Meaning, Types of Production budget01/08/2020
A production budget is a financial plan that lists the number of units to be manufactured during a period. In other words, this is a report that estimates the number of units that a plant will produce from period to period.
The production budget calculates the number of units of products that must be manufactured, and is derived from a combination of the sales forecast and the planned amount of finished goods inventory to have on hand (usually as safety stock to cover for unexpected increases in demand). The production budget is typically prepared for a “push” manufacturing system, as is used in a material requirements planning environment.
Managers use the production budget to estimate how many units they will need to produce in future periods based on the future estimated sales numbers. They also use this report as a planning tool for future production processes, machine times, and scheduling. Production managers have to estimate the future demands and plan out the workflow to make sure everything is produced timely and there aren’t long periods of wait time or down time.
This is the main reason why the production budget does not show the costs of production nor the sales revenue from the estimated sales during the period. Instead, it always shows the total estimated sales in units and the budgeted number of units produced. Remember, this is a report used to determine the number of units that need to be produced during the period. The sales budget and manufacturing budget are used to estimate the total revenues and expenses for the period.
The preparation of production budget involves the following stages:
(i) Production planning
(ii) Consideration of plant capacity
(iii) Stock quantity to be held
(iv) Sales budget figures.
A production budget depends on 3 factors:
(1) Sales Forecast in unit as indicated in the sales budget.
(2) Finished Goods Inventory level that management wants at the end of the period.
(3) Anticipated inventory at the start of the budget period.
The production budget also depends on a company’s inventory policy. Inventories may be build-up or liquidated depending upon the outlook adopted by management. Also, the cost of carrying larger inventories should be compared with the cost of being out-of-stock when the firm cannot deliver.
The production budget will project the number of units to be produced in a period using the formula:
Production Budget = Budgeted Sales Units – Opening Stock of Finished Goods + Closing Stock of Finished Goods
This can be justified because:
- The opening stock of finished goods has already been produced, and can
- Therefore be deducted from our calculation of what needs to be made, and
- The closing stock has yet to be made so needs to be added into our total of goods to be produced.
- if stocks of finished goods are to increase, then production must be greater than sales
- if finished goods stocks are to remain constant, production will be the same as sales
- if finished goods stocks are to fall, production will be less than sales
Cost of Production Budget:
The production budget determines the number of units to be produced. When these units are converted into monetary terms, it becomes a cost of production budget. The cost of production budget is the total amount to be spent on producing the units stipulated in the production budget. The physical units are broken into elements, i.e., material, quantity, labour, time and manufacturing overheads. The material cost, labour cost and overheads required for manufacturing are totalled together to make it a cost of production budget.