## What is production budget?

October 17, 2012

Budgeting is important for any organization. Preparing a master budget requires preparing financial budgets as well as an operating budget, which in turn consists of many components such as sales budget, production budget, costs of goods sold budget, etc. In this article we will learn to prepare a simple production budget, which is an important component of the operating budget. Production budget is used to prepare other components of the operating budget, including direct materials purchases budget, direct labor budget, etc.

## 1. Definition of production budget

Production budget is the component of the operating budget that determines the number of units to be produced to meet sales and ending inventory needs.

Production budget is expressed in terms of physical units (i.e., not costs).  Production budget period often depends on the product cycle as well as the operating environment of the organization. As the result, it varies in length: quarter, year, product year, product cycle, etc. For example, during difficult economic times, it might better to shorten the production budget period due to higher uncertainty regarding product demand (i.e., sales).

Production budget incorporates not only budgeted sales data but also expected ending inventory levels. When determining the required inventory levels, it is important to consider both costs and benefits.

Benefits:

• meet sales demand
• prevent shortage of inventory
• distribute production

Costs:

• Inventory storage costs
• Inventory obsolescence costs

## 2. Production budget formula and example

The general formula used to determine the required production level is as follows:

 Required Production = Expected Sales + Expected Ending Inventory – Beginning Inventory

For example, ABC Company is preparing a quarterly production budget for 20X3. The company estimates to sell 10,000, 12,000, 14,000, and 11,000 of units in each respective quarter. Also, the company wants to maintain the following ending inventory levels in each subsequent quarter, respectively: 2,000, 3,000, 4,000, and 2,500 units. At the beginning of 20X3, beginning inventory is 8,000 units.

The company would create the following production budget:

 ABC Company Production Budget (Units) For the year ended 12/31/20X3 Quarter Year I II III IV Sales 10,000 12,000 14,000 11,000 47,000 Ending Inventory 2,000 3,000 4,000 2,500 2,500 Total Needs 12,000 15,000 18,000 13,500 49,500 Less: Beginning Inventory (8,000) (2,000) (3,000) (4,000) (8,000) Required production 4,000 13,000 15,000 9,500 41,500

As the budget shows, the company will need to produce 4,000, 13,000, 15,000, and 9,500 units during each of the four quarters to meet the sales and ending inventory demands.

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