Budgeting

An important part of figuring out the future of a company is by creating a budget. With budgets, we need to know how many units we expect to sell, how many units we expect to produce, how much cash we expect to receive, and how much cash we expect to spend.

Each year, companies create what is called a master budget. Now a master budget is composed of several individual budgets, and a master budget can also be called an annual business plan. What’s important to know about the master budget is that it’s based on one level of activity. Once we estimate the amount of activity we will have, we are not going to change it throughout the year. Because we don’t change the master budget, it is called static.

Study Tip: The master budget is composed of both operating budgets and financial budgets and is based on one level of activity.

Let’s say we’re an airplane manufacturer and we estimate that we’re going to sell 200 airplanes this year. Our master budget’s going to be based on that one level of activity, 200 airplanes. We’re not going to consider what happens if we only sell 60 airplanes, or what happens if we sell 300 airplanes.

Under the umbrella of master budgets, we have operating budgets and financial budgets. When we’re creating budgets, there’s a specific order that we have to create them in. First, we have to create the operating budgets, and then we create the financial budgets.