Operating budgets

A budget is a quantified plan for a future period. It forces managers to coordinate (sales can't promise what production can't make), communicates targets, and gives a yardstick for control later. The full set of budgets for a period is the master budget; the operating budgets are its foundation.

Operating budgets are built in a chain, each from the one before:

1. Sales budget — units × selling price. It comes first because sales is usually the principal budget factor (CIMA/ACCA term; US texts tend to say limiting or constraining factor): the constraint that limits everything else. If machine time, skilled labour or a scarce material is the tighter limit, that becomes the principal budget factor and the plan is built around it instead. Get the starting point wrong and every later budget is wrong too.
2. Production budget — units to make = budgeted sales + desired closing finished-goods inventory − opening finished-goods inventory.
3. Direct materials purchases budget — materials needed for production + desired closing materials − opening materials, then × price.
4. Direct labour and overhead budgets — production units × hours or cost per unit.

Budgets are internal management tools: no accounting standard (IFRS or US GAAP) prescribes their format or method, so terminology and layouts vary between organisations and professional syllabuses.

Fernhill Ceramics makes stoneware mugs selling at 12. Policy: hold finished mugs equal to 20% of next month's sales, and clay equal to 10% of next month's production needs. Each mug uses 2 kg of clay at 1.50 a kg and 2.20 of direct labour.