The production budget It helps you calculate the number of units to be produced, as well as the cost of the materials, personnel and manufacturing materials necessary at each stage of the production of the good or service that you will sell.
There are more and more enterprises that use budgets to give direction, not only to their cash flow, but also to their strategic planning. Having a document where it is possible to visualize how much each element necessary to create what you want to sell will cost you will be of great help to meet your sales objectives. Today we want to tell you the importance of having a production budget and we will give you examples to make your own. Here we go!
What is a production budget?
The production budget is the calculation that allows you to know how much you will invest to produce or acquire the products or services that you plan to sell during a certain period of time.. With it, you will be clear about whether you will be able to have all the units you require —both to start and to close the sale period—, how much it will cost to achieve it and the expense that it implies so that you can measure it against your income.
This tool allows you to have a clear overview of each element involved during production, in order to know each gear, its participation and cost. In the same way —and very hand in hand with it— it is part of what you need to know the profitability and viability of your business.
In other words: while the sales budget tells you how much you will earn by selling what you are going to produce, the production budget tells you how much you will have to invest to generate what you want to sellin addition to satisfying your inventory demand.
What is needed to prepare a production budget?
To prepare a production budget you need basic information related to the process by which you produce or generate the inventory that you will sell. Although to start with this task you always need the same basic elements, the more information on this list you have, the more complete and complex the budget you prepare will be:
- Inventory
- Materials
- Manufacturing
- personnel costs
- Sales and forecasts
Let’s review each element so you understand its function within this type of budget and where you will find the information you are looking for.
inventory 📦
Is about the list of goods that your company has in existence and that you intend to market. To make the production budget, it is important to have two specific pieces of information:
Initial inventory 👍
It is the count of the goods you have on hand before you buy additional inventory and during the start of sales for a given period. Simpler: it is the inventory that you already have ready before starting the sale and before producing or .
Ending inventory 🖐
It is the count of the goods you will have at the end of the sales period in question. In it, the additional goods that you will produce to add to the initial inventory are contemplated. In addition, it is important because it also calculates the amount of product that you will have available to start the next inventory period.
💡 That’s right: the ending inventory of one period will become the starting inventory of the next. The production begins and closes with this beautiful planning moment.
Materials 🧱
In this section you contemplate the raw materials you require to manufacture the goods you will produce. Do you sell cookies? The dough, chocolate, milk. Is your business in clothing? Fabrics, buttons, threads, accessories. Each base element necessary for the final product to be ready, enters here.
And what happens if you sell goods produced by someone else? It’s okay and they also count. You must consider the availability of models, quantities and presentations by the original producer. Your materials, in this case, will be the products that you acquire directly from your supplier.
Manufacturing 🔨
How much does it cost you to make each unit of product you will sell? How and when do you cover those costs to produce your goods? If you produce what you sell, or are involved in some part of the manufacture of that good, you must be clear about the cost of doing so to contemplate it in your budget.
Count here each part of the process that generates a cost. Again, if they are cookies, the ovens, gas, water, electricity, mixers, etc. enter. If it’s clothes, the machines you use to sew, iron and create your garments. Each product in your catalog may have a different manufacturing cost, but you must always have it visible.
Each step necessary to transform your raw material into a finished product must be considered for this section.
Staff costs 👩🏽👨🏽
here they enter all the members of your team that are part of the elaboration of the product. The rule is simple: all the people involved, from the beginning of the transformation of the raw material until the product is finished, count.
In addition to the labor to create the goods, you should also consider the management of the manufacturing process, that is, managers or supervisors who keep your production line healthy. Each worker involved adds to your personnel cost.
Sales and forecasts 📈
This part is made up of all the complementary information that allows you to better anticipate or prepare your production process. How many pieces do you want to sell this year and how does this compare to what you did the year before? Is there a product that was delayed due to scarce raw material? Did you have any good that saturated or sold out soon in your inventory?
This data can help you —in addition to detecting possible challenges or unforeseen events— to better plan your next production period and locate areas where you need to inject more resources or attention. Much of this information comes directly from your sales budget and will help you supplement your sales budget.
What is the formula for the production budget?
The formula that allows you to calculate the production budget in order to determine the units needed to satisfy your sales and inventory needs is as follows:
Sales Budget + Ending Inventory – Beginning Inventory = Production Budget
To understand it better, let’s look at each item as part of a simple exercise to calculate a unit budget:
For this example, the Choko-Latozas™ company needs to know how many cookies it should budget to meet the demand for its last quarter of the year in order to plan its production costs. According to their sales budget, they need to produce 2,000 blueberry cookies for this period.
Now, their initial inventory (the cookies that they already have ready at the beginning of the quarter in question) is 200. It remains to know how many cookies they expect to have at the end of the quarter, this to have inventory for the beginning of the next period, since by the end of the year season, what they produce during this period will be the only thing they will have available to start later. So, they need to have an ending inventory of 500 units.
Thus, using the formula that we show you, we have that a total of 2,500 cookies are required to satisfy the demand (2,000 for the period + 500 for the Final Inventory), and of those cookies, there are already 200, so 2,300 are subtracted cookies to produce. Those are the ones that fall within the production budget. Easy, right?
This formula serves as the base calculation for any production budget, as it allows you to determine how many units you need to produce to cover the demand established by your sales budget. and, from there, calculate the individual costs required for production in your business.
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How is the production budget classified?
The production budget can be classified according to the production element to be budgeted.. So, we have that there are four classifications to make a production budget:
- Budgeted Units
- Materials required for production
- Personnel involved for production
- Manufacturing costs
Let’s review each one individually so you understand how these classifications work to make this budget within your business.
By Budgeted Units
As in the example that we show you, it is used to calculate the units necessary to satisfy demand and keep your inventories balanced. It is the most basic of the production budget types and therefore is the basis for any more comprehensive budget.
By materials required for production
If you require a calculation of how much you will have to invest in the necessary materials to produce the required units, this is what you need. It is possible to make a breakdown of each material necessary for each good produced, or by the final cost of the materials that you will use.
By personnel involved for production
When you need to budget for the cost of direct labor involved in production, this is the type of calculation to do. It is possible to make it as specific with the positions of your collaborators or as general considering the complete areas that generate the products.
For manufacturing costs
This type of budget is useful when you need a more precise calculation of direct costs —those that are exclusively part of the creation of that product— and indirect costs —those that belong to the creation of the product, but also to other areas of the company—. Here we include those expenses such as fixed services (electricity, water, property), machinery, rental of facilities, etc.
💡 Don’t forget that although each classification is used to calculate a different element of production, it is very likely that you will need two, more, or all of them to have an accurate breakdown of your expenses when calculating the products or services that you will sell.
How to make a production budget? example of each
Now that you know the classification of the production budget, you need to know which one to occupy for each occasion. Carrying it out is not different from calculating another budget that you have made, as long as you are very clear about all the expenses, variables and elements that are part of your production.
Prepare your glass of milk, because our examples come with cookies. 🥛🍪
Example of budget by budgeted units
Data you will need: sales budget, manufacturing cost (per unit of product or service), beginning inventory, ending inventory, period to budget.
It’s just like the one we saw as part of the production budget formula, and it can be as simple or as complex as your business requires. In this example, we extended the use of the formula (Sales Budget + Ending Inventory – Beginning Inventory = Production Budget) to calculate how much the total number of cookies required for a given period will cost, based on the manufacturing cost per unit. This way you will know exactly how much it will cost to meet your…
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