Cost Accounting · Budget and Budgetary Control

Functional Budgets: Sales, Production and Cost Budgets

Updated 10 October 2026 · Fact-checked

Functional budgets are budgets for each function of a business, such as sales, production, materials, labour, overhead and cash. You start with the principal budget factor, usually sales, then work in order: sales units, production units, material usage, purchases, labour and overhead, finally cash.

Understand Functional Budgets: Sales, Production and Cost

A functional budget is a plan, in units and rupees, for one function of the business for a coming period. Sales, production, purchasing, labour, overheads and cash each get their own budget. All of them are later combined into the master budget.

Budgets are linked. One figure feeds the next. The sales budget decides how many units must be available. The production budget decides how many to make, after allowing for stock. Production decides material usage and labour hours. Material usage and stock changes decide purchases.

Every budget set rests on the principal budget factor, also called the limiting factor. It is the resource that restricts activity. It is often sales demand, but it can be scarce material, skilled labour, machine hours or plant capacity. Identify it first. If production capacity is below the sales budget, you cannot produce the sales figure. The sales plan must be revised, or you plan for extra capacity through overtime, subcontracting or purchase.

When the limiting factor is a scarce resource and several products compete for it, rank products by contribution per unit of the scarce resource, and allocate the resource in that order.

The cash budget is different from the others. It converts the plans into cash receipts and payments. It uses timing, such as credit period and payment lag, and leaves out non-cash items like depreciation.

Key rules to remember

Production budget (units): Production = Budgeted sales + Closing stock of finished goods − Opening stock of finished goods; Use units only. Adjust for work-in-progress if the question gives it.
Material usage budget: Material required = Production units × Material per unit; Include normal loss in the per-unit requirement if the question gives it.
Material purchase budget (units): Purchases = Material used + Closing stock of material − Opening stock of material; Multiply purchase quantity by price per unit to get the value.
Labour budget: Labour cost = Production units × Hours per unit × Rate per hour; If idle time is given, hours paid = productive hours ÷ (1 − idle %).
Capacity check: Maximum production = Available capacity (hours) ÷ Hours per unit; If this is less than the production required, capacity is the limiting factor.
Contribution per unit of scarce resource: Contribution per unit of scarce resource = Contribution per unit ÷ Units of scarce resource per unit of product; Rank products on this when one resource is limiting.
Closing cash balance: Closing cash = Opening cash + Receipts − Payments; Ignore depreciation and other non-cash items.

How to solve Functional Budgets: Sales, Production and Cost questions

Use the same order for any functional budget question. Work in units first and rupees later.

1Read the question and identify the limiting factor. Compare sales demand with capacity and material availability.
2Prepare the sales budget in units and value, by product and by period, as asked.
3Prepare the production budget in units using sales plus closing stock less opening stock. If capacity is lower, cap production and revise sales.
4Prepare the material usage budget, then the purchase budget using the stock adjustment. Price it at the given rate.
5Prepare the labour and overhead budgets. Separate variable and fixed overheads and note which ones are cash items.
6For a cash budget, build a month-wise receipts and payments table. Apply credit periods, lag in payments and ignore non-cash items.
7Carry the closing balance of each month to the next as opening balance. Show clear headings and workings.

Quickest way: Units-first stacking

When to use it: Use this for multi-period budget problems with stock policies, where time is short.

Draw one table with months in columns and rows for sales, closing stock, opening stock and production.
Fill the opening stock of each month as the closing stock of the previous month. Do this before calculating anything else.
Calculate production for every month, then use the same columns for material usage and purchases.
Convert to rupees only at the end, once, per budget.
For cash, put workings for debtors and creditors below the table so the marks for method are visible.

Common mistakes in Functional Budgets: Sales, Production and Cost

Adding opening stock and subtracting closing stock in the production budget
Students memorise the formula as a pattern without thinking about it.
Fix: Ask what must be made: sales plus what you want left over, minus what you already have. Closing is added, opening is deducted.
Including depreciation in the cash budget
It appears in the overhead list, so it feels like a payment.
Fix: Depreciation is non-cash. Leave it out. Include only actual cash receipts and payments, such as loan instalments or capital purchases when given.
Ignoring the limiting factor and producing the full sales figure
Students run the standard sequence without checking capacity.
Fix: Check capacity before the production budget. If capacity is lower, restrict production and state the effect on sales.
Recording sales in the month of sale instead of the month of cash receipt
The credit period is read but not applied.
Fix: Shift receipts by the credit period. A one-month credit means January sales are received in February.
Applying stock adjustments to values instead of units
Students go straight to rupees.
Fix: Adjust stock in units, then multiply by price.
Using the production quantity as the purchase quantity
The step from usage to purchases is skipped.
Fix: Usage is not purchases. Add closing material stock and deduct opening material stock.

