1. Budgetary Planning – Preparation of the Master Budget
Chapter 9
Budgetary Planning –
Preparation of the Master Budget

2. Fixed budget
‘budget set prior to the control period and not subsequently changed in response to changes in activity, costs, or revenues.’
Fixed Budget as defined by CIMA Official Terminology

3. The fixed/master budget
The fixed or master budget sets out the plans for the business for the next accounting period based on various assumptions of sales and sales growth, inflation (in particular labour inflation), interest rates, taxation and capital expenditure. This master budget is known as the fixed budget as it is based on these fixed assumptions of trading performance and financial outlook. Its chief role is at the planning stage, in setting the overall direction or plan for the business

4. The master budget Operating Budgets Capital Budgets Cash Flow Budget
Sales revenue
Cost of sales
Payroll and related expenses
Other department expenses
Fixed expenses
Cash
Flow
Budget
Capital Budgets
Capital expenditure
Stocks (related to purchases)
Debtors (related to sales)
Creditors (related to purchases)
P&L account (Income statement)
Balance sheet
Cash flow
Master Budget

5. The master budget statements
Profit and Loss
Account
Balance Sheet
Cash Budget
A projected profit and loss account (income statement) includes all the revenues and expenses anticipated for the budget month under review.
A projected balance sheet is a statement of the expected position of an entity at the end of the budget month. It contains the expected monetary value of assets, liabilities and capital at the end of the budget month.
Cash budgets are prepared in order to ensure that there will be sufficient cash in hand to cope adequately with budgeted activities. They must contain every type of cash inflow (money received) and every type of cash outflow (money paid).

6. Example 9.1: The effect of sales in the master budget

7. Example 9.1: The effect of sales in the master budget

8. 10% of €100,000 sold in month 3 not received.
Profit and loss extract (months 1 to 3)
Sales revenue
€280,000
€80,000 + €100,000 + €100,000
Cash Budget – Cash inflows
Month 1
Month 2
Month 3
Cash sales (90%)
€72,000
€90,000
Credit sales (10%)
______
€8,000
€10,000
Total sales receipts
€98,000
€100,000
Balance sheet extract as at end month 3
Current Assets
Debtors €10,000
10% of €80,000 sold in month 1.
10% of €100,000 sold in month 2.
10% of €100,000 sold in month 3 not received.

9. Example 9.2: The effect of purchases and stock in the master budget

10. Profit and loss extract for (months 1 to 3) € Opening stock  €
Opening stock
Purchases (€50,000 x 3)
150,000
Closing stock
(20,000)
Cost of goods sold
130,000
Cash Budget - cash outflows
Month 1
Month 2
Month 3
Purchases
€50,000
Month 1 purchases are paid for in month 2.
Balance Sheet extract as at end month 3
Current assets
  €
Stock
20,000
Current liabilities
Creditors
50,000
Month 2 purchases are paid for in month 3.
Month 3 purchases are unpaid (due to be paid in month 4).

11. Other differences between P&L and cash budget
The purchase cost or sales proceeds of fixed assets.
Proceeds from the issue of shares
Cash flows from the procurement or repayment of loans
Depreciation of fixed assets

12. Forecasting
‘A prediction of future events and their quantification for planning purposes’
A forecast as defined by CIMA Official Terminology
Three essential elements are required before one can begin to prepare projected financial statements.
Forecast of sales.
Forecast of costs / expenditure.
Forecast of the required investment in net assets to achieve these sales.

