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MM/U3 Topic 4 Purchase Budget, Price Forecasting Technique

Purchase Budget

A purchases budget contains the amount of inventory that a company must purchase during each budget period. The amount stated in the budget is the amount needed to ensure that there is sufficient inventory on hand to meet customer orders for products. At the simplest level, the purchases budget can simply match the exact number of units expected to be sold in the budget period. However, there are a number of additional considerations that can make the purchases budget considerably more complex. Consider the following:

  • Beginning balance. There may already be many units on hand at the beginning of the budget period. If so, are these units to be drawn down to a lower level during the budget period? If that is the case, the number of units to be purchased can be reduced.
  • Service levels. What if management wants to keep more units on hand to meet short-term customer needs? If so, it may be necessary to increase the number of units purchased to a level higher than the anticipated number of units sold in the budget period.
  • Product terminations. What if a product line is to be terminated? The purchases budget should reflect the number of units needed through the termination date. Also, if new products are to replace those being terminated, the purchases budget should indicate the timing of those purchases, which should correspond with the roll-out dates of the new products.
  • Cash usage. The anticipated number of product purchases should be rolled forward into a budgeted balance sheet, to see if the expected purchases will have a negative impact on the amount of cash that the company needs. If so, and there are not adequate sources of funds, it may be necessary to budget for reduced inventory levels or reduced sales, thereby minimizing the need for additional cash to support operations.

The purchases budget is most commonly used by a retailer or wholesaler, which do not manufacture their own goods. These entities typically aggregate purchases into product classes for budgeting purposes, rather than attempting to budget at the individual product level. Doing so reduces the amount of budgeting effort, which also eliminates the inherent difficulty of forecasting at the product level. Forecasting variability tends to smooth out when products are aggregated into product families.

Price Forecasting Technique

In any integrated Materials Management environment, planning for getting the materials is the starting point for the whole MM function. Materials planning sets the procurement function and the subsequent material functions rolling.

Material planning is a scientific way of determining the requirements starting with raw materials, consumables, spare  parts and all other materials that are required to meet the given production plan for a certain period.

Material planning is derived from the overall Organizational planning and hence it is always a sub-plan of the broad organizational plan.

What it does is forecasting and initiating for procurement of materials

Factors affecting Material planning

1) Macro factors: Global factors such as price trends, business cycles, government’s import and export policies etc. are called the Macro factors. Credit policy of the government is a critical factor as banks follow these guidelines only while extending financial support to a business entity.

2) Micro factors: These are essentially the factors existing within  the organization such as corporate policy on Inventory holding, production plan, investments etc. For any organization, factors such as Lead time of procurement, acceptable inventory levels, working capital, seasonality, delegation of power are micro factors.

Techniques of planning materials:

There are a few techniques used for planning material for the given period. The following two are, however, commonly used:

1) Materials Requirement Planning (MRP)

2) Requirement based on past consumption

MRP has,as its starting point, the annual production plan of the manufacturing concern. Once a firm  determines its annual production plan , the over all material requirement , to meet the given production plan, is worked out. It is a detailed analysis encompassing the materials and quantities available for use, materials with quantities not available and hence needing procurement, the actual  lead  time of procurement etc.

Since, it is always possible to have a situation where some parts of an assembly are available and some others not available, Bill of Materials is exploded. It is quantifying all the materials (components) needed for various assemblies, all needed as per the production plan. BOM is thus a list displaying the code, nomenclature of an item, its unit and quantity, location of use and also the estimated price of each component. An explosion chart is a series of bills of materials grouped together in a matrix form so that combining the requirements for different components can be made.

Once the BOM is ready, the same is handed over to the Purchasing wing which initiates the purchasing activities. MRP thus keeps in view the Lead time also. Using computers, preparation of BOM through explosion of lists is quite easy and smooth.

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