 Revenue and Production Budgets - dummies

Revenue and production budgets, put simply, forecast how many units you plan to produce and how many units you plan to sell. Material and labor costs are considered direct costs, because they can be traced directly to your product.

Say you’re budgeting to manufacture garage doors. You need to forecast how many sales you expect. Then consider how many garage doors you already have in inventory and plan how many you need to manufacture to meet the sales forecast. Ta da! When you know the number of doors you need to make, you can budget for material and labor costs.

Indirect costs are those that can’t be directly traced to the product. Repair and maintenance costs for a machine, for example, are indirect costs. You may assign these costs by dividing the total cost incurred by the number of hours the machine ran during the month. That would give you a rate per machine hour.

If you incur two hours of machine time to make one unit of product, you would multiply two hours by the machine rate per hour. That indirect cost total would be added to the unit of product.

Revenue, production, inventory, direct materials, direct labor, indirect costs (overhead), and cost of goods sold all are budgeted items.

## Applying the revenue formula

Suppose you forecast selling 200 garage doors in March. Consider how many garage doors you need to manufacture. Assuming a sales price of \$300 per door, here’s your revenue budget:

Revenue budget = 200 units x \$300

Revenue budget = \$60,000

## Using the inventory formula

And now for the famous inventory formula:

Ending inventory = Beginning inventory + Production – Sales

Your production will change based on how many garage doors you already have in inventory. So if you already have 75 completed garage doors in beginning inventory, you won’t need to manufacture all 200 units you plan to sell.

But wait! Do you want any garage doors in ending inventory? If you think you’ll have orders during the first few days of the next month, you probably want to have at least a few garage doors left at the end of this month. So maybe you decide on an ending inventory of 50 garage doors.

Take the inventory formula and calculate the garage door production you need. Assume x is production in units, and solve for x:

Ending inventory = Beginning inventory + Production – Sales

50 = 75 + x – 200

50 – 75 + 200 = x

x = 175

This simple algebra problem shows that production should be 175 units.

Garage Door Production Budget
Cost Quantity Price Total
Direct material (wood) 80 square feet \$1 per square foot \$80
Direct labor (labor) 2 hours \$25 per hour \$50
Indirect costs allocated 1 hour \$15 per hour \$15
Cost per unit \$145
Units Unit cost Total cost
Production cost 175 \$145 (above) \$25,375

The production budget includes direct materials, direct labor, and indirect costs (overhead). In this example, the indirect cost is allocated based on machine hours. Add the costs to get a unit cost. Then multiply units to be produced by the cost per unit. That amount is the total cost of production of \$25,375.

## Assessing cost of goods sold

The goods you produce for customers end up in one of two places: You either sell them (cost of goods sold), or they’re still on the shelf (finished goods inventory). Beginning inventory and production don’t matter.

What costs should be attached to the goods you sell? How much did they cost to produce? (If you’re a retailer, how much did they cost to get?) To continue with the garage door manufacturing example, assume the first goods you sell are from beginning inventory. Because all 75 units of beginning inventory are sold, use a formula to determine how many units of the March production are sold:

March production sold = Total sales – Beginning inventory

March production sold = 200 – 75

March production sold = 125

Assume also that the cost per unit of beginning inventory is \$143. That cost is different from the March production cost of \$145. (Why the change? Because the costs of materials and labor to make a garage door rose.)

Garage Door Cost of Goods Sold Budget
Units Cost Per Unit Total Cost
Beginning inventory 75 \$143 \$10,725
March production sold 125 \$145 \$18,125
Total 200 \$28,850

The total cost of goods sold is higher (\$28,850) than total production cost (\$25,375). That makes sense, because the first table deals only with producing 175 units. You sold 200 units, but 75 units were from inventory. Because of adjustments for beginning and desired ending inventory, you don’t always need to produce in a month the number of units you sell in a month.

One more calculation. (There’s always one more calculation.) Now calculate your ending inventory budget:

Ending inventory budget = Units x Per unit cost

Ending inventory budget = 50 x \$145

Ending inventory budget = \$7,250