Production Budget
A production budget is a financial plan that estimates the number of units a company needs to produce to meet its sales objectives while maintaining its desired inventory levels. It’s a key component of the overall budgeting process and is generally developed after the sales budget because the number of units to be produced is largely based on forecasted sales.
The production budget helps determine the quantity of raw materials that need to be purchased, the number of workers needed, and the amount of manufacturing overhead that will be incurred. It also helps companies plan their production schedule and resource allocation, ensuring that they can meet customer demand without overproducing and carrying excess inventory.
Here’s a basic formula to calculate the number of units a company needs to produce:
Units to be produced = Forecasted sales in units + Desired ending inventory – Beginning inventory
Let’s break down the components of this formula:
- Forecasted Sales in Units: This comes from the sales budget. It’s the number of units the company expects to sell during the budget period.
- Desired Ending Inventory: This is the number of units the company wants to have on hand at the end of the budget period. Companies often maintain some inventory to buffer against variability in sales or production.
- Beginning Inventory: This is the number of units the company has on hand at the start of the budget period.
By calculating the number of units to be produced, the company can then estimate the costs associated with production, including direct materials, direct labor, and manufacturing overhead. This leads to the creation of the manufacturing budget, which forms a part of the overall master budget of a company.
Example of a Production Budget
Let’s take the example of a company called “SofaCo” that manufactures sofas.
- Forecasted Sales in Units: Let’s assume SofaCo, after thorough market analysis and sales forecasting, expects to sell 1,000 sofas in the next quarter.
- Desired Ending Inventory: SofaCo wants to keep a safety stock of 100 sofas at the end of the quarter to meet any unexpected demand or delays in production.
- Beginning Inventory: At the start of the quarter, SofaCo has an inventory of 150 sofas from the previous quarter.
Now we can calculate the number of units SofaCo needs to produce:
Units to be produced = Forecasted sales in units + Desired ending inventory – Beginning inventory
= 1,000 sofas + 100 sofas – 150 sofas
= 950 sofas
So, SofaCo needs to plan to produce 950 sofas in the next quarter to meet its sales forecast and desired ending inventory level.
The next step would be to determine the material, labor, and overhead costs associated with producing 950 sofas. That information will feed into the cost budgets and ultimately into the company’s master budget, informing decisions about pricing, staffing, procurement, and other operational areas.
