What Is a Master Budget?

Definition & Examples of a Master Budget

Definition

A master budget is a central planning tool that gives an overview of a business's finances, outlining cash flow forecasts, financial statements, and the financial plan.

Shop owner sitting in his workshop at a table with various tools scattered about and working on his annual master budget held in a 3-ring notebook.
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Key Takeaways

  • A master budget is a comprehensive financial planning document that includes all of the lower-level budgets, cash flow forecasts, budgeted financial statements, and financial plans of an organization.
  • It's usually developed by a firm's budget committee and guided by the budget director.
  • A master budget usually incorporates many elements, which may include the budgets for sales, production, administration, direct materials, labor, and overhead.

The master budget is a comprehensive financial planning document. It usually includes all of the lower-level budgets within the operating budget and the financial budget.

The operating budget shows the income-generating activities of the firm, including revenues and expenses. The result is a budgeted income statement.

The financial budget shows the inflows and outflows of cash and other elements of the firm's financial position. The inflows and outflows of cash come from the cash budget. As such, the result of the financial budget is the budgeted balance sheet.

How a Master Budget Works

A master budget includes all of the lower-level budgets within an organization. It gives a firm a broad overview of its finances and is often used as a central planning tool.

A strategic plan usually forms the basis for an organization's various budgets, which all come together in the master budget. It usually coincides with the fiscal year of the firm and can be broken down into quarters and further into months. If the firm plans for the master budget to roll from year to year, then it would usually add an extra month to the end of the budget to facilitate planning. This is called continuous budgeting.

Note

Companies use​ financial budgeting to facilitate planning and control within a business firm so that they can manage the financial aspects of their business and plan for new product expansion in the future.

The budget committee usually develops the master budget for each year, guided by the budget director, who is usually the controller of the company. They usually plan the operating budgets first since the information from the operating budgets is needed for the financial budgets.

Example of Master Budget

Often, a company's other budgets will roll up into the master budget.

For instance, a company may incorporate its sales budget, the cost of goods sold, selling and administrative expenses, cash budget, capital expenditures, inventory, total assets, and accounts payable to construct a master budget that gives a comprehensive picture of its financials. The master budget allows company directors to forecast the actions they will need to take in the upcoming quarter or year to meet their goals.

Components of a Master Budget

These are the most often used elements within the master budget. Some firms may not use one or another of the budgets, but most use some form of all of them. Service firms, for example, do not typically use production budgets.

Sales Budget

The first schedule to develop is the sales budget, which is based on the sales forecast. The sales budget is not usually the same as the sales forecast but is adjusted based on managerial judgment and other data.

Production Schedule

The second schedule for budget planning is the production schedule. The company must determine the number of sales the company expects to make in the next year. Then, it must budget how many sales in units it needs to make to meet the sales budget and meet-ending inventory requirements. Most companies have an ending inventory they want to meet every month or quarter so that they don't stock out.

Direct Materials, Labor, and Overhead Budget

The next schedules are the direct materials purchases budget, which refers to the raw materials the firm uses in its production process; the direct labor budget, which estimates how many hours of work and how many workers a company needs; and the overhead budget, which includes both fixed and variable overhead costs.

Finished Goods Inventory and Cost of Goods Sold Budget

The ending finished goods inventory budget is necessary to complete the cost of goods sold budget and the balance sheet. This budget assigns a value to every unit of product produced based on raw materials, direct labor, and overhead.

Administrative Budget

The selling and administrative expense budget deal with non-manufacturing costs such as freight or supplies.

Cash Budget

The cash budget states cash inflows and outflows, expected borrowing, and expected investments, usually on a monthly basis.

Note

Any item that is not in cash, such as depreciation, is ignored by the cash budget.

Budgeted Balance Sheet

The budgeted balance sheet gives the ending balances of the asset, liability, and equity accounts if budgeting plans hold true during the budgeting time period.

Capital Expenditures

The budget for capital expenditures contains budgetary figures for the large, expensive fixed assets for the business firm.

Master Budget vs. Flexible Budget

A master budget is static, accounting for one level of production volume. A flexible budget, on the other hand, separates fixed and variable costs and can adjust based on different production outputs.

Flexible budgets are useful to have when sales exceed (or underperform) expectations.

What Businesses Need a Master Budget?

Both manufacturing and non-manufacturing companies can benefit from a master budget. For instance, retail and service companies do not need to account for production costs, but they can still benefit from the organization and guidance of a master budget that rolls up the company's other budgets and financials.

Frequently Asked Questions

Why is a master budget important?

Master budgets are important because they serve as a planning tool to guide the company's actions in the upcoming time period. They also help the firm direct the allocation of its resources to achieve its goals. Master budgets provide an overview of the performance of different departments within the company and can help pinpoint areas for improvement or streamlining.

What is the starting point in the master budget process?

The master budget process begins with compiling the sales budget. You can gather data for a sales estimate by surveying your sales team, analyzing past trends, or consulting with outside research firms. Once you have compiled a sales budget, you'll need to develop a production schedule, budget for labor, materials, administration, and other costs, and calculate the cost of goods sold. Also add the capital expenditures budget and the cash-flow budget to arrive at a budgeted balance sheet.

What is the last step in developing a master budget?

The last step of developing a master budget uses the components you have compiled to create a budgeted balance sheet. The budgeted balance sheet predicts the final effect of costs and sales on the company's balance sheet.

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Sources
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  1. Saylor Academy. "Managerial Accounting: 9.3 The Master Budget."

  2. Penn State. "Financial and Managerial Accounting, 10.4: Flexible Budgets."

  3. Saylor Academy. "Managerial Accounting: 9.4 Budgeting in Nonmanufacturing Organizations."

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