The purchasing budget is the report that contains the quantity of raw materials or direct materials in inventory that a company must purchase during each budget period. The quantity indicated in the quotation is necessary to guarantee sufficient inventory on hand to fulfill customer product orders.
This budget differs from the sales or expense budget because the purpose of the purchasing budget is to determine the organization's requirements for purchasing materials in inventory. The purchase budget allows you to determine how much money and how many products are needed to achieve the desired objectives.
Any company that produces or sells a tangible product needs a purchasing budget. This budget is used for companies that have products in stock, since inventory value plays an important role.
Purchasing budgeting is just one aspect of a company's overall budgeting strategy. At its simplest level, it can match the exact number of units expected to be sold in the budget period.
The purchasing budget is created to keep track of the company's inventory value and the quantity of merchandise sold.
It is also used to help keep track of the desired ending inventory value each month. It is very important to take into account the final inventory that the company requires to have at the end of each period.
This is done following the guidelines established by the inventory policy that is managed in order to meet the production and sales needs of the following period, as well as the cost that these inventories represent.
Sales and production estimation
The main basis for making the purchase budget is the production budget, which reflects the number of finished products that must be produced in each period.
According to the quantities indicated to be manufactured of each finished product, there is an “explosion” of materials. This determines the required quantities of the materials that are part of these finished products.
In the same way, the production budget is closely based on the budget prepared by sales for each period.
Cost of materials
This element is very important to be able to plan how much money is required for the purchase of materials in each period, taking into account the amount of inventory necessary to offer a good level of service and reflecting the possible variations that may exist in the cost.
How to do it?
Because the materials purchase budget can be a significant part of all costs, both direct and indirect, careful preparation of this budget is essential to the success of the business.
Otherwise, a carelessly prepared or poorly calculated materials purchase budget can lead to over- or underestimating costs.
The budget is created using a simple formula: ideal ending inventory plus the cost of the merchandise that has been sold, less the value of the inventory that was initially had. This formula generates the total purchase budget.
For example, you want $ 10,000 in ending inventory and the value of the merchandise that has been sold is about $ 3,000; then these values are added and from this total of $ 13,000 the value of the beginning inventory is subtracted. If the starting inventory value is $ 2,000, the total purchasing budget amount would be $ 11,000.
The cost of the merchandise sold is the sum collected from all the services or products offered by the company in terms of production value.
Purchase budget formula in units
The purchasing budget shows the budgeted beginning and ending inventory of materials, the quantity of materials to be used in production, the quantity of materials to be purchased, and their cost during a specified period.
The purchasing budget is a component of the master budget and is based on the following formula:
Materials purchase budget in units = budgeted starting inventory of materials in units + materials in units needed for production - budgeted ending inventory of materials in units
In the above formula, the material in units that is needed for production is calculated as follows:
Materials in units needed for production = budgeted production during the period × units of materials required
Since the budgeted production figure is given by the production budget, the purchase budget can only be prepared after having the production budget.
Using a small pottery business, ArtCraft, the following information will be used to develop the materials purchase budget:
Estimated production figures have been obtained from ArtCraft's production budget. The following budgeted units of parts are planned to be produced in each of the four quarters: 1334, 912, 1148, and 1778.
Each final piece requires 4 kg of materials to produce in the factory. The factory has 800 kg of material in stock as of January 1. At the end of the year, the desired ending inventory is 961 kg of material.
It is ArtCraft's policy to keep 15% of next quarter's production needs in Ending Materials Inventory. This policy changes the needs for the purchase of materials, because this final inventory of 15% must be considered in the budget.
It is estimated that the unit cost per kilogram of the material to be purchased will increase in each of the four quarters: $ 3.10, $ 3.20, $ 3.50 and $ 4.00.
Preparation of the purchasing budget
The first step in preparing the purchasing budget is to use this information to calculate the ending material inventory for quarters 1, 2, and 3. The second step is preparing the materials purchasing budget.
Final inventory of material quarter 1 = 15% x (912 units x 4 kg of material) = 547
The final inventory of material quarter 2 = 15% x (1148 units x 4 kg of material) = 689
Final inventory of material quarter 3 = 15% x (1778 units x 4 kg of material) = 1068
Keep in mind that the budgeted final material for the first, second and third quarters is the initial material in the second, third and fourth quarters, respectively.
The table was developed from two simple accounting equations:
Material required for production + final material inventory = total material required.
Total material required - initial material inventory = material purchase budget in kilograms.