“A budgetary planning and control system may include many individual budgets which are integrated into a ‘master budget’. ” Budgeting is concerned with the implementation of long term strategic plans, by translating these long term plans into short term plans of action. A budget is a plan showing a firms short term objectives, and how management intends to acquire, use, and control the resources in order to attain these objectives. A firms budget should be comprehensive and co-ordinated.

That is, it must cover the whole organisation, and as long as each individual manager seeks to fulfil his/her part of the budget, the organisation as a whole should be moving in the right direction. Budgets are a useful planning and control device. “A Budget is a financial plan which is based on expected future activity and is used to control that activity. ”[1] There are several reasons for preparing budgets. Some of these are: 1. As stated above, budgets help form comprehensive and co-ordinated plans for the future. 2. To aid planning of operations.

A budget gives managers specific short term goals to pursue and achieve, and therefore forces them to think ahead. 3. The budget communicates to lower level management what is expected from them by top management. Therefore communication is facilitated. 4. When managers actively participate in the preparation of the budget, they are motivated to achieve the targets that they have set. Furthermore, this encourages an attitude of responsibility, since each manager will know that he/she is responsible for achieving the set standard.

This also leads to a certain freedom of movement, within the limits of the budget, encouraging initiative and facilitating decentralisation. 5. The budget facilitates control by providing a measure for comparing actual results to desired results, and therefore helps identify problems. This also serves as a means of performing management by exception. 6. Similarly, a budget provides the means for comparing performance. Therefore the performance of each manager can be evaluated, and he/she can be rewarded/penalised accordingly. 7. The budget assists the business in determining if price adjustments are likely to be necessary.

Therefore, pricing is facilitated. 8. Preparation of budgets helps resolve differences between functional heads by making personal goals subordinate to organisational ones; goal congruency is encouraged. When preparing a budget, there is a process to be followed. This process consists of the following stages: Budget objectives are stated. Long term plans and goals, set by top management, determine the objectives to be pursued in the annual budget. Setting of attainable financial objectives for the year. This will depend on both external and internal restrictions Sales forecast.

The sales budget is prepared, based on the expected demand. Projected cost of goods sold. All the other budgets are prepared, so that the costs can be estimated and apportioned, in order to get the final cost for the goods. If the company follows a ‘bottom – up’ approach, then the budgets are prepared by lower management, and then negotiated so as to fit the overall budget. * The Master budget is completed. The projected Profit & Loss and Balance Sheet are reviewed by top management and approved. It should be noted that while some consider all the budgets and budgeted accounts as part of the master budget (e. g. R. F.

Meigs & W. B. Meigs, ‘Accounting: The basis for Business Decisions’, eighth edition, McGraw-Hill Publishing co. , 1990, pp. 1002), others consider only the Cash flow statement, Profit & Loss and Balance Sheet as the master budget (e. g. C. Drury, ‘Management and Cost Accounting’, fourth edition, International Thomson Business Press, 1996, pp. 473). Finally, the budget is reviewed periodically so as to identify deviations and take corrective action. If there is a significant change in the environment, then the budget may need to be adjusted. This process is also illustrated by the following diagram: [pic]Adapted from: R. H.

Hermanson, J. D. Edwards & R. F. Salmonson, ‘Accounting Principles’, Business Publications Inc. , 1983, pp. 923. As we have seen, the budget consists of a number of interrelated budgets which together form the overall planned activities of the business; once the various budgets have been linked together, the overall budget, called the ‘master budget’, is constructed. Each department/function/activity may have its own budget, which will set the targets that must be achieved, in order for the department/function/activity to contribute to the overall plan. Each part of a business for which a budget is prepared is known as a budget entre. A typical master budget for a manufacturing business will include: Sales budget Production budget (in units) Manufacturing cost budget (includes: direct material usage & purchases, direct labour, variable & fixed manufacturing overheads) Operating expense budget (selling and administration budget) Budgeted income statement (Profit and Loss account) Cash budget Budgeted balance sheet In order to construct the master budget, all the individual budgets must be prepared. However, these can not be prepared in random. Some parts of the master budget should not be prepared until other parts have been completed.

This is because one budget will be influenced by another; for example, the production budget will depend on the sales budget, since the sales budget will determine how many finished units the firm will require in a given period. Therefore, a logical sequence of steps exists for preparing the parts of the master budget. We will now examine these steps, as well as the main budgets usually prepared: 1. Sales forecast The first step in preparing a master budget is to prepare a sales forecast. This forecast will be based on a number of factors, such as: past experience predicted economic conditions expected level of competition, etc.

