Primary Master Budget Components: The Major Operational Financial Plan

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Since the time she was hired as the budget officer for Apex Company, Melissa has always been watchful of deadlines for budgets. Because of this, she has to remind the department heads about the early submission of their respective financial plans so that these might be discussed as quickly as possible with management.

In an organization, budgets from the different departments are initiated by the department heads with the assistance of their subordinates because it is they who are familiar with their needs. Apex Corporation has the same procedure. Melissa, as the budget officer, is given the responsibility of integrating the statements before October of every year. She has to help whenever there is a need. These budgets are then discussed with the board of directors together with a financial consultant.

The reviewed plans are then given back to the department heads so that they can work on the necessary revisions agreed upon by concerned parties. Being involved with the integration, Melissa considers her task as tough and difficult, particularly in dealing with department heads, because some of them insist on impossible variables and figures sometimes.

Defining a Master Budget and Its Components

The master budget represents the overall plan of the organization for a given budget period. It consists of all the individual budgets for each segment of the organization aggregated or consolidated into one overall budget for the entire firm.

The exact composition of the master budget depends on the type and size of the organization. Generally, however, it is composed of two major parts: the operating and the financial budget.

Budget Components

The table below summarizes the components of a master budget for Apex Corporation:

APEX MANUFACTURING COMPANY

Master Budget

Operating Budget Financial Budget

Sales Budget – Budgeted Balance Sheet

Ending Inventories Budget

Cash Budget

Production Budget

Capital Expenditure Budget

Direct Materials Budget

Budgeted Statement of Changes in Financial Position

Direct Labor Budget

Factory Overhead Budget

Cost of Goods Sold

Selling Expense Budget

Administrative Expense Budget

Budgeted Income from Operations

Budgeted Non-Operating Items

Only the components for the operating budget are discussed in this article.

The operating budget is none other than the income statement for a certain budget period. The financial budget, on the other hand, includes the budgeted balance sheet as of the end of a certain budget period, budgeted statement of changes in financial position, capital expenditure budget, and all other budgets required in financial management.

Operating Financial Plan

Below are the 8 detailed budgets that compose the Operating Financial Plan of Apex Corporation:

1. Budgeted Sales

A master budget actually starts with forecasted sales. The sales department determines how many units of products the company will be able to sell the following year based upon the past and present figures with consideration of future economic conditions, capacity of management, business plan of the company, and other factors that affect sales.

Sales forecast is significant because it is a basis of computing the company's gross returns within a given period. From there, all integrated units will obtain a basis for their respective forecasts.

As a summary, the anticipated number of units of products to be sold multiplied by the projected price is the result of this budget.

For Apex Company, forecasted sales will be 10,000 units of Borjay Electrical Chips at a projected price of $100 each.

To calculate this, 10,000 units multiplied by $100 is equal to $1,000,000 sales in amount.

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Components of a Master Budget (continued)

2. Budgeted Production

The production department is an interested party in the company’s forecasted sales. Why? The sales forecast is the basis of computing how many units of the products are going to be produced. After obtaining the forecasted sales quantity, this is added to the desired ending inventory to obtain the total product requirement (quantity needed to have as stocks for the period). The result will be added to the remaining units from the previous month. In this example, 4,000 units were the remaining units for the previous month, September.

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For budgeted production, therefore, we need the following data

Forecasted sales in units

Beginning inventory of Product Units

Desired Ending Inventory of the Product Units

Applying that to Apex Company:

Sales Budget in Units of Borjay, 10,000

Desired Borjay stocks at the end of October, 5,000 (might be based on experience or study)

Total Borjay Requirements for October, 15,000

Less: actual stocks left for September 4,000

Budgeted Production for Borjay for the month of October, 11,000

3. Budgeted Material Requirements

After determining the budgeted production for October, the materials needed to produce this quantity can also be calculated by multiplying the budgeted production quantity by the number of materials needed for one unit resulting in the total number of materials needed for the budgeted production. Since materials are also necessary to accommodate emergency sales, the department should provide ending stocks of materials. Thus, the desired ending of inventory for materials is added to the materials requirements with deduction of any remaining materials of September.

To illustrate the above explanation, let us continue with the Apex Company:

If 2 units of materials A and B are required to produce one unit of Borjay and the company has to maintain 20,000 and 10,000 beginning and ending units of materials, the budgeted material quantity is computed as follows:

Material A Material B

Material A = 11,000 multiplied by 2 = 22,000

Material B = 11,000 multiplied by 2 = 22,000

The total number of materials A and B needed to produce 11,000 Borjay are 22,000 and 22,000, respectively.

4. Budgeted Cost of Material Purchases

Based on number 3, if material A costs 2 dollars each and material B costs 3 dollars each, the budgeted production costs for Materials A and B are as follows:

Material A Material B

22,000 multiplied by $2 = $44,000

22,000 multiplied by $3 = $66,000

The total budgeted purchases for materials A and B total $110,000.

5. Budgeted Direct Hours

This statement shows the direct labor hours required for the budgeted production. It is a mere extension of the production quantity budget.

