Ending Inventory Budget - Part 2

PART 2  -  The Ending Inventory Budget for a Manufacturer

The following formula is used to develop a Manufacturer's Ending Inventory Budget.

Beginning Inventory in Units XXX
Add: Units Purchased During the Year XXX
Less: Units Sold During the Year (XXX)
Equals: the Number of Units in Ending Inventory XXX
Multiply: the Total Cost Per Unit (or weighted average product cost) $X.XX
Equals Ending Inventory in Dollars $XXX


As you can see, the formula is the same as the one used to calculate a retailer's' Ending Inventory Budget. Manufacturers, however, must consider additional variables when calculating their Total Cost Per Unit. The Total Cost Per Unit represents all the costs or expenses required to purchase or produce one finished unit of product. A clothing retailer, for example, would purchase finished products (clothing) from their supplier. Therefore, the retailer's Total Product Cost would consist of the cost to purchase an article of clothing plus the cost to ship each piece of clothing to their place of business. A manufacturing company, on the other hand, does NOT purchase finished products. Rather, a manufacturing company purchases raw materials and, by applying direct labor and factory overhead, converts these raw materials into finished products. As a result, raw material purchases, direct labor costs and factory overhead costs form a manufacturer's Total Product Cost(s). In other words, manufacturers must determine the cost of raw materials needed to make one finished product, the direct labor cost need to make one finished product, and the factory overhead cost to make one finished product. The sum of all these costs will become the manufacturer's Total Product Cost Per Unit.

If you have been developing the Budgets in sequence, then you would have already calculated the three items needed to determine your Total Product Cost (per unit). Furthermore, the Cost of Raw Materials per Unit is calculated in Budget 1 entitled "Determining your Selling Price and Product Cost per Unit" . The Direct Labor Cost per Unit is calculated in Budget 4 entitled "Developing your Direct Manufacturing Labor Budget". And the Factory Overhead Cost per Unit is calculated in Budget 5 entitled "Developing your Factory Overhead Budget"

Assume the XYZ Company determines the following costs are needed to manufacture one unit of finished product:

  • $154.00 worth of raw materials are needed to make each finished product;
  • 2 hours of labor, at $20 per hour, ( IE $40) is needed to make each product;
  • $6.00 of factory overhead is required to produce one finished product.

Therefore, the company's Total Product Cost or total cost to make one finished unit is $200 (IE $154.00 + $40.00 + $6.00 = $200 per unit).

If you plan to manufacture more than one product, a weighted average product cost should be calculated and used in the formula.

The above Ending Inventory Budget assumes all units are finished and ready to be sold. Manufacturers, however, generally have ending inventory of raw materials (non-finished products) and work in process (partially completed products). Moreover, existing manufacturing firms would determine the costs associated with these items and include them in their financial statements. Individuals determining the feasibility of a manufacturing company, normally omit costs associated with non-finished products and deal entirely in finished units.

Categories: Forecasting