It is necessary to start the process with the sales budget, as the predicted volume of sales will determine most of the other variables, such as production, revenue and most costs. When preparing the sales budget, it is necessary to keep in mind not only the external factors mentioned above, but also internal factors, such as financial targets, the firms resources, etc. At all times the budget must be realistic and achievable. 2. Production, manufacturing, and operation expenses The units to be produced, the cost of production, selling and administration costs, etc. , are estimated so that the firm knows the costs that it is to incur.

A budget for any other costs, such as capital expenditure, would be included here. The production budget is necessary in order to ascertain that the right number of goods are available at the right time. This will be affected by the sales in that period, and the level of stock. The production budget will tell us the number of units required, but not their cost. The cost will be determined by direct materials, direct labour, and direct overhead costs, all of which depend on the level of production, which we know from the production budget. Therefore we need to find the costs for each, through the appropriate budgets.

The direct material usage budget will tell us the units of direct material used in production. Then we will construct a direct material purchases budget, which will tell us how many units of direct material we will need to buy. This will depend on the level of production in that period, and the level of stock. We will then construct the direct labour budget, which will tell us the cost of labour. The selling and administration budgets come next. The selling budget will include salaries of departmental personnel, commissions, advertising, etc. The administration budget will include salaries, stationery, and other items.

Finally the overhead budget is prepared. The overheads are normally split into two categories – variable and fixed. This is done so that they can be monitored and controlled more effectively. Variable overheads will vary with production, while fixed overheads are constant. 3. Budgeted Income statement Now that the revenue (sales) and costs are known, a income statement can be prepared, in order to calculate the estimated profit (or loss) to be made. The budgeted income statement shows the effects that our budgeted activities are expected to have upon revenue, expenses, and therefore net income (Profit & Loss account).

The budgeted profit and loss account will help senior management determine if the budget provides satisfactory results. If they are not, then adjustments should be made. This may mean going through the whole budgeting process again. 4. Budgeted Cash flow The cash budget is a forecast of the cash inflow and outflow for the budgeted period. The cash inflow depends on the sales forecast and the credit terms offered by the firm. The cash outflow depends on the forecasted costs, whether these costs are manufacturing costs, operating expenses, or any other expense.

The credit terms of our suppliers will affect when each outflow occurs. The cash budget enables a firm to identify anticipated cash surpluses and deficits, and take appropriate steps to deal with them. It brings together the results of all the other budgets, including sales, costs, and any capital expenditure. 5. Budgeted Balance sheet The balance sheet can now be prepared. It is prepared last, since it is affected by all the other budgets; cash transactions on assets, liabilities, capital expenditure, and net income, effect the balance sheet.

Conclusion: As we have seen, the master budget consists of a projected income statement and a projected balance sheet, showing an organisations objectives and the ways in which it is to try to attain them. It includes supporting budgets for each area, such as sales, costs, production, cash, etc, which are necessary in order to construct the final financial statements. The master budget “is the overall plan of the enterprise as a whole and ideally consists of all the various segmental budgets. ”[2]

The Budgeted statements provided by the master budget enable managers to look into the future and see the possible financial consequences of their plans. They may indicate poor profits or cash flow problems, in which case the budget should be reviewed and adjusted accordingly. In this way master budget helps plan and control the implementation of the strategic plans of the business. Bibliography: 1. R. Edwards & H. J. Mellett, ‘Accountancy for Banking students’, third edition, The Chartered Institute of Bankers, 1983 2. Meigs & W. B.

Meigs, ‘Accounting: The basis for Business Decisions’, eighth edition, McGraw-Hill Publishing co. , 1990 3. Drury, ‘Management and Cost Accounting’, fourth edition, International Thomson Business Press, 1996 4. Hermanson, J. D. Edwards & R. F. Salmonson, ‘Accounting Principles’, Business Publications Inc. , 1983 ———————– [1] J. R. Edwards & H. J. Mellett, ‘Accountancy for Banking students’, third edition, The Chartered Institute of Bankers, 1983 [2] R. H. Hermanson, J. D. Edwards & R. F. Salmonson, ‘Accounting Principles’, Business Publications Inc. , 1983, pp. 939