Materials Management

By

Prof Rahul Mulay

Week 01- A- Why Materials Management?

Materials are the key resources in any

enterprise as no production is possible without materials. Materials form the major constituent of the cost of product. Hence a proper control over their procurement, storage, issue, movement and consumption becomes essential. The above are achieved through effective materials management.
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Definition of Materials Management

(1) Planning and control of the kind, amount,

location, movement and timing of the various materials used in and/or produced in an enterprise. (2) Concerned with all activities of management such planning, organizing, directing, controlling and coordinating, related to materials.

Functions of Materials Management

Materials Planning Purchasing Inventory control Stores Management Materials handling. Transportation. Disposal of scrap, surplus and obsolete materials. Materials economics Waste management.
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Significance of Materials Management

Materials offer maximum scope of cost reduction and profit movement and is aptly described as the last

Gold Mine for the business manager. An illustration Suppose a company X Limited has a turnover of Rs 10,00,000/-. Its total cost amounts to Rs 9,00,000/-, which includes materials cost of Rs 5,00,000/-. The profit earned by a company is Rs 1,00,000/-, which works out to 10% on turnover. If the company achieves a savings of 5% in materials cost, other costs remaining same, what would be the profit of the company?
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 Profit at 10% on Rs 10,00,000 = Rs 1,00,000 Savings in materials cost = Rs 5,00,000 x 0.05 = Rs 25,000 Profit= Rs 1,00,000 + Rs. 25,000 = Rs 1,25,000 Hence, 5% reduction in materials cost is equivalent to 25% increase in profit. Further, the return on investment (ROI) depends to a

large extent on the manner of utilization of materials. ROI= (Profit/sales) x (Sales/fixed assets +current assets) Fixed assets constitute capital already sunk and only scope for improving the return on investment lies in the efficient management of materials which constitute the bulk of current assets.

Objectives of Materials Management

(a) To maintain steady flow of materials to ensure uninterrupted production. (b) To achieve economies in cost of materials by value analysis, variety reduction, JIT, MRP etc. (c) To provide right materials, of right quality, in the

right quantity, and at the right time. (d) To reduce investment in inventory through proper inventory control techniques. (e) To improve corporate image by maintaining good buyer-seller relations.

(f) To maintain proper records regarding purchase,

stores, transportation etc to eliminate possibility of corruption. (g) To reduce operating cost by eliminating /minimizing wastage. (h) To improve competitive strength of the firm by producing the best quality products using quality materials at the lowest possible cost. (i) To have speedy disposal of scrap and surplus materials.

Costs involved in the management of materials

(a) Basic cost of materials: The cost which is paid to

the suppliers. (b) Government levies & taxes: The cost paid to the suppliers towards Government levies and taxes namely excise duty, sales tax (VAT), octroi etc. (c) Ordering costs: The cost incurred in effecting purchasing e.g. cost of tendering, stationery, postage, visits to the suppliers plant to expedite delivery, cost of receiving, inspection, bill payment, cost incurred on staff.

(d) Inventory carrying cost: The cost incurred in maintaining inventory e.g. interest on capital locked up, losses due to deterioration and obsolescence, insurance premium, storage and preservation expenses. (e) Packaging and packing cost: Costs incurred in packaging and packing of products. (f) Material handling costs: The cost incurred for movement, storage and issuing the materials to the indenter. (g) Freight cost: The cost incurred in movement of materials from suppliers works to buyer's works.

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(h) Insurance cost: The cost incurred in providing adequate insurance cover to materials in transit and storage. (i) Wastage during receipt, storage, production etc: The cost of losses due to defects in design, poor quality of materials, improper storage methods, wrong issues, rework and rejections during manufacturing etc.

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Integrated Approach to Materials Management

It is always advantageous to have a centralized approach with complete responsibility of planning,

procuring, preserving, handling, usage and other related activities pertaining to materials. A centralized approach is bound with common idea of planning, acquisition, conversion, flow and distribution of production materials across the organization viz. from raw materials state to finished product state.

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What is Integrated Materials Management?

A well coordinated approach towards decision making with respect to materials. The activities involved are: 1. Materials Planning - Ascertaining needs of the users well in advance, translating sales projections into production requirements and making realistic estimates of various items required, their quantities and time when required. 2. Make-or-buy decisions - Deciding based on relative economics, items to be produced in-house and items to procure from outside sources. 13

3. Purchasing - Arranging uninterrupted supply of raw materials, parts, components and consumables to meet target of production. 4. Receiving & inspection - Inward receipt of materials and deciding with the help of quality control/ production/maintenance/ other departments, the acceptability or otherwise of materials. 5. Storage - Taking physical custody of materials , providing right place for storage, using proper methods for preservation, providing proper security against pilferage/ theft/ malpractices, and minimizing wastage and storage losses. 14

6. Inventory control - Maintaining optimum investment in inventories and at the same time ensuring uninterrupted supply of materials required for production. 7. Issuance of materials - Arranging fast and efficient supply to the indenters. 8. Transportation - Arranging the most economical and efficient transport for incoming and outgoing materials.

