Direct Material Budget
A direct material budget is a component of the overall company budget that estimates the cost of the raw materials required for the planned production of goods. This budget is critical for businesses, especially in manufacturing, as it provides a detailed estimation of the amount and cost of materials needed for a specific period.
The budget typically includes the following:
- Required Production: The number of units the company plans to produce, typically derived from the production budget.
- Material Requirement per Unit: The amount of direct material required to produce one unit of the product.
- Total Material Requirements: This is calculated by multiplying the required production by the material requirement per unit.
- Material Purchases: This accounts for the inventory policy of the company. It considers the inventory of raw materials the company already has and how much it plans to keep on hand at the end of the period.
- Cost of Material Purchases: This is calculated by multiplying the units of material to be purchased by the cost per unit of the material.
The direct material budget helps in managing inventory, purchasing and cash flow planning. By accurately forecasting the direct material needs, a company can prevent overstocking and understocking situations, ensuring a smooth production process.
Example of a Direct Material Budget
Let’s consider a hypothetical company called ABC Furniture Co., which produces wooden chairs.
Suppose the production budget of ABC Furniture Co. estimates that it will need to produce 1,000 chairs in the upcoming quarter. Each chair requires 10 feet of wood. The wood costs $5 per foot. ABC Furniture also wants to maintain an ending inventory of 2,000 feet of wood for the quarter, and they are starting with an inventory of 1,500 feet of wood.
Here’s how we could calculate the direct material budget:
- Required Production: ABC Furniture Co. plans to produce 1,000 chairs next quarter.
- Material Requirement per Unit: Each chair requires 10 feet of wood.
- Total Material Requirements: Multiply the required production (1,000 chairs) by the material requirement per unit (10 feet/chair), which equals 10,000 feet of wood.
- Material Purchases: ABC Furniture Co. wants to have an ending inventory of 2,000 feet of wood. Therefore, they will need to purchase 10,500 feet of wood (10,000 feet for production + 2,000 feet for ending inventory – 1,500 feet beginning inventory).
- Cost of Material Purchases: Multiply the material purchases (10,500 feet) by the cost per unit ($5/foot), which equals $52,500.
So, according to this direct material budget, ABC Furniture Co. needs to purchase 10,500 feet of wood, costing a total of $52,500 for the next quarter to meet their production goals and maintain the desired ending inventory. This will help the company plan their cash needs for the upcoming quarter and ensure they have the materials they need to meet production targets.