What is a Production Budget?
Definition: Production budget is a budgetary plan that details the total number of products that will be manufactured over a given period along with the costs. The plan is derived from sales forecast as it is an estimate of the total units a production plant intends to produce.
A production budget is normally presented in a monthly or quarterly format. Managers, on the other hand, rely on the budget to calculate the total units to produce to meet estimated sales targets. Likewise, the report is often used as a tool to estimate future manufacturing processes, equipment times as well as for scheduling purposes.
Being an estimate, a production budget doesn’t display the total costs of production. Similarly, it doesn’t calculate sales revenues from the estimated sales. Instead, it only figures the total estimated sale units and budgeted units that a firm intends to produce. However, the report is useful estimating total revenues and expenses for a given period.
Production Budget Components
The three main components taken into consideration when preparing a production budget are
- Direct Material budget
- Direct Labor Budget
- Overhead Cost Budget
- Direct Material Budget
The direct material budget is simply the cost of raw materials. In this case, a production unit must have all the necessary raw materials used in the production of goods that a firm needs to sell over a given period.
Direct Labor Budget
Direct Labor budget, on the other hand, factors the cost of labor needed to produce estimated sales units. In this case, it includes things such as wage bonuses and commissions.
Overhead cost budget
The overhead cost budget includes all other costs not included in the material and labor budget. In this case, it includes variable and fixed costs.
Production Budget Formula Calculation
A production budget is often calculated once an operating budget is ascertained. An operating budget guides managements in ascertaining the total number of units that a factory can produce depending on the type and amount of resources available. In this case, an operating budget describes income-generating activities.
Forecasted unit sales and finished goods ending inventory balance are the two main components used in the computation of a production budget. Similarly, the beginning finished goods inventory is subtracted.
When calculating a production budget, one needs to consider three main things
- The total number of units that need to be sold during a given budget period
- The total number of units of inventory in-store at the beginning of a given budgeting period
- The total number of units that must be there in store at the end of a given period
With this information, one can begin computing a production budget by simply
Production budget = Estimate Unit Sales + ending inventory balance – beginning finished goods
Production Budget Example Format
Smartphone Company ABC intends to sell 10,000 units between January and March as part of its first-quarter plans. The opening stock at the start of the quarter is 1500 smartphones. However, the company intends to maintain an inventory of 2500 smartphones at the end of the quarter.
The production budget formula in this example is as follows:
Production Budget = Expected Sales + Inventory at the end of the quarter – Inventory at the beginning of the quarter
Company ABC Production Budget = 10,000+ 2500- 1,500 = 11,000 smartphones
Production Budget Uses
Companies rely on a production budget to maintain an optimum balance between sales inventory position as well as production levels. It also helps in the coordination of policies and plans within a production unit.
A production budget also provides guidance or a plan that allows a company to meet its production targets. It also helps in giving motivation to employees as all work towards a certain target. Likewise, machinery, as well as labor, can be utilized to maximum possible levels.
Summary
A production budget being a financial plan allows any production unit to plan its manufacturing operations. The financial plans are prepared by taking into account the sales budget as well as opening and closing inventory levels.