Management Accounting · Forecasting, Budgeting and Budgetary Control

Functional Budgets: Sales, Production and Cost Budgets

Updated 10 October 2026 · Fact-checked

Functional budgets are plans for each function of a business. You start with the sales budget, then find production by adjusting sales for opening and closing finished stock. Production drives the material, labour and overhead budgets, and material purchases are adjusted for raw material stock. Work in a clean table, one budget at a time.

Understand Functional Budgets: Sales, Production and Cost Budgets

A functional budget is a budget for one function of the business, such as sales, production, purchasing, labour or overheads. Each budget is a plan in units and in rupees for a fixed period, usually a month or a quarter. All the functional budgets together feed the master budget.

The budgets are linked in a chain. The sales budget comes first because sales is normally the principal budget factor, the factor that limits what the business can do. If a different factor is the limit (for example, scarce material or machine hours), you start from that factor instead. The question will usually tell you.

The production budget says how many units you must make. You do not simply make what you sell. If you want closing stock of finished goods, you must make extra units. If you start with opening stock, you can make fewer. That is the inventory adjustment.

From production, you build the cost budgets. The raw material usage budget is production multiplied by material per unit. The material purchase budget adjusts usage for opening and closing raw material stock. The labour budget is production multiplied by hours per unit and the wage rate. The overhead budget splits cost into variable (changes with output) and fixed (does not), and may remove non-cash items such as depreciation.

The same stock-adjustment idea is used twice: once for finished goods and once for raw materials. Learn it once and you can solve most numericals in this topic.

Key rules to remember

Sales budget (value): Budgeted sales ₹ = Budgeted sales units × Selling price per unit; For several products, calculate each product separately and then total.
Production budget (units): Production = Sales units + Closing stock of finished goods − Opening stock of finished goods; Closing stock is often given as a percentage of next period's sales. The closing stock of one period is the opening stock of the next.
Raw material usage: Material required = Units produced × Material per unit; If normal loss is given, first find the input needed per good unit.
Material purchase budget (quantity): Purchases = Material required for production + Closing stock of material − Opening stock of material; Purchase cost = Purchase quantity × Price per unit.
Labour hours and cost: Hours = Units produced × Hours per unit; Labour cost = Hours × Wage rate; If idle time is given as a % of hours paid, then Hours paid = Productive hours ÷ (1 − idle time %).
Overhead budget: Variable overhead = Activity × Rate per unit or hour; Total overhead = Variable + Fixed; Cash overhead = Total overhead − Non-cash items such as depreciation.

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

Use the same sequence for any functional budget question. Do not skip the unit budgets before moving to rupees.

1Read the question and mark the period (month or quarter), the units, and the stock policies for finished goods and for raw material.
2Identify the principal budget factor. If it is sales, prepare the sales budget in units first, and in rupees if prices are given.
3Prepare the production budget in a table with rows: sales, add closing stock, less opening stock, production. Work out closing stock for every period, then take the opening stock from the previous period's closing stock.
4Prepare the material usage budget (production × material per unit), then the purchase budget with rows: usage, add closing stock, less opening stock, purchases. Multiply by price to get the purchase cost.
5Prepare the labour budget from production: hours, then rupees. Apply idle time or overtime only if the question states it.
6Prepare the overhead budget: variable part from activity, fixed part as given, then total. Remove non-cash items if a cash figure is asked.
7Add a total column and check it. For example, total production must equal total sales plus total closing stock minus total opening stock.
8Write units and rupees in separate, labelled rows, and state the answer clearly at the end.

Quickest way: Stock-adjustment table method

When to use it: Use it when the question gives sales for several periods and stock policies, and you must find production and purchases quickly.

Draw columns for each period plus a total column.
Write sales units in the first row. In the second row write closing stock using the stated policy, for example 20% of next period's sales.
In the third row write opening stock, which is the previous column's closing stock. The first period's opening stock is given.
Production = row 1 + row 2 − row 3. Do this column by column.
Check the total column: total production = total sales + last closing stock − first opening stock.
Repeat exactly the same layout for raw material using usage in place of sales, and purchases in place of production.

Common mistakes in Functional Budgets: Sales, Production and Cost Budgets

Taking production equal to sales.
Students ignore the stock policy or forget that finished goods stock changes.
Fix: Always write the adjustment rows. Production = Sales + closing stock − opening stock.
Using the wrong opening stock for the second and later periods.
The student recalculates opening stock from the policy instead of copying the previous closing stock.
Fix: Only the first period's opening stock is given. For every later period, opening stock = previous period's closing stock.
Applying the closing stock percentage to the current period's sales instead of next period's.
The wording 'of next month's sales' is skipped when reading.
Fix: Underline whether the percentage applies to current or next period. If it is next period, you may need one extra period's data, which the question will give.
Calculating material purchases from sales units or from the finished goods stock adjustment.
Students mix the two stock adjustments.
Fix: Finished goods stock adjusts production. Raw material stock adjusts purchases. Material usage is always based on production units.
Including depreciation in a cash overhead budget.
Total overhead is copied into the cash figure without reading the note.
Fix: If the question asks for cash overhead or is feeding a cash budget, subtract non-cash items such as depreciation.
Treating fixed overhead as varying with output.
A single rate per unit is applied to the total overhead.
Fix: Separate variable and fixed overhead. Multiply only the variable part by activity. Keep the fixed part constant for the period given.

