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MyBusinessKPI.com
Predicting Direct Material
COST PRODUCT Business
for a
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Direct Materials
Direct Material forecast is directly related to the forecasted sales units
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Determine the standards for making your product
Start your direct material forecast by computing the quantity you need to meet your sales forecast
I will be illustrating my point by using examples from my sample bakery shop
10 cups ready to bake flour
5 cups of cooking oil
Prep time for one cake: 35 minutes
Bake time for one cake: 45 minutes
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Include an allowance for normal wasteAn allowance should be added for normal wastage
Sales forecast = 1,000 cakes
Flour = 10,500 ((10*5%) *1,000 cakes)Oil = 5,250 ((5*5%) * 1,000 cakes)
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External factors to consider before finalizing number of units to purchase
How much inventory you need on hand besides what is needed for production
Whether the market has enough output to meet your sales forecast
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Market supplyAnalyzing market supply, allows me to answer the question, "Are there any crisis going on in my external environment that could
hamper my supply of flour"?
It’s good business practice to be aware of what is going on in your industry
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Business capacity
Do I have access to the financial resources required, how much ingredients can I store at a time, etc
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Quantities at which economies of scale occur
Sometimes my vendor might give a special discount for buying more. I have to consider If I have the financial resources and business capacity to handle the extra units
For example, that extra inventory might mean
I have to increase marketing by
another 5% to sell the excess products
Increase the amounts of items I have to store (Do I have the storage
capacity?)
Have more cash tied into inventory (Do I have the financial
resources?)
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Quantity Purchased Summary
• Make allowance for normal wastage• Consider external factors like:
• Industry supply• Business capacity• Economies of scale
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Price per unitOnce I have decided the quantities I need for my budgeting period, I
can now forecast my price per unit as follows
Price = (Industry value chain cost) * (Markup for scarcity or Markdown for surplus) * (Markup for inflation)
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Industry value chain costThe value chain analysis is the cost of the (resource owners + all
convergent agents) * their markup
(Resource owner cost * Resource owner markup) *(Markup for the number of touch points in the industry value chain before the goods gets to you)
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Markup for scarcity/ markdown for surpluses
The materials I need are usually scarce in my local area. This affects what I will be paying for oil
In my case I will have to add a 30% markup due to the scarcity of the product in my area
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Markup for inflationOvertime the price of goods go up, you can use historical data to
predict what percentage price might go up. Or you can just use the current inflation rate of 1.06%
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Price EstimationAfter my analysis I come up with a unit price for flour of $4.50 and
$2.40 for oil as follows
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The Direct Material Budget
The lower your cost the higher your profitability
Read More
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