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.

GreenLine Furniture - Q4 scenario

For GreenLine Furniture, the production budget for Q4 shows a need to produce 5,500 units. The direct materials budget will estimate the amount and cost of raw materials needed to support this production level.

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

GreenLine Furniture - Q4 assumptions

• Each unit produced requires 4 units of raw material.
• Beginning raw materials inventory for October is 1,000 units.
• Desired ending raw materials inventory each month is 2,000 units.
• Cost per unit of raw material is $3.

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 purchase, incorporating beginning and desired ending raw materials inventory. It builds directly on the direct materials usage budget, adjusting the materials needed for production for planned inventory changes:

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

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

Determine the beginning inventory

Beginning inventory for October is given as 1,000 units. For November and December, beginning inventory equals the prior month’s desired ending inventory of 2,000 units - the assumption is that whatever ending inventory a month targets becomes the following month’s starting point. GreenLine’s desired ending inventory is 2,000 units for every month of Q4.

Calculate the materials to purchase

Combining the usage budget’s totals with these inventory figures gives the completed direct materials purchases budget for GreenLine Furniture’s Q4:

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

October materials to purchase

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

November materials to purchase

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

December materials to purchase

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

Before finalizing the purchases budget, it’s worth checking feasibility: can the supplier realistically deliver 8,132 units of raw material by the start of November, given normal lead times? If procurement can’t reliably source that volume on that schedule, GreenLine would need to either revise the production budget or build a larger safety stock earlier in the quarter to cover the shortfall.