Worked examples

Example 1

Mehta Plastics makes one product. Budgeted sales are: January 2,000 units, February 2,500 units, March 3,000 units, April 2,000 units. Closing stock of finished goods at the end of each month is 20% of the next month's sales. Opening stock on 1 January is 400 units. Each unit needs 3 kg of material costing ₹40 per kg. Opening material stock on 1 January is 1,500 kg and closing stock at the end of each month is 1,800 kg. Prepare the production budget and the material purchase budget for January to March.

Show the solution

Closing finished stock: January 20% × 2,500 = 500 units; February 20% × 3,000 = 600 units; March 20% × 2,000 = 400 units.
Opening finished stock: January 400 (given); February 500; March 600.
Production: January 2,000 + 500 − 400 = 2,100 units; February 2,500 + 600 − 500 = 2,600 units; March 3,000 + 400 − 600 = 2,800 units. Total = 7,500 units.
Check: total sales 7,500 + closing 400 − opening 400 = 7,500 units, which matches.
Material required at 3 kg per unit: January 6,300 kg; February 7,800 kg; March 8,400 kg. Total = 22,500 kg.
Purchases: January 6,300 + 1,800 − 1,500 = 6,600 kg; February 7,800 + 1,800 − 1,800 = 7,800 kg; March 8,400 + 1,800 − 1,800 = 8,400 kg. Total = 22,800 kg.
Check: 22,500 + 1,800 − 1,500 = 22,800 kg.
Purchase cost at ₹40 per kg: January ₹2,64,000; February ₹3,12,000; March ₹3,36,000. Total = ₹9,12,000 (22,800 × 40 = ₹9,12,000).

Answer: Production: January 2,100, February 2,600, March 2,800 units (total 7,500 units). Material purchases: 6,600 kg, 7,800 kg and 8,400 kg (total 22,800 kg), costing ₹9,12,000 in all.

Example 2

Production budget of Sharma Engineering for product Z: April 4,000 units, May 5,000 units, June 4,500 units. Each unit needs 1.5 labour hours at ₹80 per hour. Variable overhead is ₹12 per labour hour. Fixed overhead is ₹1,20,000 per month, which includes depreciation of ₹30,000. Prepare the labour budget and the overhead budget for the three months, and show the total cash overhead.

Show the solution

Labour hours at 1.5 per unit: April 6,000; May 7,500; June 6,750. Total = 20,250 hours.
Labour cost at ₹80 per hour: April ₹4,80,000; May ₹6,00,000; June ₹5,40,000. Total = ₹16,20,000 (20,250 × 80).
Variable overhead at ₹12 per hour: April ₹72,000; May ₹90,000; June ₹81,000. Total = ₹2,43,000 (20,250 × 12).
Fixed overhead: ₹1,20,000 each month, total ₹3,60,000.
Total overhead: April ₹1,92,000; May ₹2,10,000; June ₹2,01,000. Total = ₹6,03,000 (₹2,43,000 + ₹3,60,000).
Less depreciation (non-cash) ₹30,000 per month, total ₹90,000.
Cash overhead: April ₹1,62,000; May ₹1,80,000; June ₹1,71,000. Total = ₹5,13,000 (₹6,03,000 − ₹90,000).

Answer: Labour cost for the three months is ₹16,20,000 for 20,250 hours. Total overhead is ₹6,03,000, of which cash overhead is ₹5,13,000.

Exam tips

Draw a table with a total column for every budget. Totals earn marks and also let you cross-check your work.
Show the stock adjustment rows (add closing stock, less opening stock) separately. Even if one figure is wrong, you still earn step marks for the correct method.
In MCQs, the usual trap is the opening stock, or the stock percentage applied to the wrong month. Re-read the stock policy before you pick an option.
Write units and rupees separately and label every row. Keep fixed and variable overhead in separate rows.
If a question asks for a budget for the quarter, the closing stock of the last month may depend on the following month's sales. Check the data given for that month.

Practice questions from Forecasting, Budgeting and Budgetary Control

Functional Budgets: Sales, Production and Cost Budgets in other exams

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

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

What is the order of preparing functional budgets?

Start with the budget for the principal budget factor, usually sales. Then prepare production, then material usage and purchases, labour and overheads. Each budget uses figures from the one before it.

How do I calculate the production budget when stock policy is given?

Production = sales units + closing stock of finished goods − opening stock of finished goods. Work out closing stock for each period from the policy and use it as the next period's opening stock.

What is the difference between material usage budget and material purchase budget?

The usage budget shows how much material production consumes. The purchase budget adjusts that usage for opening and closing material stock, so it shows how much you must buy.

Do I need to separate fixed and variable overhead in the overhead budget?

Yes. Variable overhead changes with activity, while fixed overhead stays constant for the period. Keeping them separate is also needed if the question asks for cash overhead or a flexible budget.