Budgeting is an essential tool for planning and controlling the financial performance of a business. However, not all budgets are created equal. There are different types of budgets that serve different purposes and have different advantages and disadvantages. In this blog post, we will compare and contrast two common types of budgets: master budget and flexible budget.
What is a Master Budget?
A master budget is a financial forecast of all elements in the business for the financial year prepared by combining many functional budgets such as sales budget, purchases budget, production budget, selling and administrative budget, etc. These different budgets are interconnected and collectively provide accounting estimates for the upcoming financial period.
The master budget has two main components: operational budget and financial budget. The operational budget prepares forecasts for routine aspects such as incomes and expenses. The financial budget outlines how the company earns and spends funds at the corporate level, including capital expenditure and revenue forecasts.
The master budget is usually prepared based on a single level of output or sales volume for the given period. This means that the master budget is static and does not change with the actual level of activity. The master budget is used as a basis for evaluating the actual performance of the business by comparing the actual results with the budgeted amounts.
What is a Flexible Budget?
A flexible budget is a budget that is adjusted by incorporating changes in the number of units produced or sold. A flexible budget separates fixed and variable costs and can adjust based on different production outputs. For example, if the actual sales volume is higher than the budgeted sales volume, then the flexible budget will increase the variable costs proportionately to reflect the higher level of activity.
The flexible budget is useful for analyzing and improving the performance of the business by comparing the actual results with the flexible budget amounts. The flexible budget shows how much revenue and cost should have been incurred at the actual level of activity, and thus eliminates the effect of volume variances that may distort the comparison with a static master budget.
Why It Matters
Both master budget and flexible budget are important tools for managing and improving organizational performance. However, they have different purposes and advantages and disadvantages. Some of them are:
– It provides a comprehensive view of the financial affairs of the business for the entire year.
– It helps in setting goals and objectives for each department and unit.
– It facilitates coordination and communication among different levels and units of the organization.
– It serves as a benchmark for evaluating the actual performance of the business.
– It requires a lot of time and effort to prepare and update.
– It may be unrealistic or inaccurate if based on faulty assumptions or estimates.
– It may not reflect the changes in market conditions or customer demand that may occur during the year.
– It may create a rigid mindset among managers and employees that may hinder innovation and adaptation.
– It provides a more accurate and relevant comparison of actual results with budgeted amounts.
– It helps in identifying and explaining variances that are due to efficiency or price factors rather than volume factors.
– It allows managers to adjust their plans and actions according to the changing level of activity.
– It motivates managers and employees to perform better by holding them accountable for their controllable costs.
– It requires more complex calculations and adjustments than a static master budget.
– It may not capture all the factors that affect costs and revenues other than volume, such as quality, mix, or timing.
– It may not provide a clear direction or vision for the long-term strategy of the business.
– It may create a short-term focus among managers and employees that may neglect long-term goals.
Master budget and flexible budget are both useful tools for planning and controlling organizational performance. However, they have different strengths and weaknesses that need to be considered. Managers should use both types of budgets with caution and flexibility, and adapt them to suit their specific situations and needs.
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(1) Difference Between Master Budget and Flexible Budget. https://www.differencebetween.com/difference-between-master-budget-and-vs-flexible-budget/
(2) 7.4 Prepare Flexible Budgets – Principles of Accounting, Volume 2 …. https://openstax.org/books/principles-managerial-accounting/pages/7-4-prepare-flexible-budgets
(3) What Is a Master Budget? – The Balance. https://www.thebalancemoney.com/budgeting-what-is-a-master-budget-393049
(4) Master Budget – What Is It, Purpose, Example, Components – WallStreetMojo. https://www.wallstreetmojo.com/master-budget/
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