A production budget is one component of a master budget. A master budget considers the total business operation. For example, sales, operating expenses and overhead, materials, labor, production, taxes, loan obligations and other expenses are part of the master budget. A production budget focuses only on the number of units of products needed to be produced to meet expected sales.
Whether a company is producing shoes or bags of cotton candy, management calls each consumer-ready finished product one unit in a production budget. Thus, for a shoe manufacturer, a pair of shoes equals one unit, and for a candy maker, one bag of cotton candy equals one unit. The unit is a basic entry used for computations in a production budget.
Considering Sales Estimates
A production budget uses projected sales figures, whether the estimates are monthly, quarterly or for more-extensive periods. For example, if the fictional PQR Corp. fixes a budget for the first quarter of the year and the company expects to sell 100,000 units in January and 120,000 in both February and March, these figures will be included in the production budget.
Evaluating Inventory Needs
Management requires an accurate count of inventory on hand to make a production budget. The business must also plan the number of units to retain in inventory after production. For example, suppose the business generally keeps 10 percent of the forecast sales volume for the upcoming month on hand to meet unexpected demand. In this example, the PQR Corp. would add 12,000 units to the January production in consideration of February sales and 12,000 units to the February production in consideration of March sales. The business would also need to forecast April sales to find the total inventory production figure for March.
Writing it All Down
Writing the budget follows a simple structure: total units needed minus the inventory on hand equals the required units for production. How much inventory the business decides to retain will then be added to the required units. This results in the simple equation: total needs minus inventory on hand plus the units needed in ending inventory equals required units to produce. Once the production budget is completed, an estimate of labor and raw materials costs can then be calculated for the labor budget and the materials budget, all part of the master budget.
- Accounting Tools: Production Budget
- Management Accounting: Production Budget Definition, Formula, and Example
- Simple Studies: What is Production Budget?
- University of North Carolina Wilmington Cameron School of Business: Ch 6 Budgets
- University of North Florida: Chapter 38 Sales, Production and Purchases Budgets
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