Budgeting Cycle and Master Budget

Well-managed companies usually cycle through the following annual budgeting steps:

1. Before the start of the fiscal year, managers at all levels take into account the company’s past performance, market feedback, and anticipated future changes to initiate plans for the next period. For example, an anticipated economic recovery from a recession may cause managers to plan for sales increases, higher production, and greater promotion expenses. Managers and management accountants work together to develop plans for the company as a whole and its subunits such as departments or divisions.
2. At the beginning of the fiscal year, senior managers give subordinate managers a frame of reference, a set of specific financial or nonfinancial expectations against which they will compare actual results.
3. During the course of the year, management accountants help managers investigate any deviations from the plans, such as an unexpected decline in sales. If necessary, corrective action follows—changes in a product’s features, a reduction in prices to boost sales, or cutting of costs to maintain profitability.

The preceding three steps describe the ongoing budget-related processes. The working document at the core of this process is called the master budget. The master budget expresses management’s operating and financial plans for a specified period, usually a fiscal year, and it includes a set of budgeted financial statements. The master budget is the initial plan of what the company intends to accomplish in the period and evolves from both the operating and financing decisions managers make as they prepare the budget.

• Operating decisions deal with how best to use the limited resources of an organization.
• Financing decisions deal with how to obtain the funds to acquire those resources.

The terminology used to describe budgets varies among companies. For example, budgeted financial statements are sometimes called pro forma statements. Some companies, such as Hewlett-Packard, refer to budgeting as targeting. And many companies, such as Nissan Motor Company and Owens Corning, refer to the budget as a profit plan. Microsoft refers to goals as commitments and distributes firm-level goals across the company, connecting them to organizational, team, and—ultimately—individual commitments.

This text focuses on how management accounting helps managers make operating decisions, which is why operating budgets are emphasized here. Managers spend a significant part of their time preparing and analyzing budgets because budgeting yields many advantages.