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9. Disposal of surplus, obsolete and scrap materials. - Analyzing and selecting the most economical channel to dispose off whatever is surplus or not required. 10. Developing new sources of supply - Locating, selecting and developing new sources of supply for improving quality and reducing cost. 11. Import substitution - Developing indigenous sources of supply for imported materials and parts to reduce purchasing cost and save on foreign exchange. 12. Ancillarization - Developing small-scale captive sources to manufacture parts and components required by the company.
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13. Insurance management - Arranging adequate insurance cover for materials in transit and in storage, lodging claims in the event of losses and damages in transit and storage, recovery thereof, and reducing insurance cost. 14. Material cost reduction and cost control - Utilizing various cost reduction techniques such as value analysis, variety reduction, JIT, MRP etc.
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15. Waste management - Minimizing materials waste by identifying causes of re-work/ rejection/ scrap of materials by reviewing design changes, methods improvement, improving material productivity. 16. Materials Research - Systematic and formal economic analysis, market analysis, suppliers analysis, price analysis, lead-time analysis, and transportation analysis.
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Week 01- B Why Integrated Materials Management?

Leads to speedier decisions, lower cost of

materials, low inventory investment, shorter lead times. Better accountability and hence easy to take corrective action. Due to centralized decision making, conflicting interests are balanced. Better coordination of various functions under the department.
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 Improved relationship with other departments as staff from other departments need not run from pillar to post to get their problems resolved.
Easier to collect and analyze data for improved decision making. Opportunities of growth of employees as they get exposed to all aspects of materials management.

For best results, all activities related to materials must be placed under one department viz. materials department.

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Organization of Materials Management

In order to be effective, the place of materials

department in any organization has to be on par with other important departments such as design, manufacturing, marketing etc. Every department has to deal with the materials department. Materials management activities are grouped together thus genuinely adding time and place utility to the purchased materials. Materials Manager provides maximum staff assistance to manufacturing and marketing in physical distribution process.
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Marketing Department

Engineering Department

Production Planning

Manufacturing Shops

Material Department

Product Design

Industrial Engineering

Personnel Department

Plant Management

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How do we organize Materials Department?

Three options are usually found. The department may be placed under (1) The Managing Director, Chief Executive, President, Vice-president to give materials department status equal to that of production, sales, finance etc.- Desirable (a) Where purchased items account for a high proportion of the unit cost of the product, or (b) When numerous diverse items are required, or (c) When prices fluctuate very widely, or (d) When quality of the materials has a considerable influence on the performance and/or manufacturing cost of the product.
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Board of Directors

Managing Director

Production Manager

Marketing Manager

Materials Manager

Finance Manager

Personnel Manager

Receiving & Stores

Inventory

Transportation

Purchase

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(2) The manufacturing manager wherein purchasing serves as a sub-division of the manufacturing department.- Desirable in small firms, especially (a) If there are no procurement problems such as materials are not scarce or lead times are short. (b) If prices normally remain steady and do not experience sudden fluctuations. (c) If variety of materials purchased is limited.
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Board of Directors

Managing Director

Engineering Manager

Marketing Manager

Manufacturing Manager

Finance Personnel Manager Manager

Production Planning & Control

Maintenance Manager

Purchase Manager

Plant Plant Manager-A Manager-B

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(3) The sales manager wherein purchasing serves

a sub-division of sales department Desirable in small firms especially (a) If the materials are purchased and resold after inexpensive processing. (b) If the firm is mainly into trading business.

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Centralized versus decentralized structure

A. Centralized arrangement Refer to the procurement of the requirements of all

the departments of the firm or all plants by a central purchase department. What are the Merits? (a) Consistency in buying policies - Possible since all purchase contracts and related decisions are taken by one department. (b) Economy in buying - Achieved due to better bargaining on price, terms and conditions with vendors, and reduction in transport costs, etc on account of large scale purchasing. 28

(c) Uniformity in purchase records - Possible since one department handles all purchases. (d) Economy in maintenance of records - Because of the fewer purchase indents, fewer receipts, and fewer payments (e) Reduction in handling and storage costs - Due to centralization of receiving, inspection and storage. (f) Specializations - Achieved by performing a particular purchase function. (g) Reduced number of contacts with the companys vendors
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B. Decentralized arrangement Refers to the system of procurement of requirements of the different divisions or different plants by local buying section attached to the divisions or situated at the plant concerned, and vested with all the powers of a purchase department. The merits are (a) Individual buyers react rapidly to changes in requirements of the divisions/plants to which they are attached.
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(b) Local buyers can render greater assistance to their respective divisions - By providing information on probable prices, deliveries and quality of materials to the concerned department. (c) Senior executive in charge of the plant/ division can be held responsible - For production cost attributable to the buyer as the buyer is under the control of the senior executive.

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Factors determining organization structure of Materials Department

(a) Complexity

of operations i.e. quantity and variety of items to be purchased. (b)Size of the company i.e. small, medium or large scale. (c) Single or multi-divisions/locations.
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Receiving, storekeeping and transportation under purchasing.

Managing Director

Marketing Manager

Finance Manager

Production Manager
Purchase Manager

Personnel Manager

Engg Design

Receiving & Stores

Inventory Control

Transportation
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Features
(a) Useful in single plant structures. (b) All materials related activities like

store keeping, receiving, inventory and transportation can be combined with purchasing as purchases are small and are not complex.

