Production BudgetDefined with Examples & More
The production budget is an accounting procedure performed by businesses that manufacture goods, outlining the number of units that they will manufacture in the budgetary time period.
The production budget calculates how many units will need to be manufactured for the period based on the anticipated amount of inventory on hand, the targeted finished goods level management has set, past trends, and forecasted sales.
As a result, the production budget is generally prepared after the sales budget, which budgets for forecasted future sales.
What Is a Production Budget?
The production budget, also known as a manufacturing budget, is a budget in which a company accounts for the number of goods that it will produce for a budgetary period.
In contrast to most budgets that a firm prepares, the production budget is stated in terms of the number of units to be produced rather than dollars.
The resulting production demands will be used in other parts of a firm’s operating budget, including the direct materials and direct labor budget, to find the dollar costs.
The production budget is a crucial part of a firm’s inventory control.
An accurately prepared production budget ensures that a company will be able to meet customer demand and will not miss out on sales or harm its relationships with customers.
It also helps to ensure that the company will not hold onto obsolete inventory because it accounts for the forecasted amount of sales for the time period.
However, for a company practicing “pull” production, a production budget is less crucial.
Under a pull production concept, a company produces goods as they are needed in real-time.
This requires a fast response to actual demand; however, it is less necessary to forecast demand accurately.
A company may still prepare a production budget for accounting purposes; however, it is arguably unnecessary if such an inventory control method is being used.
The Components of a Production Budget
A production budget includes four components.
These include beginning inventory, forecasted sales, ending inventory, and the resulting production of units required.
Beginning Inventory
A firm’s beginning inventory is composed of the remaining units from the last budgetary period.
This would be the previous period’s ending inventory.
Generally, a budgetary period will consist of a year, quarter, or month.
Although this is not a requirement, it can be another time period.
Forecasted Sales
A sales forecast is generally created prior to a sales budget.
This forecast predicts how much of a product the business believes will be sold in the budgetary time frame.
This is a crucial step as falling short of demand can result in missed opportunity and damage to customer goodwill, and holding onto excess inventory can result in higher storage costs and inventory becoming obsolete.
Targeted Ending Inventory
Ending inventory is composed of the inventory which is left over at the end of a period.
Management generally has a targeted amount of ending inventory left over at the end of a period.
At the start of a new period ending inventory becomes the beginning inventory of the new period.
Most firms will retain a small stock of inventory, referred to as a “safety stock,” in case it is needed.
This stock is added to ending inventory at the end of a period.
Required Production
The number of products that will be required can be determined by adding the sales forecast and the desired ending inventory and then subtracting the beginning inventory.
After determining the final production budget to find how many units will be produced for a period, cost accounting can be used to find the exact cost of what will be produced.
The cost of raw materials, direct labor, and overhead attributable to the product will each be accounted for in their appropriate accounts.
How to Prepare a Production Budget
Production budgets are typically calculated for a period of a month or a quarter, and once the needed components are found, the following formula can be used to find the number of units that need to be produced.
Forecasted Sales + Targeted Ending Inventory – Beginning Inventory = Required Production
For many companies with a diverse range of product lines with many variations on each product, it can be difficult to create an accurate sales forecast for each variation on the products it sells.
As a result, forecast information is generally aggregated into broad categories of similar products.
The amount of ending inventory that a company targets is highly dependent on the individual company as well as the industry it operates in.
Retaining too much inventory can lead to retaining obsolete inventory, which will be disposed of at a loss, as well as high storage costs.
However, retaining too little inventory can lead to lost sales when customers require timely delivery and damaged customer relationships.
There is no single advisable amount of ending inventory.
However, unless a company intends to end production of a given product, it will generally retain some amount of ending inventory.
Production Budget Example
As an example of a production budget, consider the XYZ Widgets Company.
This company is preparing its production budget for widgets in the upcoming year.
The company has already created its sales budget and has outlined its production budget as follows:
XYZ Widgets Company
Production Budget
| Category | Number of Units |
| Forecasted Sales | + 10,000 |
| Targeted Ending Inventory | + 2,500 |
| Beginning Inventory | – 2,000 |
| Required Production | = 10,500 |
Based on the sales forecast for the upcoming period, the XYZ Widgets Company believes it will sell 10,000 units of its product.
The company also plans to raise its targeted ending inventory to create a larger safety stock for the upcoming year based on its previous experience.
As a result, the company will need 12,500 units for the upcoming year.
Subtracting the company’s beginning inventory of 2,000 units, the company budgets for 10,500 units in the upcoming year.
Conclusion
A production budget is a crucial tool for companies to forecast production for a specific budgetary period.
This gives the company the ability to plan activities and costs for an upcoming period and to retain necessary inventory levels to meet demand.
Key Takeaways
- The production budget outlines the number of units which will be produced for an upcoming period.
- In contrast to most budgets, the production budget is stated in units instead of dollars.
- The production budget is a key part of a company’s operating budget and generally is prepared after the sales budget in order to account for forecasted future sales.
- The production budget takes forecasted sales, anticipated inventory on hand, and the targeted finished goods inventory level management has set into account in determining how many units will be produced.
FundsNet requires Contributors, Writers and Authors to use Primary Sources to source and cite their work. These Sources include White Papers, Government Information & Data, Original Reporting and Interviews from Industry Experts. Reputable Publishers are also sourced and cited where appropriate. Learn more about the standards we follow in producing Accurate, Unbiased and Researched Content in our editorial policy.
Princeton University "The Production Budget" Page 1 . October 13, 2022
Texas Southern University "The Basic Framework of Budgeting" Page 1 - 32. October 13, 2022