Prepare the Direct Material Usage Budget and Direct Material Purchases Budget

Now that we know how many units we will like to produce, we can use this number to compute the usage of direct materials in units and dollars. Direct material purchases  are based on the budgeted direct materials to be used, the beginning  inventory of direct materials, and the target ending inventory of direct materials.

Purchases of direct materials =                  Direct materials used in production

+ Target ending inventory of direct materials

–    Beginning inventory of direct materials

Next: Preparing the Direct Labor Costs Budget.

Preparing the Production Budget

Once you know what you are going to sell, the next step is to determine what needs to be produced.  For a manufacturing company the total finished goods units to be produced is calculated as follows:

Budget Production =                      Budget Sales (in units) =

+ Target ending finished goods inventory (in units)

– Beginning finished goods inventory (in units)

So let us say you predicted sales of 200, 000 units and you currently have  100, 000 units in stock (your beginning finished goods inventory) and you will like to have 20,000 in stock at the end of the budget period. You will need to produce: 200,000 + 20, 000 – 100,000 = 120,000.


Next step to be discussed: Preparing the Direct Material  Usage Budget and Direct Material Purchase Budget.

Creating an Operating Budget

These series of articles will be talking about how to create an operating budget.  A lot of times we think of budgets as very scary processes to be avoided at all cost. However if  we break down the process into smaller parts we see the process is not as hard as we make it.

The first step is to create the revenue budget: Why start with revenue rather than expenses. This is because the level of production is determined based on the projected sales. If we do not know how much sales to expect then we can accurately predict our cost. Sales revenue is determined by many factors such as the economy, industry trends, new innovations, past performance, etc. Gathering as much information as you can about potential demand for your product and service, you can predict as close as possible what sales for your budget period should be.


Next step to be discussed:  Creating the production budget