The production budget, used by businesses that produce products instead of services, is one part of a firm's operating budget, and is typically developed after the sales budget. The sales budget drives the production budget because it budgets for the forecasted future sales of the firm's products. Forecasted sales help determine the amount of the product the business will need to produce.
What Is a Production Budget?
The production budget, also called the manufacturing budget, is a budget that determines the quantity of the firm's product that needs to be produced during a budgetary time period. This budget is stated in units of the product or the quantity. Most other budgets are stated in the form of dollars instead of quantity.
The production budget is a quantity budget. It determines the number of units of a firm's product that should be produced to meet the demand of the firm's customers based on the sales forecast and sales budget.
The production budget is also one part of the firm's inventory control. If there is an accurate production budget, the business won't stock out of its product and lose customer goodwill. It will also not hold obsolete inventory since the number of units of the product produced is based on the sales forecast.
How to Create a Production Budget
A production budget has four components:
- Beginning Inventory
- Sales Forecast
- Ending Inventory
- Production Required in Units of the Product
The beginning inventory is the number of units left over from the previous budgetary period. It is the ending inventory for the previous time period. A budgetary period is a month, quarter, year, or some other time period.
The sales forecast, developed before the sales budget, is the amount of the product the company expects to sell in the same time period. The sales forecast is the anticipated demand for the firm's product.
The ending inventory is the amount of inventory leftover from the previous time period. It becomes the beginning inventory for the next time period. Your firm may want to always hold a few extra units of inventory in stock which is added to ending inventory. This is called safety stock.
The production required equals the amount of the product to be produced during the time period after the beginning inventory, ending inventory, and the sales forecast are taken into account.
After the production budget is determined and the business manager knows how many units of the product to produce in a given time period, you use cost accounting to prepare the cost of what you will produce. You reflect the cost of raw materials in the direct materials purchases budget. Both direct labor and overhead have their own budget.
The cost of the production required for each time period is composed of the cost of the raw materials, the cost of labor, and the cost of overhead, all directly attributable to the product you are producing.
How to Calculate a Production Budget
You combine the components of the production budget in the following formula to arrive at the units you need to produce:
Example of a Production Budget
Masks and More, LLC is a small manufacturing business that makes surgical masks, cloth facial coverings, and other personal protective equipment (PPE). Its sales forecast anticipates the sale of 1,000 cloth facial coverings during the next quarter. Masks and More only had 25 units of the product left at the end of the last quarter. The company likes to hold at least 50 units in safety stock.
Here is the production budget for Masks and More for their cloth facial covering masks for the next quarter:
|Number of Units|
|Plus: Demand based on sales forecast||+ 1000|
|Minus: Beginning Inventory||- 25|
|Equals: Production Required in Units||= 1025|
As the table shows, Masks and More must produce 1,025 units of its cloth facial coverings during the next quarter to fulfill customer demand.
Sales, Production, and Inventory
The sales forecast, which is developed for the sales budget, helps to determine how many units the firm should produce in a given time period. The production budget and its components help the business manager with inventory management.