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Greater degree of specialization

Materials Manager

Stores Inventory & Material Control Handling

Inbound/ Vendor Purchasing Outbound transportation Development

Buyer (Capital Goods)

Buyer (Imports)

Buyer (Raw Materials)

Buyer (Engg Components)

Buyer (Consumables & Packing)

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Multi-plants /multi-divisions organization structure

Centralized structure is preferred in case of company

having different manufacturing divisions or closely located plants. Each division has its own purchase manager to coordinate the activities of the division and all purchase manages in turn are responsible to the head of the materials department. Combination of centralized and decentralized concept works better when companys various divisions manufacture diversified products with a few or no common items.
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 Under this set up, each division has its own separate materials department under the control of the head of the division with a centralized agency to coordinate the activities and direct policies of the local purchase officer.
Centralized agency undertakes contract buying of important materials while the local buyers to place orders for miscellaneous items fom local suppliers. Centralized agency undertakes market research of all divisions.

Decentralized set up is preferred in organizations having more than one plant/ division geographically located in different places in the country.
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General Manager (Materials) Materials Manager (Plant B) Materials Manager (Plant A) Materials Manager (Plant C)

Receipts & Stores

Inventory Control

Purchasing

Transportation

Buyer-I

Buyer-II

Buyer-III

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planning
A good planing system will answer the following - What are we going to make - What soes it take to make it. - What do we have on hand - What do we need
- These are the questions of priority an d capacity - The Factors that affect Materials Planning are: - 1) Macro Factors price trends, business cycle, import policy, credit policy - 2) Micro factors plant capacity, corporate objectives, lead times, rejection

rates, working capital etc

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Manufacturing planning and control system

Strategic Business Plan

Production Plan

Master Production schedule

Material Requirement Planning Production activity control and PURCHASING

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Material planning
ERP MRP II ( Closed loop MRP)

MRP

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 Selection of vendors

Week 02 A Responsibility of Buying Division

Negotiating terms of purchase Placing purchase orders Ensuring receipt of materials in time. Taking suitable action in case of delays.

Divisions of a Purchase Functions

Purchase Manager Buying division Clerical division Transportation division

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Buying Division
Buyer (Tools & Pressed parts)

Buyer (Raw Materials)

Buyer (Bought out parts)

Buyer (Forgings & Castings)

Buyer (Office Supplies)

Clerical Division

Data Entry and Records

Order Placing

Follow up

Bill Passing

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Transportation Division

Freights contracts & documents

Follow-up

Packing & Dispatches

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Purchase Objectives
Obtaining the goods and services of the required quality

and quantity Obtaining goods and services at the optimum cost Ensuring best possible service and prompt deliveries by the supplier Developing and maintaining good supplier relationships and developing potential suppliers

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Buyers Responsibility Include

To maintain a file of purchases and thereby develop the history of each item including details like purchase orders placed, suppliers, quantities, prices, lead time etc. 2. To issue purchase orders and delivery schedules for items based on purchase indents received from user department. 3. To obtain competitive quotations for new components and suppliers and submit data to senior staff for decisions. 4. In large firms, buyers evaluate quotations and place purchase orders.
1.
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5. To negotiate prices with suppliers. 6. To review suppliers request for price increase so as to decide whether or not the request is justified. 7. To act as a liaison between suppliers and the user department.

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 In smaller firms, the buyers themselves function as expeditors. In larger firms, buyers evaluate quotations and place purchase orders while expeditors ensure the maintenance of delivery schedules. To study the delivery dates and suppliers reliability. To establish a deadline in advance of actual delivery date and decide an appropriate course of action to meet delivery dates. To advise buyers well in advance of expected late shipments and obtain decisions. To travel to suppliers plant when suppliers shortages are expected to seriously hamper

Responsibilities of Expeditors

production.

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Interdepartmental Relations
Excellent interdepartmental relations invariably lead to 1. Satisfaction of the needs of the other departments. 2. Support to other departments, when required. 3. Better communication and information that is helpful to other departments. Purchase Management and Production Purchase department is largely required to meet the needs of production department by ensuring

the availability of materials on time.

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To satisfy the emergency needs of the department to avoid production shutdown. Production department must allow adequate lead-time for procurement otherwise needless expenses will be incurred. How Production Department contributes to effectiveness of Purchase Department? 1. By assisting in inspecting materials and in conducting tests/ trials. 2. By undertaking minor rework in vendors supplies in the event of emergencies thereby reducing the pressures on both departments. 3. By giving fair trial to new/ substitute materials for the purpose of reducing material cost and/ or improving availability. 50

Purchase Management and Engineering

Engineering

is usually responsible for preparing technical specifications for materials and equipments. As specifications determine the cost, specifications adopted by engineering must specify materials that are both economical to procure and economical to fabricate. Only those materials which are easily available should be prescribed since scarcity and proprietary materials push costs.
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 Substitute materials proposed by suppliers

should be given fair trial for suitability. Variety among parts and materials should be restricted and standardized, and as far as possible existing parts should be used. Whenever there are design changes, purchase department should be informed well in advance so that they dont procure items where design changes are expected.

