Production Budget Definition
Production Budget is financial planning relates to the units of product that the management thinks that the business should produce in the upcoming period to match the estimated sales quantity, which is based on the management’s judgment related to the competition in the market, economic conditions, production capacity, consumer prevailing market demands, and past trends.
Components
Mainly there are three components, and they are as follows:
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For eg:
Source: Production Budget (wallstreetmojo.com)
#1 – Direct Material Budget
The Direct Material budget includes the opening inventory of raw materialsInventory Of Raw MaterialsRaw materials inventory is the cost of products in the inventory of the company which has not been used for finished products and work in progress inventory. Raw material inventory is part of inventory cost which is reported under current assets on the balance sheet.read more, purchase cost of raw material, material that goes into production, and closing inventory of raw material that will be incurred to produce the units of product that the organization estimate to produce in the coming period.
#2 – Direct Labor Budget
Direct labor budget includes the cost of labor that is employed into a production like wages, bonuses, commission, etc. that are expected to be payable to the workers of the business organizations.
#3 – Overhead Cost Budget
All the other cost that doesn’t constitute a part of the material budget and direct labor budget are shown in the overhead budget cost. This budget consist of both variable cost as well as a fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more.
Example of Production Budget
XYZ ltd manufactures the bottle and makes the forecast for the upcoming year, which ends in December 2020. It forecasted that the sales in the next year would be $ 8,000 in quarter 1, $ 9,000 in quarter 2, $ 10,000 in quarter 3 and $ 11,000 in quarter 4. The production manager also plans that the ending inventory will be $ 1,000 at the end of each quarter of the company’s production. At the beginning of the quarter, 1 inventory of the company was $ 2,500.
Prepare the necessary production budget of the company XYZ ltd for the coming year ending in December 2020.
Solution
Following is the production budget template of XYZ ltd for the year ended on December 31, 2020.
Production Budget of XYZ ltd for the Year Ended December 31, 2020
| Sr. No | Particulars | Quarter 1 | Quarter 2 | Quarter 3 | Quarter 4 |
|---|---|---|---|---|---|
| A | Sales Unit Forecasted | $8,000 | $9,000 | $10,000 | $11,000 |
| B | Planned Ending Units of Inventory | $1,000 | $1,000 | $1,000 | $1,000 |
| C | Total Production Required (A+B) | $9,000 | $10,000 | $11,000 | $12,000 |
| D | Beginning Inventory of Finished Goods | $2,500 | $1,000 | $1,000 | $1,000 |
| E | Units to be Produced (C-D) | $6,500 | $9,000 | $10,000 | $11,000 |
Thus in the above example, the budget prepared shows the calculation regarding the number of units that are to be produced.
Also, as planned ending inventoryEnding InventoryThe ending inventory formula computes the total value of finished products remaining in stock at the end of an accounting period for sale. It is evaluated by deducting the cost of goods sold from the total of beginning inventory and purchases.read more units is decreased by the production manager from $ 2,500 to $ 1,000 even though the production of the company is expected to get an increase every quarter. So it is a risky forecast because there is a cut in the safety stock level of a company.
Advantages
- It helps in maintaining an optimum level of balance between the sales, inventory position, and the production of the company and contributes to the coordination of policies and plans related to them.
- It provides guidance or plan to the organization as it gives the target of the production that the management of the company expects to be achieved in the upcoming period.
- With the target being set using the production budget, it gives the motivation to the employees of the company to work hard in order to achieve the goals in time and a more efficient manner.
- With the help of this budget, the plant and machinery, as well as its labor, can be utilized to the maximum possible extent by the company.
Disadvantages
- The preparation of the production budget by the company is one of the time-consuming processes as it required lots of time and effort in the management of the company.
- It is based on the judgment and the estimates of the management purely, so achieving the effective as well as the accurate level of a forecast of the production in the company is not possible generally in the present competitive, unpredictable market.
- Every person in the organization have different mindsets and different way of thinking, so the different persons in the company may have different opinions related to the production budget. In that case, employees of the organization might not be willing to accept this budget, which is prepared by top-level management of the company.
- For the company which started it working recently and does not have past data and experience, it becomes very difficult to estimate the figures for the production budget.
Important Points
The different important points to the budget are as follows:
- There are mainly three types of components of the production budget, which include Direct Material budget, Direct Labor budget, and the overhead costOverhead CostOverhead cost are those cost that is not related directly on the production activity and are therefore considered as indirect costs that have to be paid even if there is no production. Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc.read more budget.
- For the company which started it working recently and does not have past data and experience, it becomes very difficult to estimate the figures for the production budget as compared with the business which is in existence for a long time because of the availability of the past trends for them.
Conclusion
Production budget forecasts the production of the business and gives the targets to employees of the company for achieving the desired level output efficiently and incurring minimum expenses. Different organizations in the market adopt different types of strategies and policies. Also, the preparation of this budget is more cumbersome and problematic for the small organization due to the presence of fewer resources, and they can experience more level of market fluctuations when compared with the large businesses.
Recommended Articles
This article has been a guide to the Production Budget and its definition. Here we discuss the components, template of the production budget along with an example, advantages, and disadvantages. You can learn more about budgeting from the following articles –
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