5.3 The Master Budget: Budgeted Profit or Loss, Financial Position and Cash Flow
Key Takeaways
The master budget consists of a budgeted statement of profit or loss, a budgeted statement of financial position and a budgeted cash flow forecast.
Cash received from customers equals opening receivables plus credit sales minus closing receivables; payments to suppliers follow the same logic using payables.
Depreciation reduces budgeted profit but not budgeted cash, so it is added back when reconciling operating profit to operating cash flow.
Closing retained earnings equal opening retained earnings plus budgeted profit minus dividends, and the budgeted statement of financial position must balance.
Why this topic is examined
Syllabus area C1(c) asks you to explain budget statements, specifically the "master budget, including statements of profit and loss, financial position and cash flow". Objective test questions typically give you a few budget figures and ask for one balance: cash received from customers, the closing receivables figure, budgeted profit, closing retained earnings or the closing cash balance. You need to understand how the statements connect, not memorise a format.
What the master budget contains
Functional budgets (Section 5.2) answer operational questions: how many units to sell and make, how much material to buy, how many labour hours are needed. The master budget translates those plans into the organisation's overall financial position:
| Master budget statement | Question it answers | Main inputs |
|---|---|---|
| Budgeted statement of profit or loss | Will the plan be profitable? | Sales budget, cost of sales, overhead budgets, depreciation |
| Budgeted cash flow (cash budget, sometimes also a statement of cash flows) | Will there be enough cash, and when? | Receipts and payments timing, capital expenditure, financing, dividends |
| Budgeted statement of financial position | What will the organisation own and owe at the end of the period? | Opening balances plus the effects of the profit and cash budgets |
The three statements are linked. Profit increases retained earnings; the difference between profit and cash is explained by non-cash items (such as depreciation) and changes in working capital (inventory, receivables and payables).
Worked example: Brook Ltd
Brook Ltd makes one product. Its variable production cost is $20 per unit (materials $12, labour and variable overhead $8). Fixed overheads are charged to profit in full.
Opening statement of financial position, 1 January
| Item | $ |
|---|---|
| Non-current assets (cost $200,000, accumulated depreciation $50,000) | 150,000 |
| Finished goods inventory (1,000 units × $20) | 20,000 |
| Trade receivables | 40,000 |
| Cash | 25,000 |
| Total assets | 235,000 |
| Trade payables (materials) | 12,000 |
| Share capital | 100,000 |
| Retained earnings | 123,000 |
| Total equity and liabilities | 235,000 |
Budget for the year
- Sales: 10,000 units at $50, all on credit. Closing receivables: $60,000.
- Closing finished goods inventory: 1,500 units.
- Materials are bought on credit and used immediately (no materials inventory). Closing payables: $18,000.
- Labour and variable overhead are paid in the year incurred.
- Fixed overheads: $150,000, including depreciation of $20,000. The rest is paid in cash.
- A new machine costing $60,000 is bought for cash.
- Dividends of $30,000 are paid. Ignore tax.
Step 1: production and cost of sales
Production = sales + closing inventory − opening inventory = 10,000 + 1,500 − 1,000 = 10,500 units.
| Cost of sales | $ |
|---|---|
| Opening inventory (1,000 × $20) | 20,000 |
| Production (10,500 × $20) | 210,000 |
| Less closing inventory (1,500 × $20) | (30,000) |
| Cost of sales (10,000 × $20) | 200,000 |
Step 2: budgeted statement of profit or loss
| Budgeted statement of profit or loss | $ |
|---|---|
| Sales (10,000 × $50) | 500,000 |
| Cost of sales | (200,000) |
| Contribution | 300,000 |
| Fixed overheads (including $20,000 depreciation) | (150,000) |
| Operating profit | 150,000 |
Dividends of $30,000 are a distribution of profit, not an expense, so retained profit for the year is $120,000.
Step 3: receipts and payments
Use the "opening + incurred − closing" logic for each working capital balance:
Materials purchased = 10,500 units × $12 = $126,000.
Labour and variable overhead paid = 10,500 × $8 = $84,000. Cash fixed overheads = $150,000 − $20,000 depreciation = $130,000.
Step 4: budgeted cash flow
| Budgeted cash flow | $ |
|---|---|
| Opening cash | 25,000 |
| Receipts from customers | 480,000 |
| Payments to suppliers | (120,000) |
| Labour and variable overhead | (84,000) |
| Cash fixed overheads | (130,000) |
| Purchase of machine | (60,000) |
| Dividends paid | (30,000) |
| Net cash flow for the year | 56,000 |
| Closing cash | 81,000 |
Step 5: budgeted statement of financial position, 31 December
| Item | $ |
|---|---|
| Non-current assets (cost $260,000, accumulated depreciation $70,000) | 190,000 |
| Finished goods inventory (1,500 × $20) | 30,000 |
| Trade receivables | 60,000 |
| Cash | 81,000 |
| Total assets | 361,000 |
| Trade payables | 18,000 |
| Share capital | 100,000 |
| Retained earnings (123,000 + 150,000 − 30,000) | 243,000 |
| Total equity and liabilities | 361,000 |
The statement balances, which confirms that the profit and cash budgets are consistent.
Reconciling budgeted profit and budgeted cash
Brook's operating profit is $150,000, but its operating cash flow is only $146,000 ($480,000 received minus $334,000 of operating payments). The reconciliation, in the format of a statement of cash flows, explains why:
| Reconciliation | $ |
|---|---|
| Operating profit | 150,000 |
| Add back depreciation (non-cash) | 20,000 |
| Increase in inventory (20,000 to 30,000) | (10,000) |
| Increase in receivables (40,000 to 60,000) | (20,000) |
| Increase in payables (12,000 to 18,000) | 6,000 |
| Cash from operations | 146,000 |
| Investing: purchase of machine | (60,000) |
| Financing: dividends paid | (30,000) |
| Net cash flow | 56,000 |
Important
Increases in inventory and receivables tie up cash, so they are deducted. An increase in payables means suppliers are financing more of the business, so it is added. Depreciation is added back because it reduced profit without any cash leaving the business.
Why the master budget matters
- Planning: it shows whether the functional plans add up to an acceptable profit and a sustainable cash position.
- Financing: a budgeted cash shortfall (Section 5.4) signals the need for an overdraft or other finance well before it happens.
- Control: the budgeted statements become benchmarks for actual results.
- Communication and approval: the board approves the master budget as the organisation's plan for the period.
Tip
In exam questions, always check whether sales or purchases are on credit and whether there are opening and closing balances. The mistake most candidates make is treating the sales figure as the cash received.
A company's opening trade receivables are $55,000. Budgeted credit sales for the year are $640,000 and budgeted closing trade receivables are $70,000. What is the budgeted cash received from credit customers?
$625,000
$655,000
$640,000
$765,000
Which of the following is part of the master budget?
The budget manual setting out budget procedures
The budgeted statement of financial position
The minutes of the budget committee
The standard cost card for a single product
A company's opening retained earnings are $410,000. Its budgeted operating profit for the year is $95,000, which includes depreciation of $18,000, and it plans to pay dividends of $40,000. What are the budgeted closing retained earnings?
$523,000
$483,000
$465,000
$545,000
Sections you finish are checked off in the contents.