If you are in manufacturing, you should be regularly creating a production budget. This budget will factor in two basics: the cost of labor and the cost of materials. Knowing these two pieces of information can help you set the price of your item at a competitive price that will still allow you to profit.
Putting a Production Budget in Action
Let’s say you pay a worker $10 an hour. You own a bakery, and one worker using a machine can make 1,800 bagels an hour. Your ingredients for the bagels cost $420. Your production cost is $430 per hour or approximately .24 cents per bagel.
Of course, this is a very simplistic example. You must also consider your cost for renting or paying for your production space, paying for the machinery, your electricity and other utilities as well as any benefits you pay your workers. Some companies such as GM include these factors into their cost to produce every vehicle they make.
Benefits of a Production Budget
Having a production budget is important for several reasons:
- You can determine your company’s profitability on a particular item. If you make bagels for .24 cents and sell them for .50, you have a very small profit margin, if any. Knowing your exact production cost can help you price your item at a profitable, but competitive, price.
- You can search for the best price. If you buy flour for .50 cents a pound but find a different source that offers the same quality flour for .40 cents if you buy in bulk, you know you have now increased your profitability for that particular item.
- You can take advantage of sales or seasonal fluctuations. If you have the ability to store the flour and you know that the price falls in one season, you may be able to stock up at the lower price or build in a cushion for your profitability.
If you own a small business, likely you, as the owner, will be crunching the numbers. As your business grows, you will rely on a team including an accountant as well as a purchasing agent to do most of these figures for you.
However, it is important not to grow complacent. Many recommend setting up a production budget before you even begin producing the item (this is called a projection budget) and then to also have post-production analysis to account for the production process. Were there any shortfalls? Did you produce too much of a product? Were costs as you expected them to be when you created the projection budget?
Because of the different people, supplies and expenses that go into producing something for your business, making a production budget can be a difficult, but necessary, part of your business. The production budget should be determined for each of the items your company manufactures.
What suggestions or tips would you give someone who is trying to create a realistic production budget?
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