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Predicting Direct Material

COST PRODUCT Business

for a

Direct Materials

Direct Material forecast is directly related to the forecasted sales units

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

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)

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

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

Business capacity

Do I have access to the financial resources required, how much ingredients can I store at a time, etc

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?)

Quantity Purchased Summary

• Make allowance for normal wastage• Consider external factors like:

• Industry supply• Business capacity• Economies of scale

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)

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)

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

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%

Price EstimationAfter my analysis I come up with a unit price for flour of $4.50 and

$2.40 for oil as follows

The Direct Material Budget

The lower your cost the higher your profitability

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Predictive Accounting with KPIs: A More Predictable, Less Stressful Way to Run Your Business.

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