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Developing an Accurate Direct Materials Budget

Developing an Accurate Direct Materials Budget, Centage

A business budget isn’t just the single, master budget. Instead, there are focused budgets that companies rely on to help them understand their cash flow and financial needs. While every organization needs a master budget, the need for other budgets is based on the kind of business you operate.

For businesses that make their own inventory, there are several other budgets that feed into understanding the business’s costs for the coming budget period. The sales budget helps to clarify how much inventory a company may need. The direct labor budget factors into the cost of goods sold. And the direct materials budget ensures that you not only keep production of your products flowing, but helps the business understand its financial needs to meet product demand. 

Unfortunately, your planning tools may cause problems instead of solving them when creating a direct materials budget. You need flexible tools to develop a clear and accurate manufacturing materials financial plan. 

What is a Direct Material Budget?

Businesses that produce a physical product must plan for the costs associated with building that product. To budget for the materials needed for production of a product, a direct materials budget is created. It accounts for the purchase of the items needed to create inventory, month by month or quarter by quarter.

A direct materials budget is dependent on a few other calculations. One of those is the production level, defined in your production budget. This is how many units you project you’ll need during the budget time period. 

In addition to the production level, you’ll also need to know your beginning inventory and desired ending inventory. These two numbers take into account the inventory you already have on hand and those that you’ll want to have at the end of a budget period. By having an ending inventory amount, you’ll have products to start the next budget period while you acquire and produce the products you’ll sell going forward.

Your inventory amounts will be directly impacted by your direct materials inventory. Your beginning direct materials within a budget period will indicate if additional material inventory is needed to meet the production needs planned, and the additional direct material purchases that will be needed to get to the projected number of units from the production budget.

Lastly, you’ll need to know what materials go into creating your product, the quantity of direct materials, and the cost of direct materials.

It’s important that these numbers be considered carefully. Inaccuracies or failing to tie your projections into your other business plans can result in costly budget mistakes.

How your budget tools can improve your direct material planning

Some companies use a percentage of direct materials used from budget actuals. They simplify the direct material budget process by assuming a constant ratio of material costs to product revenue. 

In reality, most companies experience a fluctuation in which products sell and when. Understanding these changes requires looking back over a longer period of time and tying that data to business activities and goals going forward. This method may also miss changes to sales caused by a product launch or another factor that increased sales for a short period of time.

It can also be detrimental to assume static materials costs. If you’re only looking back over the last few quarters for the cost of raw materials, you may miss a larger pattern of cost increases, or be estimating your budget based on a recent drop in materials costs. 

If your office of finance is using a static or rigid budgeting tool, like Excel, it could be challenging and time-consuming to build a direct materials budget that reflects market fluctuations and changes over time. 

Ideally, the finance team should have access to dynamic reporting tools and the ability to quickly adapt key assumptions, such as materials costs, to create a budget that is flexible and accurate. 

With flexible budget tools, changes can be made to the production budget and filter automatically to the direct materials budget. This offers the business an accurate view of what an increase or decrease in production will do to the budget without the finance team dedicating hours of time to reprogram formulas and rebuild dependencies.

For companies that build products, the direct materials budget is a key planning tool to ensure the company can meet customer demand while not overextending itself with materials purchases and threatening cash flow. With a flexible, advanced budgeting tool, the finance team can rapidly understand and report on how changes to demand or materials costs will impact the company’s bottom line.

Centage Corporation’s Planning Maestro is a cloud-native planning & analytics platform that delivers year-round financial intelligence. With Planning Maestro, Centage offers the sophisticated features needed by small and mid-market organizations to integrate budgeting, forecasting, and deep data analysis within one easy-to-use, scalable SaaS solution. For more information on how to modernize your office of finance with intelligent planning, view our product demonstration video, or call 800-366-5111.