Production budget definition
/What is the Production Budget?
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.
When to Use a Production Budget
A production budget is used in manufacturing environments where companies need to plan production levels based on sales forecasts and inventory targets. It is particularly useful in the following situations:
When operating in a "push" manufacturing system. A production budget is essential in a push-based manufacturing system, where goods are produced in anticipation of customer demand rather than in response to actual orders. This approach ensures that sufficient inventory is available to meet expected sales, reducing the risk of stockouts and lost sales. It is commonly used in industries with stable demand patterns, such as consumer goods or automotive manufacturing.
When managing seasonal or fluctuating demand. Businesses with seasonal demand use a production budget to plan manufacturing output in advance, ensuring they have enough inventory before peak sales periods. For example, a toy manufacturer may increase production in the months leading up to the holiday season to avoid stock shortages and meet customer demand efficiently.
When controlling costs. A production budget helps manufacturers manage costs and resources by aligning production levels with expected demand. By planning how many units to produce, companies can optimize labor schedules, reduce waste, and avoid overproduction, which can lead to excess inventory and higher carrying costs.
When ensuring consistent supply for distribution channels. Companies that distribute products through retailers, wholesalers, or distributors use a production budget to ensure a steady supply of goods. This helps maintain strong relationships with partners by preventing delays or supply chain disruptions that could affect sales and profitability.
By using a production budget, manufacturers can balance demand, inventory levels, and production capacity to operate efficiently and meet business objectives.
Calculation of the Production Budget
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.
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Example of a Production Budget
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:
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.