182 Understanding the Numbers
degree of achievement of plans embodied in the budget. To minimize adverse
behavioral problems, managers should take care to develop and administer bud-
gets appropriately. Budgets should not be used as a hammer to demand unat-
tainable performance from employees. The best safeguard against unrealistic
budgets is participative budgeting.
DEVELOPING A BUDGET
Budgets are useful, and in most cases essential, to the success of virtually all
organizations whether they are for-profit or not-for-profit organizations. The
larger and more complex the organization, the more time, energy, and re-
sources are needed to prepare and implement the budget.
The Structure of Budgets
Regardless of the size or type of organization, most budgets can be divided
into two categories: the operating budget and the financial budget. The operat-
ing budget consists of plans for all those activities that make up the normal op-
erations of the firm. For a manufacturing business, the operating budget
includes plans for sales, production, marketing, distribution, administration,
and any other activities that the firm carries on in its normal course of busi-
ness. For a merchandising firm, the operating budget includes plans for sales,
merchandise purchases, marketing, distribution, advertising, personnel, ad-
ministration, and any other normal activities of the merchandising firm. The
financial budget includes all of the plans for financing the activities described
in the operating budget plus any plans for major new projects, such as a new
production plant or plant expansion. Both the operating and financial budgets
are described later in more detail.
The Master Budget
The master budget is the total budget package for an organization; it is the end
product of the budget preparation process. The master budget consists of all the
individual budgets for each part of the organization combined into one overall
budget for the entire organization. The exact composition of the master budget
depends on the type and size of the business. However, all master budgets rep-
resent the organization’s overall plan for a specific budget period. Exhibit 6.4
lists the common components of a master budget for a manufacturing business.
The components of the master budget form the firm’s detailed operating
plan for the coming year. As noted earlier, the master budget is divided into the
operating budget and the financial budget. The operating budget includes rev-
enues, product costs, operating expenses, and other components of the income
statement. The financial budget includes the budgeted balance sheet, capital
expenditure budget, and other budgets used in financial management. A large
part of the financial budget is determined by the operating budget and the be-
ginning balance sheet.