Direct materials budget

Connection between the production budget and direct materials budget

The direct materials budget is based directly on the production budget. As the production budget defines the units of finished goods to be produced, the direct materials budget calculates the raw materials required to meet production goals at the specified cost per unit.

In preparing the direct materials purchases budget, it’s also essential to consider the company’s payment policies with suppliers, as this directly impacts the cash budget. While the direct materials budget outlines the quantity and cost of materials needed for production, payment terms determine when these costs will actually be paid. If purchases are made on credit, the cash outflows for direct materials may occur in a different period than the purchases themselves. This distinction is crucial for accurately projecting cash flow in the cash budget, allowing the company to anticipate and allocate funds for supplier payments based on agreed-upon credit terms, ensuring smooth operations without unexpected cash shortfalls.

Impact of inventory levels and procurement policies in the DM budget

Inventory management and procurement policies play a significant role in the direct materials budget. Companies aim to balance enough inventory to avoid production delays with efficient procurement practices to minimize carrying costs.

• Beginning inventory and desired ending inventory: These figures help in calculating the direct materials needed for production while keeping buffer stocks. Maintaining appropriate inventory levels ensures there is enough material on hand to meet production goals.
• Procurement policies: Bulk purchasing, just-in-time procurement, and supplier lead times impact the budget. For instance, bulk buying may result in larger purchases less frequently, while just-in-time policies require smaller, frequent purchases.

Preparing the direct materials budget

The direct materials budget is divided into two parts:

1. direct materials usage budget; and
2. direct materials purchases budget

Direct materials usage budget

This budget calculates the total quantity and cost of raw materials needed for production. This is directly linked to the amount of units required to be produced determined by the production budget.

Input data from the production budget

Data from the production budget are used as a starting point for the DM usage budget:

Calculate the total materials required and total materials cost

Using the following formula, we can fill-in the other details of the budget:

$$\text{Total materials required}=\text{Units to produce}\times \text{Materials per unit}$$

$$\text{Total materials cost}=\text{Total materials required}\times \text{Cost per unit}$$

Direct materials purchases budget

This budget determines the quantity and cost of materials to be required purchased, incorporating beginning and desired ending inventory of raw materials. This is directly linked to the direct materials usage budget. Also the logic of the formula to determine the required raw materials to purchase is the same as the purchases budget:

$$\text{Material to purchase}=\text{Total material required}+\text{Desired ending inventory}-\text{Beginning inventory}$$

$$\text{Total purchase cost}=\text{Material to purchase}\times \text{Cost per unit}$$

Input the information from the DM usage budget

Based on the information we have so far, you can fill in the following schedule. Note that according to the requirements of GreenLine Furniture, the desired ending inventory every month for Q4 is 2,000 units.

Determine the beginning inventory

Using the assumption that the ending inventory of the previous month is the projected beginning inventory of the next month, we should be able to fill-in additional details.

Calculate the materials to purchase using formula

In addition, we can use the “Material to Purchase” formula presented above to determine the required direct materials to be purchased. After these, we are left with the following direct materials purchases budget for GreenLine Furniture for Q4:

The materials to purchase for each month of Q4 are calculated as follows:

$$\begin{array}{rl}\text{Material to purchase}& =\text{Total material required}+\text{Desired ending inventory}-\text{Beginning inventory}\\ & =6,800\text{ units}+2,000\text{ units}-1,000\text{ units}\\ & =7,800\text{ units}\end{array}$$

$$\begin{array}{rl}\text{Material to purchase}& =\text{Total material required}+\text{Desired ending inventory}-\text{Beginning inventory}\\ & =8,132\text{ units}+2,000\text{ units}-2,000\text{ units}\\ & =8,132\text{ units}\end{array}$$

$$\begin{array}{rl}\text{Material to purchase}& =\text{Total material required}+\text{Desired ending inventory}-\text{Beginning inventory}\\ & =7,068\text{ units}+2,000\text{ units}-2,000\text{ units}\\ & =7,068\text{ units}\end{array}$$