13. Forecasting - factors influencing sales
Past sales volume and mix
Level of competition
Quality of the product or service
Consumer behaviour
Strength of the brand name
State of the economy
Planned advertising expenditure
Political and industrial outlook
Pricing policy
Local activities and events
Capacity
Seasonality
Advance bookings
Demand analysis

14. Forecasting - costs
Fixed cost
Variable cost
Semi-variable cost

15. Forecasting – balance sheet items
Debtors: Debtors tend to increase as sales increase.
Stock levels: More stock is required to meet increased demand.
Cash: More cash is required to meet increased costs associated with the increase in sales.
Creditors: More credit is required from suppliers as purchases increase in line with sales.
Accrued expenses: More accrued expenses occur as a result of increased overheads.
Bank overdraft: A bank overdraft is frequently used to bridge any financing gaps caused by increases in activity.
Fixed assets: As the business expands new fixed assets are required. (Note that fixed assets will not increase as sales increase, but only as the business reaches capacity and requires expansion). Hence there is a long-term relationship between sales and the fixed assets requirement.
Long-term finance: As fixed assets expand, one will also expect long-term finance in the form of equity and more likely long-term debt to increase.

16. Other forecasting issues
Taxation and rate of corporation tax.
Variable interest rates on borrowings.
The rate of inflation.
The policies and commitments of the business.
Capital expenditure
Financing methods
Dividend payouts

17. Example 9.3: Projected financial statements

18. Example 9.3: Projected financial statements

19. Example 9.3: Projected financial statements

20. Example 9.3: Projected financial statements

21. Example 9.3: Projected financial statements

22. Example 9.3: Projected financial statements

23. Projected financial statements and decision-making
Is the projected profit satisfactory in relation to the risks involved and the required return on capital? If not, what can be done to improve this?
Are sales and individual expense items at a satisfactory level?
How adequate are the projected cash flows of the business and can they be improved?
Should management consider additional financing?
What type of financing is required, long, medium or short-term financing?
What type of financial instruments are appropriate, debt or equity?
Will there be surplus funds and if so, what plans have the company as regards investing these funds?
Is the business overly financed through debt?
How liquid is the business?
Is the financial position at the end of the period acceptable?

24. Alternative approaches to budget preparation
Incremental budgeting
Zero-based budgeting
Activity based budgeting
Rolling budgets

25. Incremental budgeting
‘Method of budgeting based on the previous budget or on actual results, adjusting for known changes and inflation’
Incremental budgeting as defined by CIMA Official Terminology
This is where the current budget and actual figures act as the starting point or base for the new budget.
The major disadvantage of this is that the major part of the expense (the base) does not change and.

26. Zero-based Budgeting Zero-based Budgeting ‘Method of budgeting that requires all costs to be specifically justified by the benefits expected’ CIMA official terminology
Advantages
Fosters a questioning attitude to all revenues and costs.
Focuses attention on value for money concept.
Should minimise waste and result in more efficient allocation of resources.
Disadvantages
Costing and time consuming approch

27. Activity based budgeting
‘Method of budgeting based on an activity framework and utilising cost driver data in the budget setting and variance feedback processes’
Activity based budgeting as defined by CIMA Official Terminology
ABB is an extension of the zero-based budgeting approach and goes into far greater detail in identifying value and non-value activities. It can be more effective than zero-based and incremental budgeting because:
It avoids slack that is often included in the incremental approach.
ABB focuses attention on each activity, highlighting those that do not add value.

28. Rolling budgets
‘Budget continuously updated by adding a further accounting period (month or quarter) when the earliest accounting period has expired’
Rolling budgets as defined by CIMA Official Terminology
A rolling budget is a twelve month budget which is prepared several times each year (say once each quarter).
The purpose of a rolling budget is to give management the chance to revise its plans, but more importantly, to make more accurate forecasts and plans for the next few months.

29. Rolling budgets Advantages Disadvantages
Budgets are reassessed regularly and thus should be more realistic and accurate.
Because rolling budgets are revised regularly, uncertainty is reduced.
Planning and control is based on a recent updated plan.
The budget is continuous and will always extend a number of months ahead.
Disadvantages
Rolling budgets are time consuming and expensive as a number of budgets must be produced during the year.
The volume of work required with each reassessment of the budget can be off-putting for managers.
Each revised budget may require revision of standards or stock valuations which is time consuming.