[SOUND] Hi welcome back. We just saw how to integrate the ending year inventory budget with production budget. Now what next? We'll go through direct materials budget, since this is a consequence of the production budget. Remember where we are in our framework, direct materials, you can see the highlight there. Direct materials involve all raw materials, components, and parts consumed to make the products. They typically represent a great deal in the total cost of the products. Therefore it is important to invest time in developing a good budgeting on direct materials. Before starting the discussion, bear in mind that direct materials budget is not intended to support purchase area in their day by day work. Supply and procurement applies other tools and business support systems to do it. Of course, they use direct materials budget to guide them. But it's not the idea to base all the procurement process on it. That said, let's look at the budgeting approaches for direct materials. We can develop the budget by rolling up direct materials costs based on estimation of production. That's the method one, the roll-up method. Another approach is to calculate the historical percentage of direct materials cost within the revenue. And this is the method 2, the historical data. So starting the discuss method 1, the roll-up method. In this method we projected data in the budgeted period. Look at this example here. We can see in the table that the physical number of units sold of product line X is the starting point. In the example, we consider only raw material A. And it's not only for deductical purpose. That's because the direct materials budget should also serve as a reference to estimate how exposed the company is to the supply channels. In this case here, direct material A. In other words, the company may have some threats or even opportunities in the materials budget analysis. By consequence, it's good to have the breakdown of direct materials budget, at least for the most relevant materials. So the budget serves for a more strategic analysis, whereas the procurement area will rely on a more operational approach. Observe also that the same concept of ending and beginning inventory is applied here, but in this case the unit of analysis is the direct materials inventory, not the finished good inventory. We saw that the defining the ending and beginning inventories will have impact in the direct materials budget. Invest time in this analysis, because any mistake, tiny mistake here, can lead the company to buy excess of materials, or to a lack of them. Either way, the company may lose money. Now we discuss the historical data method, this approach assumes that the direct materials cost maybe estimated by a percentage of the revenue. And this assumption is useful because in the roll-up method, we cannot properly include the estimation of wasted materials, the rework and spoilants that occur in the manufacturing process. Not all companies are able to estimate them. Therefore, by applying the percentage of the revenue as a model to estimate direct material costs, we can sum up these variables into a single line and fine tune the costs of direct materials. Look at this example here. In the case 45.3% of the adjusted revenue is the cost of direct materials. We can adjust the cost by including expectations on industrial process improvement, such as waste reduction, new technologies to add in the production process. Not to mention that we may also change the materials mix in the product formulation. In the end, you have a new adjusted percentage, which will be used to estimate the costs of direct materials for product X. Now, between us, you might be wondering hey Nelson, why don't we combine both methods, the roll-up method with the historical method? I would say absolutely. Let's do it. But maybe it's better to do it in the next video. Read the materials about the direct materials budget. Do the assessments, stay tuned, and see you soon. Bye. [SOUND]