- Create a direct materials budget
Hupana Running Company is off to a great budgeting start. We have put together a sales budget, so we know how many pairs of our amazing running shoes we intend to sell, then we created a production budget, so now we know how many we need to produce each quarter to meet sales and finished inventory needs.
Next we will need to figure out, based off the information in our production budget, what we need for direct materials. Remember, the number of pairs of shoes we sell each quarter, does not necessarily match the number of pairs we need to produce each quarter. Keeping that information in mind, let’s move on to our direct materials budget.
In order to complete this budget, let’s look at a few pieces of important information.
- How many units of raw materials are required for each pair of shoes?
- How many units do we need to meet our production budget?
- How many units of raw materials would we like to have in our ending inventory?
- What do we currently have in our raw materials inventory?
- How many units of raw materials do we need to purchase?
- How much does each unit of raw material cost?
Let’s assume we are showing 250 units of raw material in our ending inventory coming into the new year. Each pair of shoes we make requires 5 units of raw materials. Let’s also note that our buyer has secured a price for our raw material of $2 per unit for the entire year. Our buyer has done great work on an annual contract. This will certainly help us in our budgeting process right?
This information will help our buyers to purchase raw materials, especially if it has a long lead time to receive, or if we like to receive it close to when needing it. This is called just-in-time inventory (JIT). Let’s review all of this information in a chart.
|Hupana Running Company Direct Materials Budget|
|Required production in pairs||450||500||500||600||2050|
|Units of raw material needed per pair||5||5||5||5||5|
|Units of raw material needed to meet production||2250||2500||2500||3000||10250|
|Plus desired ending raw material inventory||500||500||500||500||500|
|Total units of raw materials needed||2750||3000||3000||3500||10750|
|Less units in beginning raw material inventory||250||500||500||500||250|
|Units of raw materials to be purchases||2500||2500||2500||3000||10500|
|Cost of raw material per unit||$2||$2||$2||$2||$2|
|Cost of raw material to be purchased||$5,000||$5,000||$5,000||$6,000||$21,000|
What information is helpful? We now know how much money we need to have each quarter to cover the cost of our raw materials. Our buyer is happy and so is our production manager, knowing that we will have raw material in stock for production.
We can use this information to start working on the next part of our budget! What comes next? Labor, of course.