Production Budget Definition
Production Budget is financial planning related 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 of Production Budget
Mainly there are three components and they are as follows:
#1 – Direct Material Budget
The Direct Material budget includes the opening inventory of raw materials, 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 consists of both variable cost as well as a fixed cost.
Example of Production Budget
The following is an example of the 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. It is also planned by the production manager of the company that the ending inventory will be $ 1,000 at the end of each of 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.
Following is the production budget template of XYZ ltd for the year ended on December 31, 2020.
Thus in the above example, the production budget prepared shows the calculation regarding the number of units that is to be produced in the organization.
Also, as planned ending inventory units of the company 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 the risky forecast because there is the cut in the level of the safety stock of a company.
Advantages of Production Budget
The different advantages are as follows:
- 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 the guidance or the 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 in a more efficient manner.
- With the help of the production budget, the plant and machinery of the company as well as its labor can be utilized to the maximum possible extent by the company.
The disadvantages related to the budget are as follows:
- Preparation of production budget by the company is one of the time-consuming processes as it required lots of time and effort of the management of the company.
- The preparation of the production budget by the company is based on the judgment and the estimates of the management purely, so achieving the effective as well as 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 it is possible that the different persons in the company have different opinions related to the production budget. In that case, it is possible that all of the employees of the organization might not be willing to accept the production 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.
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 cost 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.
Production budget forecasts the production of the business and gives the targets to employees of the company for achieving the desired level output in an efficient manner 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.
This 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 –