Question

What is the purpose of budgeting? What is the master budget, and what are its major components? How does a top down budgeting process differ from a bottom up approach?

Answer 1

A business requires that a management must plan future financial and physical requirement just to maintain profitability and productivity of the business concern. The procedure for preparing plan in respect of future financial and physical requirement is generally called budgeting.

                          Thus budgeting is the forward planning and involves the preparation in advance of the quantitative as well as financial statement to indicate the intention of the management in respect of various aspects of business.

Master budget-master budget is also called as summary budget. It can be easily consider as summary of detailed functional or departmental budgets .it is a summary budget which incorporates all functional budgets and it may take the form of profit and loss account or balance sheet at the end of budget period. When separate budget regarding all functional area are finalised (i.e. final target of sale, production costs, finance etc are determined), targeted final accounts may be prepared with the help of these figures. On the basis of last year balance sheet and information collected by the above budgets projected balance sheet may be prepared. Sometimes accounting ratios are also used in this purpose.

Major components of master budget are-

Capital expenditure budget

Sales budget

Production budget

Income and expenditure (revenue or expenditure budget)

Material budget.

Direct labour budget

Selling and administrative budget

There are many methodologies for preparing financial forecast the two of the most common are top-down and bottom-up analyses.

A top bottom approach involves senior management to development high level budget for entire organisation. Under this approach senior management   meets and determines high-level targets for the company for sales, expenses, and profits. A crucial factor for successfully implementing this method for estimating budgets is the experience and judgment of those involved in producing the overall budget estimate

Under bottom up budget approach, it begins with identifying all the constituent tasks that are involved in implementing a project and working out the resources and funding required by each. It starts with individual department where manager create a budget and then send it upwards for approval.