How To Create a Direct Material Purchase Budget

Now, more than ever, businesses need to assert as much control over their spending and cash flow as possible. In this challenging climate, it’s more important than ever to eliminate cost inefficiencies that can impede your cash flow and make you less effective and agile than the competitors that are snapping at your heels! Without a direct material budget, you run the risk of cost inefficiencies that could create perilous cash flow problems for your company. 

Here, we’ll look at how to create a direct material purchase budget and take control of your company’s material costs and cash flow.

What is a direct material purchase budget?

If you produce or manufacture anything, your cash flow depends on your ability to manage your production budget effectively without compromising on quality. Given that this figure can account for the majority of your operational costs, the importance of a direct material purchase budget (also known as a direct material usage budget) cannot be understated.

Having said that, it would be impractical or even impossible to create a material purchase budget for every single component in your inventory. However, a simple formula can be used to identify the direct material purchase costs for each month, quarter, or year. 

Understanding the direct material purchase budget formula

 Once you understand the formula for direct material budgeting, you can easily work this into your master budget and prevent production costs from spiralling out of control. 

First, you need to know a few variables that will be used in your calculations. These include:

• Your production level, i.e. the amount that needs to be produced or the rate of production.

• Your beginning direct materials inventory. What remains after the most recent period.

• Your ending direct materials inventory to ensure you have enough materials for the next production period. 

• Direct materials that go into production and their cost.

Once we have accounted for these variables, we have everything we need to apply the formula:

• Budgeted direct material purchases in units =

• Budgeted beginning direct material in units +

• Direct material in units necessary for production -

• Budgeted ending direct material in units

“But”, you may be thinking “how do I know what my direct material necessary for production is?”. To work this out in units, just apply another simple formula:

• Budgeted production level during the period x

• Units of direct material required per unit =

• Direct material in units necessary for production

A direct material budget example

Now we know the formula, let’s take a look at an illustrative example. This will likely be a little more simplified than your operation, but it should hopefully serve as a template from which you can build your own direct material purchase budget. 

Let’s say your company makes scaffolding poles for the construction industry. Your direct material (DM) will mainly be steel ore. To take control of your production budget, you’ll need to know exactly how much you’ll need to spend on steel ore every month to meet your production quota. Once you know how many tons of steel ore you’ll need to purchase, you will have a strong foundation on which to build your direct materials budget. 

In the table below, you can see what a simple direct material purchase budget for such a company might look like. 

Feel free to build on this template to compose your own direct material budget and take control of your company’s cash flow. 

We can help

If you’re interested in finding out more about creating a direct material purchasing budget, then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.