Purchases budget definition
/What is the Purchases 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:
Inventory 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.
Desired 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 to the roll-out dates of the new products.
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Impact on Cash
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.
How to Create a Purchases Budget
You should complete the following steps in order to create a purchases budget:
Forecast sales. Itemize the sales that you think you will generate over the budget period. This will require an analysis of historical sales trends, as well as input from your sales staff regarding what is hot and what is not.
Set ending inventory goal. Decide how much of each inventory item you want to have on hand at the end of the budget period. This decision should incorporate the amount of inventory buffer you want to have on hand to guard against unexpected sales surges, and how much storage space you have available.
Calculate purchase requirement. Combine your ending inventory with your forecast sales figure for each item, and subtract out your beginning inventory balance. The result is the amount of inventory that you need to purchase.
Match to available cash. It is possible that your projected cash balance for the budget period will not allow you to pay for the indicated amount of inventory purchases. To be sure, match your preliminary purchases budget to your cash balance. If you will not have the funding to buy the required inventory, you may need to scale back the purchase quantities, or budget for additional financing elsewhere in the budget.
Who Uses a Purchases Budget?
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.