This is the third article in our 3-part series on budgeting to support the MABU unit for level 4 students.
Study tips: Budgeting series
- Part 1 – Compiling the materials elements of a budget
- Part 2 – Labour, overheads and operating budget
- Part 3 – Production budget report
In part 1 of this series on budgeting we focused on the raw materials element of an operating budget and set out some key planning assumptions based on our scenario. Part 2 looked at the labour and overheads elements and compiled the draft budget and submitted it to the budgetary committee for approval.
Let’s assume that the committee has met but have requested some further information before a final decision is made. It has specifically asked for more information about production so you have re-formatted the production budget which is based on the production forecast:
Draft email submitting the Production Budget
And below, we have drafted up an email that you could send to the Budget Committee with the production report.
To: The Budget Committee
From: Budget Accountant
Subject: Production Budget
Date: xx xx xx
Budget submission – additional information
I attach the draft quarter one production budget for the new fruit smoothie for your consideration and approval as requested. It has been calculated from planned sales volume targets agreed with the marketing manager as a result of recent research and development work. Sales targets start at 5,000 units with a weekly 10% increase until the target volume of 10,000 units is achieved, which is projected to be in week 9 of production.*
Low quantities of closing inventory are preferable because the product is perishable so the closing inventory has been calculated as 2% of the following week’s sales volume. The production manager has advised that 8.5% of production could be rejected during quality control so an allowance has been included at this rate. This equates to £9,227 worth of raw materials.**
There has been a 114% increase in the price of wholesale mixed berries over the last two year and this year’s actual average cost per kg was £4.43. The chief buyer has been monitoring statistics published by the Department for Environment, Food and Rural Affairs, and has suggested it would be prudent to budget at £5.10 which is 15% more than this year’s actual average per kg.***
Key budget factors
As this is a new product the reliability of the sales budget and fluctuations in demand are as yet unknown. Whilst the figures have been based on PEST analysis and commissioned market research this does not guarantee total accuracy and actual sales could be influenced by unknown competitor activity and market demand.
Whilst closing inventory of 2% minimises wastage due to spoilage it may be insufficient as a contingency against capacity constraints due to potential limited resources.
There is potential for production to be limited if raw materials are in short supply or the just in time daily delivery is delayed. Fruit is a key ingredient in the product and supply is obviously seasonal. It can also be affected by poor harvests caused by inclement weather. This is outside of the managers’ control as are delivery delays due to logistical problems such as congestion on the roads. However, consistency of supply can be safeguarded to a degree by having a range of suppliers in a number of locations. The chief buyer monitors wholesale price fluctuations and it is fair to assume that prices will increase if available supplies are insufficient to meet demand.
Production constrains could also arise due to machinery idle time and/or labour shortages. As the company produces similar existing products it is reasonable to assume that machinery idle time can be predicted with a reasonable degree of accuracy. Equally, as the production lines for similar existing products are supervised by three members of staff, potential staff shortages can be realistically anticipated, such as leave and training, as well as unforeseen shortages, such as idle time and absences.
The estimated rejection rate is also a key budget factor and a significant cause for concern. Further investigation is required to determine the reasons why 8.5% of production could be rejected during quality control. Possible causes could be the quality of raw materials, their storage or the length of time between acquisition and usage. If current projected levels of rejection are realised and quarter 1’s budget taken as representative of the year, then wastage will cost £36,908 in raw materials. This will have a significant negative impact on the product’s profitability.
The reliability of the budget is yet unknown as this is a new product and should therefore be monitored closely. It contains a number of variable factors that could be regularly monitored using the following performance measures:
- the wholesale purchase price of mixed berries per kilo
- weekly production and sales volumes, in units
- weekly rejection levels, in units and as a percentage of production
- weekly closing inventory levels, in units.
The performance indicators should be compared to the budgetary assumptions and revisions to sales targets and production levels should be made as appropriate.
I hope this submission meets with your approval but if you require any further information or explanations please do not hesitate to contact me.
This series has looked at the individual elements of an operating budget, its compilation and how to submit it for approval. Whilst we don’t know the final decision made by the budgetary committee there are plenty of fruit smoothies on supermarket shelves today – maybe one is there as the result of our scenario!
* Sales volume figures in the production forecast:
** 9,046 rejected units x £5.10 per kg x 0.2kg per unit = £9,226.92
*** Wholesale price increase:
£4.60 – £2.15 = £2.45
£2.45 ÷ £2.15 x 100 = 114% rounded to the nearest whole %
This year’s actual average per kg:
£5.10 ÷ 115 x 100 = £4.43
For more Professional level study materials: Professional study tips
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.