If you run a one- or two-person business, it’s likely you’ll be doing most of the prep work yourself. However, if you have sales or production managers, be sure to get them involved in the budget creation process as well. Preparing a master budget will require you to first prepare all of the smaller budgets, starting with the sales budget, since the numbers in your sales budget will directly affect the others. In the top-down approach, management must devote attention to efficiently allocating resources to ensure that expenses are not padded to create budgetary slack. The drawback to this approach to budgeting is that the budget is prepared by individuals who are not familiar with specific operations and expenses to understand each department’s nuances. Altogether, the Operating, Cash Flow, and Capital Budgets depict a company’s expected financial performance.

But to unlock the full potential of budgets, you need to have a clear sense of the specificities that go into handling them. Most large-scale organizations will have not one but several documents that all feed into the holistic Master Budget. Understanding its purpose, typical structure, and contents is the next step a master budget consists of towards perfecting the budgeting process. If you’ve been in business for a while, you can use totals from previous years to guide you through the financial projections needed to create the financial budget. If you’re just starting out, all the numbers in both your operational and financial budgets will be estimates.

How are budgets developed?

However, spreadsheets may contain formula errors, and also have a difficult time constructing a budgeted balance sheet. Larger organizations use budget-specific software, which does not have these two problems. Both manufacturing and non-manufacturing companies can benefit from a master budget. For instance, retail and service companies do not need to account for production costs, but they can still benefit from the organization and guidance of a master budget that rolls up the company’s other budgets and financials. The budgeted balance sheet gives the ending balances of the asset, liability, and equity accounts if budgeting plans hold true during the budgeting time period. Whether you’re manufacturing products to sell or just buying them for resale, you’ll need to create a materials budget, which will directly tie to your sales budget.

By now, you should know that we could either use the bottom-up or the top-down approach. Another document sometimes included in the master budget is a set of key performance metrics that are calculated based on the information in the budget. For example, it may show accounts receivable turnover, or inventory turnover, or earnings per share. These metrics are useful for testing the validity of the budget model against actual results in the past. The last step of developing a master budget uses the components you have compiled to create a budgeted balance sheet.