To begin with, if the sales and production budgets are carried out correctly, the company will be able to satisfy the demand for products in the market, generating income.
On the other hand, because this budget includes an estimate of the units to be kept in inventory, the company will always have merchandise available in case the manufacturing process suffers any inconvenience.
Establishing a budget is one of the most relevant steps that must be carried out in any organization. The final budget of a company includes a series of stages, such as the financial budget, the operational budget, the sales budget and the production budget.
The production budget is part of the operational budget and consists of a table that shows an estimate of the number of units that must be produced by a company to be able to satisfy the sales demand and the ending inventory in a given period of time. This type of budget is carried out only by manufacturing companies.
The operational budget and the production budget
Before a product is purchased by a consumer, it has to be manufactured. The production budget is a financial plan used by manufacturers to obtain an estimate of the number of products to create.
The production budget is just one phase of the operational budget. The latter shows the activities that generate income for a given company, such as sales, production, and units in ending inventory.
In turn, the operational budget is only a part of the final budget of a company. In this sense, budgets constitute an uninterrupted chain that allows the proper functioning of a company or company.
Preliminary step to the production budget
Before starting to develop the production budget, the sales budget must be made, which is the first stage of the operational budget. The sales budget is the report on the amount of products that are expected to be sold in a year.
This collects the forecasts of the businesses in charge of selling said product and the sales histories of the company. It also takes into account factors such as the general state of the economy, prices, advertising and competition.
Production budget
Once the sales budget has been developed, you proceed with the production budget. This shows how many units of a certain product the company must produce to satisfy the demands of the sale, as well as the demands of the company's ending inventory.
In this sense, the production budget is based on two main aspects: the first is the inventory and the second is the sales goal that the company sets. It is important to note that only manufacturing companies make production budgets.
The production budget depends directly on the sales budget, since the latter indicates an estimate of the quantities to be sold in a given period.
How often is a production budget made?
The frequency with which the production budget is made will depend on the product cycle, as well as the operating system that is managed in the organization.
Certain companies can make this budget only once a year; other companies do so every three months because they fear that sales budget predictions will not be consistent over long periods of time.
Also, in times of economic difficulties, it is preferred that the waiting period between one budget and the next is short, due to the uncertainty regarding the demand for the product.
Product demand
As seen previously, the demand for the product directly affects the production budget; This means that the higher the demand, the higher the production and vice versa.
When demand is low, the company can take advantage of this off-peak period to produce extra units and keep them for the next busy period.
In this way, the company will avoid finding itself in a situation where it needs to produce large quantities, but cannot meet the demand since it lacks the labor, raw material or time to do so.
How to calculate the number of units needed to satisfy the demand?
The formula to calculate the quantity of products that are required to satisfy the demand is the following:
Units expected to be sold + units expected to be in ending inventory - Units already in inventory = Units to be produced
Examples of production budgets
Example 1: Annual production budget
A company that sells ceramic objects aims to sell 1000 pots in the year and expects 240 pots to remain in the ending inventory.
The initial inventory shows that the company already has 180 of these vessels in stock, which means that 1060 units have to be produced. The equation applied to this case would be the following:
Units expected to be sold: 1000 + Units expected to be in the ending inventory: 240 = 1240- units already in inventory: 180 = 1060 units to be produced.
Example 2: Quarterly production budget
Here is an example of a company that wants a quarterly production budget:
A company that sells wooden objects is developing a quarterly budget for 2018. It expects to sell 10,000, 12,000, 14,000 and 11,000 units in each quarter respectively.
Similarly, the company wants to keep the following quantities in inventory: 2,000 for the first quarter, 3,000 for the second, 4,000 for the third, and 2,500 for the last. On the other hand, the opening inventory shows that the company has 8,000 units in stock. The application of the formula for this case would be the following (simplestudies.com):
Trimester I
Units you expect to sell: 10,000
Units expected to be in ending inventory: 2,000
Total: 12,000
(Fewer) existing units in inventory: 8,000
Units to be produced: 4,000
Quarter II
Units expected to sell: 12,000
Units expected to have in ending inventory: 3,000
Total: 15,000
(Fewer) existing units in inventory: 2,000
Units to be produced: 13,000
Quarter III
Units expected to sell: 14,000
Units expected to have in ending inventory: 4,000
Total: 18,000
(Less) existing units in inventory: 3,000
Units to be produced: 15,000
Quarter IV
Units expected to sell: 11,000
Units expected to have in ending inventory: 2,500
Total: 13,500
(Fewer) existing units in inventory: 4,000
Units to be produced: 9,500
Year
Units expected to sell: 47,000
Units expected to have in ending inventory: 2,500
Total: 49,500
(Fewer) existing units in inventory: 8,000
Units to be produced: 41,500
As the table shows, the company will have to produce 4,000, 13,000, 15,000 and 9,500 units respectively in each quarter in order to meet the demand for sales and ending inventory.
Parts of the production budget
The production budget consists of three parts:
Raw material acquisition budget.
Labor budget, which shows the cost of labor and the time required to manufacture the units required to meet demand.
General budget.
Raw material acquisition budget
The raw material acquisition budget allows you to calculate the amount of materials that will be needed for each production period. The equation to calculate how much raw material should be purchased according to the website thebalance.com is as follows:
Raw material required for production + raw material expected to be in the ending inventory = Total raw material needed for production.
It should be noted that this part of the budget only includes materials that are directly needed for production.
For example, a company that makes pots will budget for the ceramics and paints it requires to meet demand. The gasoline used to distribute the products is not part of this stage.
Labor budget
The labor budget shows the number of workers and the time required to manufacture the units required to meet the demand from sales and inventory.
As with the raw material budget, only people who directly influence production are included in this phase of the budget. If it is a company that sells vessels, the workforce will be made up solely of artisans.
Does the production budget include production costs?
The production budget is worked in units to be produced and not in monetary units. This means that it does not offer data regarding the cost of production or the income that the sale of these products could generate; such information is supplied by sales and manufacturing budgets.
