Preparation, Advantages, and Limitation

Introduction

Master Budget can be defined as the budget of all budgets. It comprises the budget of all the relevant departments and functions within an organization.

It is the sum of the four divisional budgets that are prepared by the respective divisions. It also includes financial planning, cash-flow forecasts, as well as budgeted profit and loss accounts, and forecasted balance sheet of the organization.

Master Budgets are often considered to be one large budget of the organization. However, this is not true. In fact, the master budget can be broadly defined as the summary of the divisional budget. It is regarded as a continuous financial plan.

Steps to Prepare a Master Budget

As mentioned earlier, Master Budgets can be defined as budgets that comprise budgets of other divisions. In this regard, the first step is drafting the Sales Budget.

The sales budget mainly constitutes the predicted amount of sales that the company is going to achieve over the course of time. It includes the number of units that are expected to be sold, in addition to the average selling price, and other administrative costs that are associated with the selling process.

The second most important task in preparation of the master budget is the preparation of the production budget. This also holds tantamount importance because of the reason that it helps the users to be able to get a clear idea regarding factors like procurement, and other respective production-related decisions that need to be undertaken.

Capital Asset Acquisition Budget is also created in cases where the company plans to sell off (dispose of), or acquire (purchase) new capital machinery. This is vital in terms of figuring out cash-related arrangements that need to be undertaken by the company.

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Cash Budgets are drawn as part of the Master Budget in order to ensure that there is proper planning regarding the cash that is going to be required across the course of the year.

Cash Budgets are prepared using Sales and Purchase Budgets so that there is clarity regarding the resources that are required by the company.

In this regard, it is also imperative that companies plan their liquidity position accordingly so that there are no operational backlogs during the course of the year.

Finally, the Budgeted Income Statement and Budgeted Financial Statement is produced to be included in the Master Budget.

This tends to be an important aspect too, essentially because of the reason that it helps companies to estimate the profitability at the end of the given year so that decisions can be made in accordance with the required targets that need to be met.

Advantages of Master Budget

Master Budgets tend to hold tantamount importance for a number of reasons. It can be seen that Master Budgets are required to establish a clear cut idea regarding the financial status of the company.

This is really helpful in cases where there are strategic changes required in order to change the predicted outcome of the company.

Master Budgets tend to give companies a clear sense of direction and approach that can be used as an increasingly important planning tool.

It measures performance, and this helps the company to improve its performance over the course of time. It acts as motivation in terms of the targets that have been set and helps all the people within the company to work for those respective targets.

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It also results in improved communication within the organization, because of the fact that all departments collaborate in order to abide by the Master Budget. In case of any irregularity, they would have a blueprint to follow, which would inevitably result in improved communication within the organization.

Limitation of Master Budget

However, regardless of the advantages of preparing a Master Budget, it can be seen that there are certain additional issues within the realm of Master Budgets that need to be accounted for. Firstly, it can be seen that Master Budgets cannot be changed over the course of time.

This is because of the fact that they require certain planning, and changing one variable leads to changes in almost all parameters. Therefore, they cannot be changed once prepared, and it is really hard to account for these changes.

Additionally, because of the fact that it involves a holistic approach, where there is interdependency on almost all parameters within the organization, figuring out mistakes and errors within the master budget is often a hard task. This is something that makes it hard to identify what went wrong, after the respective year.

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