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9.1: Production Budget

  • Page ID
    45914
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    Learning Objectives

    • 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
    Quarter Q1 Q2 Q3 Q4 Totals
    Budgeted unit sales (pairs) 500 500 500 500 2000
    Desired finished goods inventory 50 50 50 150 300
    Total need 550 550 550 650 2300
    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.

    Note: So Hupana Running Company is a manufacturer. What might be different if they were a merchandising company who simply purchased finished goods to sell?  Well, instead of a production budget, they would have a merchandise purchases budget. It would be similar in layout to the production budget, but the wording would be different.  Rather than a required production in units, we would simply have required purchases. Oh, and we could skip some of the additional budgets, like production, direct labor and manufacturing overhead! Why? Well, if we aren’t actually manufacturing anything, those budgets aren’t needed. A merchandising company is a bit easier to budget for, but let’s keep plugging away at our manufacturing company!

    Now let’s practice!

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    • Production Budget. Authored by: Freedom Learning Group. Provided by: Lumen Learning. License: CC BY: Attribution

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