Worked examples

Example 1

A company sells one product. Budgeted sales: January 2,000 units, February 2,400 units, March 2,600 units, April 2,200 units. The policy is to keep closing finished goods stock equal to 50% of next month's sales. Opening stock on 1 January is 1,000 units. Each unit needs 3 kg of material at ₹40 per kg. Material closing stock is to be 20% of next month's production requirement in kg. Prepare the production budget for January to March, and the material purchase budget for January and February. Opening material stock on 1 January is 1,800 kg.

Show the solution

Closing finished stock: January = 50% × 2,400 = 1,200. February = 50% × 2,600 = 1,300. March = 50% × 2,200 = 1,100.
Production: January = 2,000 + 1,200 − 1,000 = 2,200 units.
February = 2,400 + 1,300 − 1,200 = 2,500 units.
March = 2,600 + 1,100 − 1,300 = 2,400 units.
Material used: January = 2,200 × 3 = 6,600 kg. February = 2,500 × 3 = 7,500 kg. March = 2,400 × 3 = 7,200 kg.
Closing material stock: January = 20% × 7,500 = 1,500 kg. February = 20% × 7,200 = 1,440 kg.
Purchases January = 6,600 + 1,500 − 1,800 = 6,300 kg. Value = 6,300 × ₹40 = ₹2,52,000.
Purchases February = 7,500 + 1,440 − 1,500 = 7,440 kg. Value = 7,440 × ₹40 = ₹2,97,600.

Answer: Production: January 2,200, February 2,500, March 2,400 units. Purchases: January 6,300 kg (₹2,52,000); February 7,440 kg (₹2,97,600).

Example 2

Prepare a cash budget for April and May from the following. Sales: March ₹2,00,000; April ₹2,40,000; May ₹3,00,000. Sales are 50% cash and 50% on credit, with credit sales collected in the month following sale. Purchases: April ₹1,20,000; May ₹1,50,000, paid in the month after purchase. March purchases were ₹1,00,000. Wages ₹30,000 per month, paid in the same month. Other expenses ₹20,000 per month, which include ₹5,000 depreciation. Opening cash on 1 April is ₹25,000.

Show the solution

April receipts: cash sales = 50% × 2,40,000 = ₹1,20,000. Collection of March credit sales = 50% × 2,00,000 = ₹1,00,000. Total = ₹2,20,000.
May receipts: cash sales = 50% × 3,00,000 = ₹1,50,000. Collection of April credit sales = 50% × 2,40,000 = ₹1,20,000. Total = ₹2,70,000.
April payments: March purchases ₹1,00,000, wages ₹30,000, other cash expenses 20,000 − 5,000 = ₹15,000. Total = ₹1,45,000.
May payments: April purchases ₹1,20,000, wages ₹30,000, other cash expenses ₹15,000. Total = ₹1,65,000.
April closing cash = 25,000 + 2,20,000 − 1,45,000 = ₹1,00,000.
May closing cash = 1,00,000 + 2,70,000 − 1,65,000 = ₹2,05,000.

Answer: Closing cash: April ₹1,00,000; May ₹2,05,000.

Exam tips

Write the stock policy in your own words at the top of the answer. This protects your marks if you misread one figure.
Always show the opening and closing stock lines in the production and purchase budgets. Step marks are given for them.
In every cash budget, scan the question for depreciation, provisions and non-cash items before you start.
If a question gives capacity data, check it first. Examiners often hide a limiting factor in the last line.
For MCQs, check whether the question asks for units or rupees and whether it asks for production or purchases. Wrong-option answers are usually the result of a skipped stock adjustment.

Practice questions from Budget and Budgetary Control

Functional Budgets: Sales, Production and Cost in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CA IntermediateFunctional Budgets: Sales, Production and Cost Budgets

Functional Budgets: Sales, Production and Cost: frequently asked questions

What is the first budget to prepare?

Prepare the budget for the principal budget factor first. This is usually sales. If another resource, such as machine hours or a scarce material, is the limit, start with that and fit the other budgets around it.

What is a limiting factor in budgeting?

It is the resource or condition that restricts the activity of the business, such as demand, material, labour or plant capacity. All other budgets must be set within it. When it is a scarce resource, rank products by contribution per unit of that resource.

How do you calculate the production budget?

Add budgeted closing stock of finished goods to budgeted sales and subtract opening stock. Do this in units. If capacity is lower than this figure, production is restricted to capacity.

Should depreciation be in a cash budget?

No. Depreciation is a non-cash expense, so it is excluded. Include only actual cash inflows and outflows, such as collections from debtors, payments to creditors, wages and cash expenses.