A production budget is an accounting procedure used to both record and propose manufacturing supply expenses. Keeping an organized production budget ensures that the supply of raw materials to the production line continues uninterrupted and meets consumer demand. Maintaining a detailed post-purchasing production budget also helps to account for material losses due to shrinkage.
Key Factors
The key factor to remember is that there are two types of production budgets. The first is the projected budget, which is the budget presented for approval to management and acted upon by material purchasers. The second is the post-production budget accounting, which tracks the use of the materials purchased based upon the initial budget and raises the flag if any issues are encountered, such as material shortfalls or over-purchasing during the last business cycle, as well as other potential avenues of capital loss.
Importance of Market Research
Manufacturing companies should thoroughly research the materials used in their production processes, since their cost is subject to supply and demand as well as production concerns. Choice of materials can have a dramatic effect on the cost of the end product, particularly in applications where the actual material itself is interchangeable, such as manufacturing cookie tins on an assembly line. The consumer does not care whether the tin is made of steel or aluminum; however, for the purposes of production, budgeting is affected by regional supply and demand and the choice between steel or aluminum for those tins will have a dramatic effect on the bottom line. Adequate research related to estimating demand for a production product is also critical, because overproducing can lead to a decline in the per-unit value of an item that is not in particularly high demand, which can ultimately lose money. On the other side of the coin, companies that are not prepared for high demand situations may end up missing the height of their earning opportunity on a particular product.
Common Pitfalls
One common production budgeting pitfall is not taking advantage of uncharacteristically low purchase prices on commodity products. This is likely to occur when the production company does not have anyone monitoring commodity market trends relating to materials they deal in. A variety of factors can cause these types of situations. For example, an urban rejuvenation project may cause a local influx of readily available inexpensive scrap steel, which a local manufacturing company could obtain at great profit if they are watching for the opportunity. International factors affecting commodity prices for production budgeting can range from the opening of major supplying projects that lowers the overall per-unit price on the material that the company needs, to a dip in international demand for the raw material in question. Using spreadsheet software to monitor pricing trends and look for uncharacteristically low prices can help identify good purchasing opportunities.
Turn a Low Production Budget into a Marketable Feature
Companies with low production budgets can maximize their profits by building hype for their product via marketing. The buzz built up by marketing departments can artificially raise the per-unit value of the items produced. A good example of this behavior is the hype built up around certain tailored clothing and accessory products, which when crafted by a small-scale, low-production budget, "exclusive" tailors demand an unrealistically high value that is disproportionate to their material investment cost and functionality. Another approach is to use an inexpensive base product to manufacture a valuable processed commodity. A prime American example of this is the use of corn, which is processable into virtually any food product ranging from chips to soda pop, making a production unit for corn a fantastic investment for a company with a lower production budget, provided it is able to process it adequately.
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