What is a Purchases Budget?

Purchases Budget

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Purchases Budget

A Purchases Budget is a financial plan that outlines the amount of goods that a company needs to purchase in a given period to meet its sales goals and inventory targets. This budget is an essential part of a company’s overall operational plan.

Creating a Purchases Budget involves several steps:

  1. Estimate Sales: The first step in creating a Purchases Budget is to forecast the sales for the period. This requires an understanding of market trends, historical sales data, and any other relevant factors.
  2. Determine Required Ending Inventory: The next step is to decide how much inventory the company wants to have on hand at the end of the period. This decision will be influenced by factors such as expected future sales, storage capacity, and the desire to have a buffer against unexpected demand.
  3. Calculate Total Inventory Needed : Add the estimated sales to the required ending inventory to find out the total amount of inventory needed for the period.
  4. Determine Beginning Inventory: Take into account the amount of inventory that the company already has at the beginning of the period.
  5. Calculate Purchases: Finally, subtract the beginning inventory from the total inventory needed to determine how much inventory the company needs to purchase.

The Purchases Budget helps a company plan its cash needs, negotiate with suppliers, and manage its inventory levels to avoid overstock or stockout situations. It also feeds into the cash budget, as purchases will affect cash outflows, and the sales budget, as the availability of inventory will influence sales capabilities.

Example of a Purchases Budget

Let’s consider a hypothetical company called “Gizmo World” that sells a type of electronic device. They are creating a purchases budget for the next quarter (Q1 of the upcoming year).

Here’s how they would do it:

  • Estimate Sales : Based on their market analysis and historical sales data, they estimate that they will sell 5,000 units in Q1.
  • Determine Required Ending Inventory: Gizmo World likes to keep enough inventory on hand at the end of each quarter to cover 20% of the next quarter’s sales. They estimate that they will sell 6,000 units in Q2, so they want to have 20% x 6,000 = 1,200 units on hand at the end of Q1.
  • Calculate Total Inventory Needed: Gizmo World will need 5,000 units (for Q1 sales) + 1,200 units (for ending inventory) = 6,200 units in total for Q1.
  • Determine Beginning Inventory: At the end of the previous quarter (Q4), Gizmo World had 1,000 units on hand.
  • Calculate Purchases: Gizmo World needs to purchase 6,200 units (total needed) – 1,000 units (beginning inventory) = 5,200 units during Q1.

So, Gizmo World’s Purchases Budget for Q1 would be 5,200 units. This would allow them to meet their sales target for the quarter, and also maintain their desired ending inventory level.

Note that in this example, we’re only considering the number of units to be purchased. In a real purchases budget, you would also consider the cost per unit to calculate the total cost of the purchases, which would be an important input for the cash budget.

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