Materials Budgeting Concepts

Material budgeting refers to the procedure of preparing material or purchase budget in terms of quantity and money value of materials to be procured in a specified time period. Not only does it helps in estimating the material prices over a period of time, but also analyses the material requirement. Material budgeting ensures low risk of inventory planning, highest purchase lead time, low transportation costs and better vendor relations.

An inventory budget is a “best guess” estimation of the amount of working capital a business needs to invest in inventory assets. Analysis looks behind the numbers to see whether items that go into inventory budget planning, such as sales forecasts and internal inventory controls, are on target or require modification. Ensuring estimates and actual inventory costs match as closely as possible is crucial, because an inventory budget can represent 45 percent to 90 percent of a business’s overall expenses.

Direct Materials Budget: Proper material budgeting is of utmost importance, even when it comes to budgeting direct materials, which add up to the production cost of an organization. Correct budgeting can lead to better projections of direct material requirement. Here, direct materials (or simply, materials) refer to the supplies needed for manufacturing goods, and can also regarded as raw materials, stores, stock and productive materials.

Materials budget measures the materials to be purchased to fulfill the production budgetary requirements, and is generally presented in monthly or quarterly formats.

Total requirement for Raw Materials = for production + planned ending inventory

Raw Materials to be purchased = total requirement – beginning inventory

It is not possible to estimate the materials budget for every part component in inventory, as the estimation could be huge. As a matter of fact, it is customary to either make a rough estimation of amount of inventory required regarded as the total inventory, or expressed in terms of commodity type. Further, if you have an MRP software package with a planning module, you can perhaps create an appropriate materials budget by either of the means. The inclusion of the production budget into the planning module through this software helps create the expected materials budget for the ensuing period. In the absence of such software, the materials budget needs to be calculated manually.

For instance, Sharon Ltd. plans to manufacture an array of plastic goods, while 95% of its raw materials involve the purchase of plastic resin. Therefore, only one important commodity is of the prime concern here.

Sharon Limited – Materials Budget for the year ended December 31, 2011

	Quarter 1	Quarter 2	Quarter 3	Quarter 4
Product A (units)	5,000	6,000	7,000	8,000
x Resin/unit (lbs)	2	2	2	2
Total resin needed (lbs)	10,000	12,000	14,000	16,000
+ Planned ending inventory	2,000	2,400	2,800	3,200
Total resin required	12,000	14,400	16,800	19,200
– Beginning inventory	1,600	2,000	2,400	2,800
= Resin to be purchased	10,400	12,400	14,400	16,400

The planned ending inventory for raw materials at the end of each quarter is projected to be 20%

of the total resin amount during the month, and so the ending inventory differs over a period of time, and rising as production requirements increase. The planned increase can be attributed to the fact that Sharon Ltd has difficulties in receiving resin from its vendor in a timely manner, and therefore, it maintains a safety stock of on-hand inventory. The purchasing department envisages the global demand to intrigue the resin price, which is why it includes a slight rise in priced into Quarter 3, carrying it forward to the Quarter 4.

Calculating Materials Budget

Step 1: To start with, find out the exact amount of set of products to be manufactured. This stage is also known as the total order or the order size.

Step 2: Estimate the kind of raw materials you will require to manufacture your order. Identify the quantity as well as costing for each of the raw material requirements.

Step 3: The quantity identified in Step 2 will determine your total projected costs.

Step 4: The next step is to add costs for scraps or wastes removal, if any.

Step 5: Deduct the value of scrap materials which could be sold after manufacturing.

Material Consumption Budget

This is required after determining the production requirement. The material consumption budget is based on the volume of production. Material consumption per unit of output aids in preparing material consumption budget for various kinds of materials to be used by the output. Budgeted production volume multiplies with material per unit of output produces the budgeted material consumption which is thereafter multiplied with the purchase price per unit, and the budgeted material consumption value is as follows:

	Product A	Product B
Budgeted Production Units	xx	xx
Add: Material Consumption / Output	xx	xx
Budgeted Use of Materials	xx	xx
Purchase Price Per Unit	Rs x	Rs x
Budgeted Material Consumption Value	Rs xx	Rs xx

Material Purchase Budget

This is required by both manufacturing and merchandising companies. For instance, manufacturing companies measures the quantity of materials to be purchased through production volume and inventory requirement. This along with the value of materials for the period budgeted and the materials inventory needed for sustenance. This is determined by considering the consumption for budgeted production volumes and opening and closing inventory requirement.

	Material A	Material B
Budgeted Consumption Units	xxx	xxx
Add: Required Closing Inventory	xxx	xxx
Total Requirement	xxx	xxx
Subtract: Opening Inventory	xxx	xxx
Budgeted Purchase Quantity	xx	xx
Budgeted Purchase Price Per Unit	Rs x	Rs x
Budgeted Material Purchases	Rs xx	Rs xx

Merchandising companies, on the other hand, prepare merchandise purchase budget, based upon budgeted sales units as well as on opening and closing stock of merchandise, and expressed in terms of units as well as price.

	Material
Budgeted Sales Volume	xxx
Add: Budgeted Closing Inventory	xxx
Merchandise Requirement	xxx
Subtract: Opening Inventory	xxx
Budgeted Purchase Quantity	xx
Budgeted Purchase Price Per Unit	Rs x
Budgeted Purchase Value	Rs xx

Factors Affecting Materials Budget

Some of the factors that can critically affect your Materials Budget:

• Production Budget should be considered the foremost factor in preparing such budget.
• Material cost is also equally important. You may like to consider purchasing the material only when its prices are lowest.
• There are certain materials that are prone to seasonal fluctuations. And therefore, it is recommended to procure them only when they are readily available in the market.
• The store position and the stock of existing material are also key considerations. If your business does not have ample space, you should not be buying the stock in advance.
• Management policy, rules and regulations on JIT (Just-In-Time) inventory, inventory level fixation and EOQ (Equal Order Quantity) are also major influencers to materials budgeting.
• Past policies of the business and that of the competitors’ should also be considered while you prepare the Materials Budget.
• At times, you may also need to consider the fresh stock or easily availability of stock materials.
• Transport costs are very crucial again. If the materials are not available easily, the management needs to consider sufficient quantity of raw materials for purchase and thus, transport costs can be minimized.
• Other factors, such as cash/credit availability, conditions of vendors, etc should also be taken into account, while preparing Materials Budget.

Bottom-Up Approach

Sales forecasts form the foundation of an inventory budget. For this reason, an inventory budget analysis most often takes a bottom-up approach that starts by evaluating the accuracy of sales forecasts. From sales forecasts come an inventory plan and from there, ordering estimates that support the plan and ensure demand is met without creating inventory overstocks. If sales forecasts are accurate and inventory turnover meets expectations, inventory on hand at the end of a month shouldn’t exceed predetermined inventory holding requirements.