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 .
Production budget determines how much money will be spent on the entire project. It involves the identification and estimation of cost items for each phase of pre-production, production, post-production.
There are three parts to the production budget: direct materials purchases budget, direct labor budget, and overhead budget.
Production budget is used to prepare other components of the operating budget, including direct materials purchases budget, direct labor budget, etc.
A production budget is a quantity budget which lays down the quantity of units to be produced during the budget period.
The main purpose of this budget is to maintain an optimum balance between sales, production and inventory position of the firm.
It is also known as output budget because it depicts the quantitative estimates of output for the budget period as well as also the estimates at different control period within the budget period.
The quantity of output to be manufactured during budget period may be expressed either in terms of number of articles, weight or standard hours.
Where standard products are manufactured, they must be expressed in terms of number of units. For non-standard products weight must be used.
The Budgetary Control Process
The starting point for any budgetary control system is the actual preparation of the budget, within guidelines laid down by the objectives of the organisation. ''These objectives would be framed within a long-term corporate plan.
From the plan, it becomes possible to formulate a budget, the detail of which is discussed below. Once the budget has been prepared, agreed and issued, the actions are then monitored against it. The measured information is reviewed and investigated. The reasons for variances with the plan/budget are considered.
How to Prepare a Production Budget
To prepare a production budget, we get the number of goods that the company expects to sell in a given period. Often, the same period is used that is defined in the sales budget. That means you'll often prepare a production budget every quarter - possibly every month. With those numbers, add the number of units that the company wants to have in inventory at the end of the period. This gives the total production required.
Purpose of Production Budget
A production budget is a financial plan used by manufacturers to estimate the costs of manufacturing a product. This type of budget often is found in written form, but it is subject to change depending upon various factors.
Componets of Production Budget
- Sales Budget
- Production Budget
- Direct Material Purchases Budget
- Labor, Overhead, and SG&A Budget
- Cash Budget
- Budgeted Financial Statements
Tools & Techniques Of Production Budget
- Cost aggregation
- Reserve analysis
- Expert judgement
- Historical relationships
- Funding limit reconciliation
Important & Objective of Production Budget
Production cost budgeting is basically the planning process for a firm's long time production costs. It is very important for a manufacturing firm because:
- It helps in allocation of resources
- It helps in analyzing the profitability of the production activities
- It helps in analyzing the future cash flows from the production activities
- Return on investments
The objectives of the preparation of a production budget are as follows –
(1) To consider all the relevant factors affecting the sales and other operational activities of the organization.
(2) To make provision for raw materials at right time and place.
(3) To plan the sequence of operations necessary for economical production.
(4) To co-ordinate the various aspects of factory production operations in order to maximize the profits of the firm.
Advantage of Production budget
1.As an essential part of the management process budgets compel planning, making people within an organisation think about the future. A formal budgeting procedure with specified deadlines compels operations managers to divert their attention away from day-to-day business and get down to completing the budget.
2.Budgets promote essential principles of communication and coordination. This may be seen as applying the obvious, but the formal procedure will make the sales function talk to the operations and/or customer service function.
3.A basis for performance evaluation is provided by budgets. They are an integral part of control and review procedure in that they establish agreed targets to be achieved, and for performance to be monitored against. This is why participation in budgets is so vital, since operations managers are effectively being asked to achieve an agreed objective within agreed parameters.
4.Historically it has been argued that budgets can be used to identify considerable savings in overheads and costs. This may be true, but what is important is that the budgetary control system keeps the organisation fit, monitors its progress and provides an important database in the decision-making-process.
Disadvantage of Production Budget
1.Budgets are bureaucratic.
2.If an organisation has clearly identified its Key Volume or Activity Indicators, why go for the time consuming exercise of budgeting? This idea is flawed since you need to consider what the Key Indicators might be and suggest a day-to-day control system based upon them. In such circumstances, cash is an obvious answer and many entrepreneurial forwarders still rely on managing the business with few indicators - usually shipment margin (for each shipment) and the daily bank balance.
3.Budgets are coercive and although control is important, good management should be able to control and motivate a work force without resorting to coercion with all its negative and ''Theory X'' connotations.
Limitations of Production Budget
- Budgets are only as good as the data being used to create them. Inaccurate or unreasonable assumptions can quickly make a budget unrealistic
- Budgets can lead to inflexibility in decision-making
- Budgets need to be changed as circumstances change
- Budgeting is a time consuming process – in large businesses, whole departments are sometimes dedicated to budget setting and control
- Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budget
- Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers
Steps in the Budgeting Process
- Update budget assumptions
- Note Available funding
- Step costing points
- Create budget package
- Obtain revenue forecast
- Obtain department budgets
- Validate compensation
- Validate bonus plans
- Obtain capital budget requests
- Update the budget model
- Review the budget
- Obtain approval
- Issue the budget
Steps in production cost
- Define the Direct Labor Cost
- Estimate the Material Costs of the Project
- Assess Potential Travel Costs of the Project
- Estimate the Cost of the Project Office
- Define What Equipment Costs May Exist in the Project Budget
- What Administrative Costs Will Be Incurred?
- Define the Cost of Software, If Necessary