To calculate the budgeted direct labor cost, the budgeted quantity of production is multiplied by the required direct labor hours per quantity. This results in the total budgeted direct labor hours which is then multiplied by the direct labor rate per hour to determine the budgeted direct labor cost.

Still using the Apex Corporation, if the budgeted production is 11,000 Borjay units, and production needs 5 hours to produce one unit of Borjay, the total budgeted hours needed to produce 11,000 Borjay is computed as follows:

Budgeted Production for Borjay Units 11,000

Number of hours to finish one Borjay 5 hours/unit

Number of hours needed to finish 11,000 Borjay units = 55,000

6. Budgeted Direct Labor Cost

Furthermore, for Apex’s labor hours, if management wants to know how much will be spent in dollars, the following applies:

With the 55,000 of hours needed to finish 11,000 Borjay units, the cost of such labor hours can be determined by simply multiplying 55,000 by the cost per hour, say $4.

Applying the formula, 55,000 hours multiplied by $4/hour, the total direct labor cost is $220,000.

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Components of a Master Budget (continued)

7. Factory Overhead Cost Budget

Unlike direct materials and direct labor which are usually classified as purely variable costs, factory overhead costs are composed of both variable and fixed costs elements. In preparing the factory overhead costs budget, it is advisable to show the two cost elements separately so as to consider the behavior of each type of cost.

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For producing Borjay, a total amount of $100,000 factory overhead incurred during the current month’s production:

Variable Fixed

Factory Supplies $4/unit

Electricity $0.50/unit

Repairs and Maintenance $2/unit $2,000

Indirect Labor $5,000

Property Taxes $2,500

Insurance $1,500

Depreciation $3,000

You can see from the above schedule that variable expenses are usually computed as per unit. If the company produces more units, the variable expenses number is bigger than when the company is producing less. Fixed expenses remain the same in spite of volume change.

8. Cost of Goods Budget

After the accomplishment of the 7 computations above, you can now compute the goods sold.

How are you going to do this?

Adding the amounts from 4, 6, and 7, we can obtain $430,000 which represents the Total Manufacturing cost:

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(4) Budgeted Cost of Material Purchases $110,000

(6) Budgeted Direct Labor Cost $220,000

(7) Factory Overhead Cost budget $100,000

The total manufacturing cost, $430,000, is then added to the Work in Process, beginning (this amount represents product costs that were not finished the previous month of September and will be put into process this current month of October. If the cost of the work in process beginning for October is equal to $5,000, then the amount of total cost placed in process for October is $435,000 ($430,000 plus $5,000). If there is any cost of work in process (unfinished) for October or the so-called work in process, end, this amount will be deducted from $435,000. If $6,000 is the work in process, end, the total cost of goods manufactured or being transformed into finished products for the month of October is $429,0000 ($435,0000 minus $6,000).

Applying the figures above, the computation for getting the total costs placed in process is:

Total Manufacturing Cost $430,000

Add: Cost of Goods in Process, beginning $5,000

Total Cost Placed in Process $435,000

Less: Cost of Goods in Process, end, $6,000

Total Goods Transformed as Finished Goods $429,000

In obtaining the cost of goods sold, simply add the figure $429,000 to the remaining finished goods of the previous month and deduct whatever remains during the current month.

Applying the formula above, if the cost of the ending finished goods (unsold) for the month of September is $10,000 and the cost of the ending finished goods for the month of October is $20,000, then the Forecasted Cost of Goods Sold for the month of October is $419,000.

Applying these figures, let us continue:

Total Goods Transformed as Finished Goods $429,000

Add: Finished Goods unsold last September $10,000

Total Goods Available for Sale $439,000

Less: Remaining Goods for October $20,000

Cost of Good Sold for the month of October $419,000

Finally, if there are no other items to consider, the Budgeted Gross Income is obtained by deducting the Forecasted Cost of Goods Sold from the Forecasted Sales. Applying the figures, it is $1,000,000 minus $419,000, or $581,000. Any budgeted operating expenses can now be deducted from $581,000 to obtain the BUDGETED NET INCOME OF APEX CORPORATION.

Effectiveness of Operating Plan and the Master Budget

The operating plan, as a major component of the master budget integrated from the various operating budgets that were created by the concerned departments will become effective if:

1. Desired targets of departments are realistic.

2. People involved with the budgets are:

a) Aware of their respective department's objectives.

b) Capacitated in visualizing the output they want to achieve.

c) Ready to accept accountabilities during challenging times.

d) Motivated and skillful.

e) Conscious of deadlines.

f) Able to set up budget figures that are neither too tight nor too excessive for their actual needs.

3. There is always a room for flexibility. Everyone in the organization accepts that changes occur along the way and they must be ready for them.

4. There is supportive management for these components of a master budget.

5. Products are competitive.

Conclusion

A budget is only a tool. It does not mean that if the company has an excellent strategic tool, everything will work out right. Nothing can subsititute for teamwork in the organization. Everyone should be united in achieving the goals and leading the race in this competitive world of business.

Book and image credits:

Management Advisory Service by Rodelio S Roque, 1990

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