Sales, Production & Purchases Budgets

Functional budgets are prepared in a logical sequence, because each one depends on the previous:

1. Sales budget — the starting point: how many units the business expects to sell (and the revenue).
2. Production budget — how many units must be made to meet sales and achieve the desired finished-goods inventory.
3. Materials (purchases) budget — how much material must be bought to support production and the desired raw-materials inventory.
4. (And a labour budget, overhead budget, etc.)

The sales budget drives everything, because there is no point making or buying more than can be sold. Each subsequent budget adjusts the previous one for inventory changes. Getting this chain right — sales → production → purchases — is the core skill, and it relies on the inventory adjustment at each step.

The production budget works out how many units must be made. It is not simply the sales units — the business must also build up (or run down) its finished-goods inventory:

$\text{Production (units)} = \text{Sales units} + \text{Closing finished goods} - \text{Opening finished goods}$

Example. Sales 10,000 units; opening finished goods 1,500; desired closing finished goods 2,000 → production = 10,000 + 2,000 − 1,500 = 10,500 units.

The logic: the units available to sell = opening inventory + units produced; these must cover sales + closing inventory. Rearranging gives the formula. So:

• if closing > opening inventory (building stock), produce more than you sell;
• if closing < opening (running stock down), produce less than you sell.

The materials (purchases) budget works out how much material must be bought. First find the materials used in production:

$\text{Materials used} = \text{Production units} \times \text{material per unit}$

Then adjust for the desired raw-materials inventory (exactly like the production budget, but for raw materials):

$\text{Purchases} = \text{Materials used} + \text{Closing raw materials} - \text{Opening raw materials}$

Example. Production 10,500 units × 3 kg = 31,500 kg used; opening raw materials 2,000 kg; desired closing 2,500 kg → purchases = 31,500 + 2,500 − 2,000 = 32,000 kg. At $4/kg, the purchases budget value = 32,000 × 4 = $128,000.

So the purchases budget is the production budget's logic applied one level down — production drives usage, which (after the raw-materials inventory adjustment) drives purchases.

The labour budget follows directly from the production budget:

$\text{Labour hours} = \text{Production units} \times \text{hours per unit}; \quad \text{Labour cost} = \text{hours} \times \text{rate}$

Example. 10,500 units × 2 hours × $12 = $252,000.

So the production budget is the hub: it drives the materials, labour and variable overhead budgets, all flowing from the sales budget. The full chain:

Sales budget → Production budget → Materials/Labour/Overhead budgets → (Master budget).

A typical exam question gives the sales forecast, inventory levels and per-unit usage, and asks for the production and purchases budgets (and sometimes labour). The key is to apply the inventory adjustment correctly at each level and keep the chain in order. These functional budgets later feed the master budget (a later subtopic).