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Purchase management and Inspection & Quality Control. Q.C. department is responsible to ensure that goods received from suppliers conform to laid down specifications. Many times, Q.C. inspectors reject materials due to minor defects such as burs, dents, high points, rusty etc. Repetitive rejections due to such minor reasons drive the vendors away. Suppliers request for deviation especially in case of expensive items must be given due consideration.
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 Purchase department should involve quality

control department at all stages of development of the item. Vendors should be selected based on their quality assurance capability Purchase management and sales Accurate sales forecast is necessary for economic manufacture and low priced delivery to customers. Sales forecasts influence a firms capital equipment budget, advertising budget, materials budget and production budget.
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 Purchase department should provide information on costs of major items to sales so that the products are priced correctly. Sales should provide information on special orders well in advance so that materials requiring long lead-time can be planned/procured economically. Purchase management and finance Finance department should periodically advise purchase department on availability of funds. Timely payments to the vendors are necessary to guarantee smooth inflow of materials. Purchase department to maintain close liaison with finance department in matters of forward buying to take advantage of low prices.
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Purchase

management

and

maintenance

department Maintenance department needs to provide purchase department the list of consumables spares, which are required regularly so that they can be covered under inventory levels. Purchase department to ensure that spares are available in right time as well as emergency requirements of the department are met immediately.

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Purchase management and planning Planning enables purchase department to provide materials without tying up much capital. Purchase department must be informed of the changes in production programme failing which materials received will add to idle inventory. Purchase department should ensure the requirements

are made available as per commitment and expected delays are communicated so that production schedule can be revised if required.

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Purchase management and personnel

Close liaison between these two departments

is necessary to ensure that right types of personnel are selected. Purchase department must provide job descriptions of the personnel required by it and personnel department must ensure that they provide manpower according to the specified skills. Personnel department should also organize training of the employees of purchase department.
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Purchase management and legal

All purchase contracts especially those

involving project purchases must have the review / approval of the lgal department to avoid litigation later. Many problems can be avoided by proper drafting of tenders and contractual terms.

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Week 02 BPrinciples of effective purchasing

Purchase department, in order to improve its effectiveness must take the following actions. Locate, select, develop, retain and deal with reliable sources. Provide data about the lead-time necessary for different group of materials. Involve quality control department in all quality related decisions. Reduce procurement lead-time by developing new and better sources. Build good relations with suppliers to ensure preferential treatment.
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 Develop a culture among all buyers to treat indenters as internal customers. Review stocks regularly to avoid last minute rush orders/ stock outs. Request for long term planning for standard parts. Invest time and money to build accurate and efficient stock record system. Stores to be managed properly thus minimizing losses due to breakages, spoilage, evaporation, corrosion, pilferage, and other malpractices.

Careful packing, loading and unloading to prevent damages in transit thereby avoiding the need for replacement of parts.
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Purchasing Management
Purchasing is procurement of raw materials,

components, tools, consumables, and services required for the manufacture of products, maintenance of machines, and uninterrupted running of the manufacturing plant. Purchasing is the process of facilitating marketing of the companys products in the quantities desired, at the time promised and at a competitive price consistent with the quality desired.
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In essence, purchasing is the task of buying

goods of right quality, in the right quantities, at the right time and the right price. The emphasis has to be more on locating, selecting, developing and retaining right kind of suppliers. Growing Significance of purchase function Traditionally, purchase was regarded as one of the activities of production management. In today's environment, it is considered as one of the major functions in business.
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Why Purchasing is becoming significant?

1. Higher cost of goods and services (a) Raw materials, components and services account

for as much as 50 to 60% of the companys total expenditure. (b) Mere one percent savings in material cost can give benefit equivalent to eight to nine percent rise in sales volume. 2. High cost of stock outs (a) Lack of continuity in the availability of materials seriously affects the profitability of the company. (b) Financial losses due to stock out of materials particularly in continuous process industries intensive industries can be enormous.
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3. Higher cost of capital (a) Around 70% of the working capital gets locked up in the inventory of raw materials, work in progress, finished goods, spares, etc. (b) Thus, no organization can afford to invest such a big part of its capital in the stocks. (c) Bulk of these stocks can be reduced and the capital lock-up can be avoided if purchasing is made efficient.
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4. Purchase is not just buying (a) In modern context, purchasing include many materials related activities such as market research, vendor rating, standardization and variety reduction, codification, indent control, surplus disposal, pre-purchase value analysis, price negotiations, inventory control, purchase budgets, import substitution, purchase system design etc.

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5. Changing nature of purchase (a) Purchasing is becoming more of a technocommercial activity rather than a pure commercial function. 6. Professionalization of materials function (a) Various management concepts such as ABC analysis, economic lot size, variety reduction, codification, value analysis, vendor rating etc has given an improved status to materials management in business.
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7. Changing concept of buyer-seller relations (a) Old concept that a supplier is dependent upon buyer and he can be made to perform the way a buyer desires no longer exists now. (b) To ensure continuity in availability of materials with lowest inventory investment , buyer must be good at business relations. (c) With increasing competition, retention of good suppliers is becoming difficult and hence buying function is becoming challenging day by day.
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Objectives of scientific purchasing

1.

2.

3.
4. 5.

