Production budget

Relationship between sales budget and production budget

The sales budget is a primary driver of the production budget. Since sales projections dictate the quantity of goods expected to be sold, the production budget must align with these projections to ensure adequate supply without overproducing. By accurately forecasting production needs, companies can better manage costs, optimize resources, and maintain adequate inventory levels.

It is good to note that the production budget involves the units of finished goods needed to satisfy the sales forecasted in the sales budget. The breakdown and dollar costs of these units of finished goods are determined in the succeeding budgets on direct materials, direct labor and overhead.

Role of inventory levels in production planning

Inventory levels play a pivotal role in developing an accurate production budget. Beginning inventory is the finished-goods units already on hand at the start of the period. It equals the prior period’s ending inventory, and those units reduce how much must be produced. Ending inventory (the desired amount of inventory on hand at the end of a period) is also essential, as it affects the production needs for the current period and ensures availability for future sales periods.

The formula used to determine the units that need to be produced, incorporating inventory levels, is:

$$\text{Required production units}=\text{Projected sales units}+\text{Desired ending inventory}-\text{Beginning inventory}$$

Beyond inventory levels, a production budget also needs to account for:

• Production capacity: whether the plant can physically produce the required units within the period.
• Production strategy: whether to produce at a level rate across months (smoothing production) or to let production rise and fall with sales (chasing demand).
• Carrying and stockout costs: holding too much inventory raises storage costs, while holding too little risks stockouts.
• Lead times and availability: how long it takes to obtain materials and labor, which affects how far in advance production must begin.
• Expected spoilage or yield losses: scrap, rework, or quality rejects that reduce the good units obtained from a given production run.

Preparation of the production budget

Example: GreenLine Furniture production budget assumptions

For GreenLine Furniture, let’s assume the following:

• The sales budget forecasts the following monthly sales for Q4: October 1,200 units, November 1,500 units, and December 2,300 units (5,000 units total).
• Desired ending inventory for the end of October and November is two thirds of the next month’s projected sales to meet anticipated sales in the following period.
• Desired ending inventory for the end of December is 1,000 units to meet anticipated sales in the following period.
• Beginning inventory at the start of October is 500 units.

Applying the two-thirds policy: October’s ending inventory is based on November’s projected sales, and November’s ending inventory is based on December’s projected sales.

$$\begin{array}{rl}\text{October ending inventory}& =\frac{2}{3}\times 1,500\text{ units}\\ & =1,000\text{ units}\end{array}$$

$$\begin{array}{rl}\text{November ending inventory}& =\frac{2}{3}\times 2,300\text{ units}\\ & =1,533.33\text{ units, rounded to }1,533\text{ units}\end{array}$$

Input the provided details

Using GreenLine’s Q4 forecast and the information provided we can input the following data below. Note that some of the information is unknown on a monthly basis but we can work them out through some assumptions.

Each month’s beginning inventory equals the prior month’s ending inventory: November’s beginning inventory is October’s ending inventory (1,000 units), and December’s beginning inventory is November’s ending inventory (1,533 units).

Use the formula to determine the required production each month

We can then use the formula to determine the required production in units. After these, we are left with the following production budget for GreenLine for Q4:

Here’s how the formula works for November; October and December follow the same approach:

November required production

$$\begin{array}{rl}\text{Required production units}& =\text{Projected sales units}+\text{Desired ending inventory}-\text{Beginning inventory}\\ & =1,500\text{ units}+1,533\text{ units}-1,000\text{ units}\\ & =2,033\end{array}$$

In this example, GreenLine Furniture would need to produce a total of 5,500 units in Q4 to meet sales demand and ensure sufficient ending inventory for the next period. This production budget will guide GreenLine’s direct materials, labor, and overhead requirements, linking the production plan with subsequent budgets.