Materials forecasting is the process of creating direct materials cost budgets and forecasts to help your business better understand and manage its future profitability. In manufacturing businesses direct material purchases are the largest cost driver and it is mandatory to understand how expected material price developments will affect your gross margins. However, building a robust materials forecasting system is far from easy.
This paper is intended to help Finance, Procurement and IT people involved in the process of creating direct materials forecasts and budgets in their companies. Whether you are looking to build materials forecasting capabilities from scratch or want to step up the game with your existing processes, we got you covered.
In the following pages we will thoroughly discuss what materials forecasting means in large enterprises – its value and benefits, but also the main challenges and solutions to those.
Part I - Understand and Manage your Future Profitability
Materials Forecasting is a key tool for understanding and managing how direct material costs affect a company’s future gross margins and profitability.
Let us use a bag of potato chips as an example. The picture below illustrates how vegetable oil price changes can impact gross margins for a potato chips manufacturer:
It is impossible to run a business in a fact-based manner without a good visibility to expected material price developments. Unfortunately, creating good direct materials budgets and forecasts is far from easy. In fact, many companies are struggling to create even basic materials forecasts, let alone being able to fully benefit from all the insights that a world-class materials cost forecasting process can bring.
Part II - Creating Reliable Materials Forecasts is Challenging
Companies have well-established processes and systems for building revenue-side budgets and forecasts. Typically, there is a dedicated Planning team or function responsible for end-product demand planning and sales and operations planning activities. These planning teams often use integrated tools and systems to carry out these activities. However, when it comes to direct materials forecasting things tend to be much less robust. One of the main reasons for this is that while understanding end-product demand is the responsibility of a dedicated planning team there is no comparable and as clearly dedicated entity to carry out materials forecasting activities.
Typically, the responsibility of conducting materials forecasting is on Finance’s turf. As Finance is responsible for the overall budgeting and forecasting processes, they also have an inherent interest and need for material cost forecasts. If a company has a dedicated Procurement Finance team then that is a natural home for the materials forecasting process. Finance responsibility regarding materials forecasting is two-fold:
However, Finance has little input to the actual content of the forecast and must rely on other functions to provide the needed data. And here lies the challenge: even though the ownership of the process is clear, getting reliable data into the budgets and forecasts is often a painful and resource consuming process without clear benefit for the parties involved.
Simple Process in Theory, Difficult in Practice
The premise of creating materials forecasts is simple enough: First, gather volume forecast data from existing ERP and planning systems. Then, with this accurate volume forecast data in hand, the Procurement team can give solid predictions on the future materials prices. Finance just needs to combine this data, do some visualizations, and review the results with business stakeholders.
However, in large global enterprises creating solid materials forecast is usually a daunting task. Good quality volume forecast data is not readily available from existing systems and coming up with solid price forecasts for thousands of materials can be a real struggle for procurement organizations that have their hands already full with other work.
Part III - Do You Know How Much and What You Are Going to Buy?
Interested in learning more? Download your full Materials Forecasting Explained whitepaper here.