To procure at a competitive price the needed materials of right quality, in the right quantity and at the right time. To maintain continuity of supply with minimum inventory. To ensure the production of goods of better quality at the competitive prices. To suggest better substitutes to materials that are currently being used. To assist in standardization, variety reduction, value analysis and cost reduction programmes.
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6. To advise on probable prices, deliveries and performance of materials/ components etc. 7. To create goodwill and enhance the companys reputation through ethical dealings with the suppliers. 8. To enable company to maintain competitive position and earn a fair return on its investment.
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Functions of Purchase Department

Locating, selecting and developing qualified sources of supply. Scrutinizing purchase indents and deciding suitable methods of buying. Floating enquiries, processing quotations,

conducting negotiations, and releasing purchase orders. Pre-delivery follow-up and chasing of shortages. Coordination with inward inspection including timely return of defective materials back to suppliers.

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 Endorsing suppliers invoices for payment. Processing

suppliers requests for price increases including price renegotiation. Attending to suppliers representatives and traveling salesmen. Arranging meetings for necessary discussions between suppliers representative and companys officials. Disposal of surplus, obsolete and scrap material. Advising management regarding new materials, new products, forward buying etc.

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 Acting as a link between companys

finance department and suppliers for timely payment/ settlement of suppliers bills. Attending to activities like liasioning with government authorities such as central excise etc. Maintaining companys image among suppliers.
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5 Rs of Buying
Right Source Source selection and source development Vendor rating Purchase research Right Quality Quality specifications Vendor up gradation Self certification Value analyses Standardization

5 Rs of Buying

Right Time and Place Replenishment Methods Lead-time analysis

Right Price Basic cost elements Competitive bidding Negotiations Right place of delivery Right transportation Legal aspects Price renegotiations Payment methods

Right Quantity EOQ Replenishment System Buying methods

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 The major activities of purchase cycle are:

Establishing the need for procurement
Scrutiny of the purchase indent Purchase market research

Week 03 APurchasing Cycle

Receiving and inspection

Follow up with suppler

Order preparation

Storage and Record keeping

Invoicing and payment

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A. Establishing and communicating need for procurement. - The need originates in one of the firms operating departments or inventory control section and is

communicated to the purchase department through a document called Purchase Indent or a Bill of Materials. What is a purchase indent? A formal purchase requisition made to the purchase department to purchase materials or services specified therein. It serves as an authority to purchase department to go ahead with the purchase activity.

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 It

provides written information regarding quality specifications, time when required etc. The authority to raise purchase indents is limited and standing instructions as to who in the organization is permitted to sign the purchase indents for different kinds of materials are issued by the top management.

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 Procedure for raising indents (a) Stock items i.e. items of regular use (1) Generally the stores issues indents for items

of regular use. (2) Maximum-Minimum levels, re-order levels, order quantity is generally established for each of these standard items. (3) When the stock level drops to or nears the reorder level, an indent is sent from the stores to the purchasing department to replenish the stock.
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(b) Capital items (1) The purchase department receives indents for capital items, the purchase of which is approved by the management committee. (c) Non-standard items (1) These are materials that are usually not carried in stocks. (2) The operating departments fill the indents. (3) The request for items to be sub-contracted may come from planning department of the company.
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 Procedure for Bill of Materials 1. Bill of material is routed through the stores

to purchase as a notification of the need for materials. 2. The stores checks the availability of materials from the stocks, subtracts the same, and forwards it to the purchase department. 3. Copy of BOM serves as the purchase indent.

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B. Scrutinizing Purchase Indents 1. The purchase indents must describe the items clearly by Brand name and/or Performance standards, and Should be accompanied by the drawing or sample of the item, where required.

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2. Must be signed by the authorized signatories in order to avoid irresponsible purchases. 3. Routed through the stores department to certify non-availability of the item in stores. 4. Description and the quantity of material required must be clearly stipulated. 5. Whether the right source of supply is available. 6. Whether there is any pending order to be completed. After scrutiny, the indent is logged in the purchase indent register and given to the concerned buyer.
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C. Market research and selection of the sources

of supply Involves review of information about supply sources, catalogues, previous quotations received and selecting potential sources of supply that can (a) Supply goods of the right quality (b) Supply goods at the right price (c) Meet buyers quantity requirement and make delivery promises.
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Factors in Selecting the Suppliers

1) 2) 3) 4) 5) 6) 7)

Technical ability Manufacturing capability Reliability After sales service Supplier location Other factors such as credit terms PRICE

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The work involved in this phase is as under: 1. For off-the-shelf materials, telephonic quotations are obtained from the vendors and a verbal order is given to a supplier whose terms are found to be better than others. (a) To regularize the transaction, a formal purchase order is sent later. (b) Sometimes, placing the blanket orders are also considered. 2. Where the prices fluctuate from time to time, an inquiry is sent to probable sources and quotations are received from the suppliers. (a) A comparative statement is prepared from the quotations received from the suppliers and landed cost arrived at, leading to provisional selection of a particular source. 85

(b) Vendors are then called for negotiations and precise terms of contract are finalized with the vendor. 3. When the amount involved is less and item is easily available, the buyer may opt for petty cash purchases. D. Order preparation A purchase order is a formal document i.e. written communication prepared by the buying department on behalf of the company to authorize the supply of the goods and services in the quantities, at the time, at a place, and at a price specified in the document. A purchase order is a legal document and serves as an evidence of the contract between the buyer and seller.
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1.

2.

3.

Buyer has to obtain approval of the comparative statement by his immediate superior and take his signature on the same. All possible details such as name and address of the supplier, item description, prices, delivery schedules, mode of transport, place of delivery, insurance, payment terms, and late delivery clause are required to be furnished in the purchase order. Materials required urgently are purchased on verbal or telephonic orders, which are covered immediately by written purchase order.

