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How to make sense of production department budgets

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The production process is usually a continuous conveyor belt of activity, meaning that unit-driven budgets need regular monitoring.

24th Jan 2024
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January is a crucial month at work. The 2024/25 budgets have to be finalised and reported to the board in readiness for the new financial year in April. There is a bit of a bottleneck at this time of year. Current year Quarter 3 forecasts are scrutinised ever more keenly as it will be the final official forecast before the dreaded year end. The joys.

But let me bend your ear on one of the challenges I am facing in setting the new budget. For the first time I have been handed a production cost centre. Direct labour, direct materials and a unit of output. This is where I cut my teeth. Blue-collar graft.

The end product, which must be measurable, determines the resource that must be made available to achieve the targets. Armed with standard costs, history and a keen eye on inflation the pot of money can be determined. Of course, I am being very simplistic but the process can be worked off a template, updated as necessary.

Production unit-driven budget process

This is in essence a zero-based budget. It is a budgeting process that is based on the units of production or output. This approach ties financial planning and resource allocation directly to the level of activity or the service output, and the number of units produced or sold by a business. It is a method commonly used in manufacturing and other industries where production volume is a key factor.

Let’s look at how unit-driven budgets generally work.

1. Identifying units of activity

Determine the key units of activity or output relevant to your business. This could be the number of products manufactured, services provided or any other measurable unit. The area I am currently involved in has the job of fitting windows and doors. We have a planned programme of delivery so working out the targets is done in partnership with the cost-centre managers.

2. Setting standards

Establish standards for costs and revenues associated with each unit of activity. This involves estimating the average cost and revenue per unit. Easier said than done. The cost will also be based on historical performance and efficiencies that demand an eye for monitoring output on a timely basis. Standards will have to be revised.

3. Budgeting based on units

Develop the budget by multiplying the estimated units of activity by the standards set for costs and revenues. For example, if the goal is to produce 100,000 units and the cost per unit is £5, the budgeted cost would be £500,000. As discussed above, the standard costs will need to be realistic.

4. Flexible budgeting

The unit-driven budget can also be used to create a flexible budget that adjusts for changes in activity levels. This allows for better variance analysis, as actual performance can be compared to the budget based on the actual level of activity.

5. Monitoring performance

Regularly monitor actual performance against the budget to identify variations. This helps in taking corrective actions if necessary and improves future budgeting accuracy, which is why finance can be a pain in the backside for production centre managers. Always putting their nose in, but this is where liaison with the department is crucial. A good relationship with managers makes for a working environment where everyone understands and appreciates the benefits of monitoring.

6. Decision-making

Use the unit-driven budget for decision-making processes, such as determining the economic feasibility of different production levels or assessing the impact of changes in unit costs on overall financial performance.

The financial year

In an ideal world production departments will start anew at the beginning of the financial year and come to an abrupt halt at the end, thus giving us finance people a neat parcel of data we can work with. If only. Usually the production process is a continuous conveyor of activity. It is therefore crucial the monitoring is done regularly, incorporating trends and issues that may require rectification and intervention. 

One of the main complaints managers tell me about is that the finance department operates in a bubble, with little understanding of ground-level challenges. We like to work with cold figures, cute spreadsheets that often undermine the hard work direct operatives put in. I will admit to that. So the financial year must be a journey and a dialogue between the managers. It is a two-way approach with managers to appreciate that management accountants provide the gauge of how well things are ticking over.

However, it is essential to recognise that while unit-driven budgets provide a straightforward way to align financial plans with operational activities, they may not capture all factors influencing financial performance. Therefore, businesses often use a combination of unit-driven budgets and other budgeting methods to create a comprehensive financial plan.

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