The master budget is usually a short term budget, generally covering a period of one year to eighteen months and is used to control the entire organization. The formation of the master budget requires the following steps.
This forecast may be based upon simple intuitional judgements about the future trends or it may be the result of more complex statistical calculations.
For example, production costs that are directly attributable to production should be assigned to production department. However, such incremental production costs that are incurred due to special production runs, initiated because of emergency direction from the sales department, may be assigned to the sales department.
These costs include predetermination of expected material costs, labour costs and other proportionate administrative and overhead costs. These costs can be determined either from the past cost data and cost patterns or from current cost and engineering studies of the process.
These are all interrelated. Purchasing budgets make provisions for acquiring the required material resources to meet production targets. The production target and production budget provide for production facilities and production capacities in order to satisfy forecasted sales demand.
All the individual unit budgets are integrated into one single harmonious unit. This unit, known as profit plan, has provision to record financial input from sales of the merchandise and the expenditures for purchasing of raw materials, labour and other expenses such as various taxes due and paid.
At- the end of the budget period the profit plan would indicate whether there are any reserve funds or any deficits as a result of differences between the revenues and total expenses. This will indicate the financial health of the organization so that any changes that may be necessary can be made to improve its financial situation.