- Create a production budget
Once we get the sales budget prepared, you can see on the flow chart that the next budget we need to work on is the production budget. This budget is necessary to provide all of the details we need to prepare direct materials, direct labor and manufacturing overhead budgets that come next.
The production budget outlines the number of units that we need to produce to meet the requirements we put together in the sales budget. This information needs to be completed prior to moving forward. Without knowing how many of our products we need to make, it would be impossible to move forward with the remaining budgets!
So remember our sales numbers for Hupana Running Company from our sales budget. We plan to sell 2,000 pairs of shoes, evenly distributed between the four quarters of the year. Armed with this information, we can create our production budget.
We had 100 pairs of shoes in our finished goods inventory at the end of the previous year, so we can use that number as we start our production budget. We also want to always have at least 50 pair in our finished goods inventory at the end of each quarter, but would like to end the year with 150 pair in inventory to start the next year.
|Hupana Running Company Production Budget|
|Budgeted unit sales (pairs)||500||500||500||500||2000|
|Desired finished goods inventory||50||50||50||150||300|
|Less beginning finished goods inventory||100||50||50||50||250|
|Required production units||450||500||500||600||2050|
So taking a look at our production budget, what do you notice?
Even though we intend to sell 2000 pairs of shoes this year, we are producing 2050! Why? Because we would like to have a larger ending inventory at the end of this year. This could be for a few reasons. Perhaps we anticipate higher sales in the first quarter, or maybe we want to have a plant shut down in the early part of the year. This higher ending finished goods inventory would allow us to cover those two situations.
Also notice, that in the first and fourth quarters, we are actually producing either fewer or more pairs of shoes than we intend to sell. This is to adjust for finished goods inventory.
Now let’s practice!