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Preparing a Direct Materials Budget

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  • 0:04 What Is a Direct…
  • 0:58 Formula
  • 1:44 How It's Used
  • 2:39 Example
  • 4:05 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

One of the most important budgets that a company puts together is the direct materials budget. Not only does it show how many raw materials are required, but also the cost for producing the goods a company makes.

What Is a Direct Materials Budget?

Chances are that either on your fridge or on your phone you have a list of things you need from the store. Maybe it's a few eggs, or perhaps you meant to pick up a new pair of socks. In any event, chances are that this list changes pretty often. Sure, some things are always there, but I'm willing to bet you don't purchase socks every time you go to the store.

Companies, on the other hand, tend to buy the same thing over and over again. This is especially true for companies that manufacture something. Because of the fact that they are always buying the same things, they can budget what they'll need in order to make the relevant purchases. The direct materials budget shows how much must be purchased of each raw material in order to meet the orders for that time period. This is a very useful budget not only from a financial perspective, but also from the perspective of making purchasing decisions.

Formula

As you might expect, there is a formula for finding the direct materials cost. First, we start by finding out how many raw materials are needed. To do this, take the total amount needed for production and add it to the amount that you need to have on hand afterwards. You'll want to have some extra raw materials on hand to deal with any situations as they emerge. From that number, subtract the amount of raw materials that you currently have on hand. That tells you how much you need to purchase.

You would then repeat this for every other raw material that your company needs, and multiply them by the respective unit cost of the raw materials to find out what your direct materials cost would be. As you can imagine, this can be maddening to do exactly, so many companies offer their best estimation.

How It's Used

The direct materials budget has plenty of use across the company. Obviously, it has a place in the procurement department, as it tells the company how much of each raw material is necessary in order to meet relevant orders. It's also useful for the people in the distribution department so they can see what transportation needs are required.

Still, it is in the accounting department where this budget is most acutely felt. Master budgets are impossible to create without having access to the numbers found in the direct materials budget. Likewise, the numbers found in the direct materials budget help to make sure that the balance sheet is correct. After all, the balance sheet has to show the total inventory on hand, and the direct materials budget is a source of that information. Finally, the direct materials budget helps to prepare the budgeted income statement by providing information necessary to ensure the plans are financially possible.

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