The second step in developing the operating budget is the development of the production budget; the production of the product(s) the firm offers. The production budget tells the business owner or financial manager how many units of the product(s) the firm needs to produce to meet sales needs as delineated in the sales budget of the firm.
Calculation of Production Needs
The formula to calculate production needs is as follows:
Units to be Produced = Expected Unit Sales + Units in Desired Ending Inventory (EI) - Units in Beginning Inventory (BI)
Example of a Production Budget
Using the example from the explanation of the operating budget, here is a simple production budget:
The Art Pottery Company expects sales of 1,000 pots. They expect 240 pots in ending inventory at the end of the first quarter. Where will 1,240 pots come from? Beginning inventory supplies 180 of them leaving 1,060 to be produced. You can put this in the format of the equation above to see how it works. Production budgets are always expressed in terms of units, not dollars.