Budgeting Basics and Beyond

Chapter 6. Master Budget: Genesis of Financial Forecasting and Profit Planning

A comprehensive—master—budget is a formal statement of management's expectation regarding sales, expenses, volume, and other financial transactions for the coming period. It consists basically of a pro forma income statement, pro forma balance sheet, and cash budget.

At the beginning of the period, the budget is a plan or standard. At the end, it serves as a control device to help management measure its performance against the plan so that future performance may be improved.

With the aid of computer technology, budgeting can be used as an effective device for evaluation of "what-if" scenarios. Management can find the best course of action among various alternatives through simulation. If management does not like what it sees on the budgeted financial statements in terms of financial ratios such as liquidity, activity (turnover), leverage, profit margin, and market value ratios, it can always alter its contemplated decision and planning set.

The budget is classified broadly into two categories:

1. Operating budget

2. Financial budget

The operating budget consists of:

• Sales budget

• Production budget

• Direct materials budget

• Direct labor budget

• Factory overhead budget

• Selling and administrative expense budget

• Pro forma income statement

The financial budget consists of:

• Cash budget

• Pro forma balance sheet

The five major steps in preparing the budget are:

1. Prepare a sales forecast.

2. Determine expected production volume.

3. Estimate ...