Production Budget Definition
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.
The production budget is typically presented in either a monthly or quarterly format. The basic calculation used by the production budget is:
+ Forecasted unit sales
+ Planned finished goods ending inventory balance
= Total production required
- Beginning finished goods inventory
= Products to be manufactured
It can be very difficult to create a comprehensive production budget that incorporates a forecast for every variation on a product that a company sells, so it is customary to aggregate the forecast information into broad categories of products that have similar characteristics.
The planned amount of ending finished goods inventory can be subject to a considerable amount of debate, since having too much may lead to obsolete inventory that must be disposed of at a loss, while having too little inventory can result in lost sales when customers want immediate delivery. Unless a company is planning to draw down its inventory quantities and terminate a product, there is generally a need for some ending finished goods inventory.
Production Budget Example
As an example of a production budget, ABC Company plans to produce an array of plastic pails during the upcoming budget year, all of which fall into the general Product A category. Its production needs are outlined as follows:
For the Year Ended December 31, 20XX
|Quarter 1||Quarter 2||Quarter 3||Quarter 4|
|Forecasted unit sales||5,500||6,000||7,000||8,000|
|+ Planned ending inv. units||500
|= Total production required||6,000||6,500||7,500||8,500|
|- Beginning F/G inventory||1,000||500||500||500|
|= Units to be manufactured||5,000||6,000||7,000||8,000|
The planned ending finished goods inventory at the end of each quarter declines from an initial 1,000 units to 500 units, since the materials manager believes that the company is keeping too many finished goods in stock. Consequently, the plan calls for a decline from 1,000 units of ending finished goods inventory at the end of the first quarter to 500 units by the end of the second quarter, despite a projection for rising sales. This may be a risky forecast, since the amount of safety stock on hand is being cut while production volume increases by over 30 percent. Given the size of the projected inventory decline, there is a fair chance that ABC will be forced to increase the amount of ending finished goods inventory later in the year.
Other Production Budget Issues
The production budget deals entirely with unit volumes. Unlike most other parts of the corporate budget, the production budget does not translate its production requirements into dollars. Instead, the unit requirements of the production budget are shifted into other parts of the budget, such as the direct labor budget and the direct materials budget, which are then translated into dollars.
A case can be made that this budget is not needed in a "pull" production environment, where goods are produced only on an as-needed basis. Under this concept, it is not necessary to estimate unit quantities to be produced, since the production environment merely reacts to actual demand.