Planning, Budgeting and Forecasting
The architecture of the master budget
Strategy drives long-range plans, which drive the master budget. The master budget has operating budgets (sales, production, direct materials, direct labor, overhead, ending finished goods, cost of goods sold, selling and administrative) and financial budgets (capital expenditures, cash, budgeted income statement, budgeted balance sheet). The sales budget is always the starting point.
Core formulas and mechanics
- Production budget = budgeted sales + desired ending finished goods - beginning finished goods.
- Material purchases = production needs + desired ending materials - beginning materials.
- Predetermined overhead rate = estimated overhead / estimated activity base.
In a cash budget, collections follow the sales collection pattern; disbursements ignore noncash items; borrowing occurs to maintain a minimum cash balance and is normally in round increments, with interest computed on the beginning balance and principal repaid only after the minimum is satisfied (and usually only at the end of the period).
Traps and forecasting tools
Depreciation is not a cash disbursement, yet it indirectly affects cash through taxes. A common trap is confusing a static budget variance with a flexible budget variance: only the flexible budget variance isolates price and efficiency, while the sales-volume variance is the difference between static and flexible budgets.
Forecasting methods include regression (interpret R-squared as the proportion of variation explained and the standard error as forecast precision), time-series decomposition (trend, seasonal, cyclical, random), expected value, sensitivity and scenario analysis, Monte Carlo simulation, and the learning curve (an 80% curve means cumulative average time falls by 20% each time output doubles).
Worked example
Budgeted sales 10,000 units; desired ending finished goods 2,000; beginning finished goods 1,500. Production = 10,000 + 2,000 - 1,500 = 10,500 units. Each unit needs 3 lbs of material; desired ending materials 4,000 lbs; beginning materials 3,000 lbs. Purchases = (10,500 x 3) + 4,000 - 3,000 = 32,500 lbs.