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A written purchase order must serve the following functions Provide full and complete details of the materials to be supplied thereby avoiding ambiguities. Help buyers receiving department to verify that material received in accordance with those ordered. Help buyer's accounts department in linking goods receipt reports with suppliers invoices and prevent duplicate payments. Serve as a future reference for placement of orders.

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How to select a supplier for new items

i.e. those that have not been purchased before? Carry out information search on likely sources. Undertake activity of selection and development of suppliers.

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Flow chart in placing order and vendors performance evaluation

Purchase indent Is this a regular Item?

No Yes Make short list of possible sources No Yes Obtain quotation Prepare comparative statement Select supplier

Yes

Is there an annual contract for it?

No
Was last supplier Satisfactory?

Yes
Is it time to check the market yet? Place order Evaluate performance

Finalize terms of contract 90

Week 03 B- E. Follow-up with Suppliers

Follow-up is required to ensure that the suppliers effect the deliveries on time. Basic rules of follow-up (a) Should be done on the basis of market condition and buyers experience with the vendors delivery performance. (b) Buyer should keep a constant track of outstanding orders and keep himself up-to-date with the latest progress on each order. (c) Post-dated folder should be used to remind the buyer of the action to be taken. (d) Mode of follow-up should be based on the importance of the item, reliability or otherwise of the supplier, number of suppliers, locations etc.
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Follow-up

Pre-deliver follow-up

Shortage chasing

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Pre-delivery follow-up is required to

To remind the supplier of the due date, and To obtain advance information of expected

delays. Pre-delivery follow-up enables buyer To make alternate arrangement if the supplier is expected to fail in the delivery commitment by requesting other source for an early delivery. To decide on an alternate mode of transportation for delivery from suppliers.
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Methods used for follow-up are Phone call to local suppliers at a set period prior to due date. Letters to outside supplier typed and signed by the buyer, preferably by the Head of Materials Department. Regular visits, particularly to new suppliers to review progress. Shortage chasing Universally accepted vital part of purchase follow-up. The objectives are: To obtain the shortage materials as soon as possible, and To create feeling that this company wants quality deliveries and that too, in time thereby preventing future recurrences. 94

Approach to the shortage chasing

In case of suppliers of proprietary materials nothing much may be possible except requesting them to expedite and take care in future supplies. During negotiations, the cost implication should be explained to the supplier in case of any such eventuality. Suppliers performance should be measured regularly and their ratings be communicated on periodic basis. (1) Suppliers with A and B ratings should be encouraged.

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(1) Those with C and D ratings should be

coaxed to improve their delivery performance and those who fail to improve even after repeated warnings should be blacklisted and removed. (2) Those below D ratings should be removed from vendor base. New sources should be developed and more orders should be given to these new sources. Regular meetings between the senior managers and the suppliers should be organized to discuss the problems.
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F. Receiving and Inspection Materials in the receiving department are received against certain specific documents depending upon the mode of dispatch and geographical location of the supplier. In case of domestic supplier, the materials are received along with the delivery challan and L/R or R/R. In case of imports, the materials are received along with the packing list, Bill of Entry and the B/L or AWB.

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Traditionally, all supplies are subjected to inspection and testing. Items that are purchased on the basis of Brand Name do not require detailed inspection. Only visual inspection is adequate.

Critical items requiring specialized measuring instruments are inspected at the vendors plant prior to dispatch.
Quite often, materials are inspected on receipt by the inward inspection at the buyers works for one or more of the following checks.

(1) Conformance to dimensions (2) Conformance to materials specifications (3) Conformance to performance
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Conformance to dimensions - Checked against component drawings. - Components are subjected to both visual as well as dimensional checks with gauges and other measuring instruments. Conformance to material specifications - Checked with the help of chemical and metallurgical tests. - Small samples of materials are forwarded to the laboratories for checking hardness, material composition, microstructure and other properties.

99

Conformance to performance - Checked on the basis of tests and trial runs e.g. machinability tests for raw materials, life tests for bearings, r.p.m. tests for motors, bursting strength for corrugated cartons. A Goods Receipt Inward Note (GRIN) is handed over to the inspection or concerned department. The inspector checks receipted materials and affixes the stamp Accepted or Rejected on the GRIN. A copy of GRIN is sent to the supplier.
100

Storage and Record Keeping After inspection, the goods are segregated into accepted/ rejected, or rework categories. Only accepted quantity is forwarded to the stores. The quantity is physically verified and then entered into kardex/ ledgers or bin cards and thereafter issue is allowed. H. Invoicing and Payment Invoices are raised on receipt of GRINs enabling the supplier to know the exact quantity of materials accepted by the buyer.
G.

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I.

