Financial statements look backward — they report what already happened. A Budget is a financial plan for a specific accounting period, and it looks forward instead: it is management's best estimate of what revenue, expenses, cash flow, and financial position will look like if the plan is followed.
The master budget and its pieces
A Master Budget is an overall budget for a company, built up from several smaller, connected budgets that all start from the same forecast.
| Budget | Definition |
|---|---|
| Sales Budget | An estimate of the goods to be sold and the total revenue to be realized from sales — the starting point for every other budget |
| Capital Budget | A plan that estimates the equipment and building items to be purchased during the period |
| Budgeted Income Statement | An estimate of the revenue, expenses, and net income for the financial period |
| Budgeted Balance Sheet | Shows the estimated assets, liabilities, and equity at the end of the period |
Everything else in the master budget flows from the Sales Budget: if a company forecasts selling more units, it must also plan to purchase more inventory, employ more staff, and hold more cash for those purchases — all of which ripple into the Budgeted Income Statement and, eventually, the Budgeted Balance Sheet at period end.
Variance: comparing plan to reality
Once the period is over, actual results are compared against the budget. The difference is called a variance. A favourable variance means results beat the plan (more revenue than budgeted, or less expense than budgeted); an unfavourable variance means results fell short. Investigating variances — asking WHY sales came in lower than budget, for example — is one of the most direct ways accounting information gets used to make decisions.