The invoices are linked with the necessary papers thereby avoiding delays in payments. Need to raise credit or debit notes for discrepancies in quantities due to rejections are avoided. Reconciliation statements are easy to prepare. The work of handling invoices may be carried out either by accounts department or purchase department. Scrutiny of invoices Suppliers invoices are sent to accounts department where they are sorted out according to suppliers and the payment due date. GRNs are received and supplier's invoice file is reviewed daily to link incoming GRNs and suppliers invoices.
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 Missing GRNs and missing invoices are investigated at the end of each accounting period and the receiving department (for GRNs) or the suppliers (for invoices) are asked to furnish the same.
Invoices that are found linked up with GRNs are taken up further for verification in respect of price, sales tax, transport charges, discounts etc against the

purchase order while quantity is checked against GRN. Arithmetic calculations are also checked to ensure correctness of invoice amount, invoice is stamped for verification, countersigned by the authorized person and is passed for payment.
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J. Journal entries Verified invoices are entered in purchase register, supplier wise, called purchase journal. Each invoices prior to its entry in the purchase journal is allotted a serial number called JE No. K. Effecting payment The purchase journal is reviewed periodically, say weekly, and the accountant is informed of the invoices, which are due for payment. Cheques are drawn to effect the payments on due dates.

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The method of buying would largely depend upon the following : (1) Production or non-production materials. (2) Low-priced or expensive items. (3) Materials that are controlled by the market forces or available off-the-shelf. (4) Materials that are to be procured from manufacturers or from middlemen. (5) Seasonal or non-seasonal materials. (6) Materials produced to buyers specification / design or produced to commercial standards. (7) At a time when prices are stable or at a time when prices are falling down.
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Week 04 A Methods of Buying

 To summarize, factors influencing the selection of a buying method are:

Nature of the material. 2. Regularity of its demand. 3. Quantities required. 4. Susceptibility to price variations. Different buying methods are Hand to mouth buying Scheduled buying Market purchasing Speculative buying
1.
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A. Hand to Mouth Buying Materials are bought exactly according

to requirements. The characteristics are: 1. Purchases are made only when the demand arises. 2. Purchases are made only to cover immediate requirements.

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3. Quantity purchased is generally small though at times large quantities may be purchased. 4. The terms of contract are negotiated and generally competitive quotations are not obtained, as normally there is not enough time. The effectiveness of purchase department depends upon selection of suitable vendors who are known for quality, reliability and integrity so that they fill the buyers orders without taking advantage of the situation.

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 Suitability of hand to mouth buying

(a) Items required for product development. (b) Items that are used infrequently therefore not

required to be stocked hence are purchased when they are needed for definite consumption e.g. machine tools, special building materials, office furniture etc. (c) To cover immediate requirements of a stock out item caused either due to delay in delivery from regularly suppliers or due to increase in consumption. (d) To cover immediate requirements of items whose prices are expected to fall in near future.
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(e) Procurement of replacement spares.

(f) Items having limited shelf life and are normally not stocked for fear of perishability. (g) Items that are bulky and need a lot of storage space e.g. wooden boxes as packing materials, thermocol sheets, cotton waste etc.

B. Scheduled Buying Materials are procured in a staggered deliveries according to the delivery schedule furnished to the supplier by the buyer.

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The characteristics are (1) A purchase order covering annual requirements or alternatively a purchase order without specifying the order quantity called open order is placed. (2) The supplier is given the estimate of the procurement needs covering a mutually agreed period of time. (3) Commonly, 2-3 months confirmed schedule and 2-3 months tentative schedule is given. (4) Monthly deliveries are specified especially when supplier has set up production facilities particularly for the buyer.
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The system is best suited for Items of regular use such as oils,lubricants,

castings and forgings etc. Items produced to buyers specifications and requiring long lead-time to manufacture. Proprietary items from suppliers wh insist on long-term schedules. C. Market Purchasing Procurement of sufficient quantity of an item in advance of its need, and at a time when prices are low or expected to rise; also known as Forward buying
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The characteristics are (a) Purchases are made to cover production requirements for a considerable period. (b) Quantity purchased is generally large. (c) Market is generally favourable for negotiations. (d) Purchases are made when prices ar low and buyer also gets discounts on large purchases. The purchase department must keep updated on market conditions, prices and changing trends. High inventory carrying charges and deterioration should be constantly balanced against price advantage.
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Forward buying is best suited for Non-perishable items Items of steady and regular consumption. Materials such as coal, steel, coke, bought out parts that are less susceptible to radical changes in specifications. Seasonal items Pre-budget purchases. D. Speculative Buying Refers to buying large requirements of an item when

its price is low with intention to sell bulk of it at a higher price for speculative profits.

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The characteristics are: (a) Purchases may not be related to the companys

production programme. A particular material, which is not even required for production may also be purchased. (b) Buying does not base decisions on quantity as its sole aim is to make speculative profits. Thus, quantity purchased is generally high and is as much as the company finance can permit to buy. (c) The speculative buying is really not a function of purchase department and it should be ordinarily discouraged.

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E. Contract Buying Purchasing made under a formal contract in

which the delivery of materials is frequently spread over a period of time. The characteristics are: (a) Contract are given to suppliers for large amount of future requirements or for a certain time frame usually a year. (b) Quantity received per delivery is generally small. The cycle time between two consecutive receipts may be a week, fortnight or a month. The period would depend upon the value of requirements.

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Merits of contract buying It saves company from the trouble of

inviting quotations, preparing comparative statements, placing of orders, etc which in turn reduces the procurement expenses. The buyers company is assured of regularity in supply despite market fluctuations.

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 The buyer needs to keep very little inventory

and safety stock thereby reducing the working capital lock up and cost of carrying inventory to the barest minimum. Prices and other terms of contract are generally favourable to the parties involved. The buyer can plan his requirement of finance as he has an advance idea as to when and what amount he has to pay to his vendor.

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Week 04 B Types of Contracts

Contract buying is of three types:

(a) Rate Contract The rate is fixed and not the quantity. However, some tentative requirements are given. (b) Running contract Rate and quantity both are fixed for the contract period. As soon as the vendor supplies the specified quantity, the contract automatically comes to an end.
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(c)Service contract Various services are obtained periodically. Suitability of contract buying Contract buying is suited to the procurement of materials and production items of regular use. Service contract may be entered into for getting periodical services such as servicing of computers, air-conditioners, water filters, fire-fighting equipments, cleaning of boilers etc., repairs or calibration of measuring instruments, pressure gauges etc.

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F. Tender Buying Government departments and public sector undertakings in India follow this method of buying. A few large-scale private organizations too aopt tender buying. Characteristics of the system are (1) The buying department establishes a list of bidders and invites a written bid to be submitted by them. (2) Bids are evaluated by comparing and the right supplier is selected. (3) Lowest price is the criteria used except when the lowest price supplier is not able to commit to the delivery schedule, quality and is poor on reliability or financial stability. 121

Merits and Demerits are: (1) Purchasers most important single tool to select

qualified supplier on the basis of competitive prices. (2) Eliminates possibility of favouritism , patronage and personal preference. (3) Costly, and time consuming and hence used by large private sector undertakings only when value of purchases is high. The responsibility of buying department: For each new product, material or service, a buyer must obtain quotations from at least three potential suppliers.
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Past performance of old supplier must be taken into account while deciding on the contract of a new item. Buyers should guard against such suppliers who submit extremely low quotations initially and increase their prices later. The bids should be evaluated considering the capabilities of the competing firms. Types of Tenders

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(1) Limited or closed tender An enquiry is sent to limited number of suppliers and bids are received in response. All registered suppliers are mailed enquiry from the buyer. (2) Open tender The enquiry is advertised in the newspapers or periodicals or trade journals of the home country and bids are received in response. Encourages unlimited competition by publicizing the enquiry.

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 Used for items, which are required in large value/ volume and/or difficult to procure.

(3) Global tender Enquiry is advertised in the newspapers and trade journals of not only the home country but also in the foreign countries and bids are received in response. Used for purchasing involving huge investments such as procurement of plant and machinery. Used for purchases that are both capital intensive and technical.

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G. Seasonal Buying Buying of the annual requirements of an item during its season. Used for materials available in particular season only such as items required for food industries. Need to be purchased and stocked in sufficient quantities till the next season e.g. oranges, sugarcane, apples etc. Materials are normally purchased at the cheaper rates. Usually purchases are made directly from manufacturers/ producers of goods. Suitable for materials that are either of purely seasonal nature or which show marked price fluctuation during off-season. 126

H. Sub-contracting Hiring of another firm to perform some of the manufacturing operations or to provide certain parts and sub-assemblies to be incorporated into the buyers end product. Types of sub-contracting (1) Company makes some quantity of the final product an buys balance from outside. Happens when company receives big orders but is unable to supply the full quantity within the contracted period.
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(2) The company gets certain operations like electroplating, heat treatment, grinding and finishing etc done from others because either it does not have necessary manufacturing facilities or its present facilities are inadequate.

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When to undertake sub-contracting ?

Product involves number of components requiring different types of machines.

Specialized operations are called for certain components and the same are not available with the buyers firm. Shortage of capacity that cannot be made good immediately.
Comparative economies of cost to manufacture the

part at the companys own plant versus cost of subcontracting justifies procurement from subcontractors.
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Why proximity of the sub-contactors to the buyers plant ? Transportation cost, both of men and materials is less. Follow up is easy and less costly. Buyer can have better control on suppliers quality that gets facilitated by periodical visits and feedback. Responsibilities of the buying department 1. Must work out a detailed quality assurance system, complete manufacturing process and inspection

criteria with the sub-contractor.

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 Manufacturing process must include sequence

of operations. Inspection criteria should include raw materials inspection, in-process inspection and finished product inspection. Inspection criteria should also include instruments to be used during inspection at each selected inspection points in the manufacturing process.

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 A large firm in the public or private sector may have decentralized stores at different places.

Week 05 ACentral Purchase Organization

The purchases can be made in either of the following ways.

Each store to make its own purchases. 2. A central stores to make purchases and supply materials in turn to different stores. Advantages of central stores purchase (1) Quantity discounts, lower rates, and better contractual terms due to large purchases that result from consolidating the requirements of individual stores. 132
1.

Better control on consumption thereby minimizing the risk of malpractices. (3) A single direct contact with the manufacturer for obtaining materials as per the specifications becomes possible. Typical examples are State Road Transport Corporations such as MSRTC, GSRTC, etc., Nationalized Banks, and Co-operative Banks etc.
(2)

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Directorate General of Supplies & Disposals

A

central Purchasing Organization for various Government departments Enters into contract with various firms for supply of materials for the Govt. departments during the year at an agreed rate. A formal document raised for this purpose is called rate contract.

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Purchasing Capital Equipment

Purchase of major capital equipment, plant and machinery differs substantially from other routine

purchases of production materials, MRO inventories and spares which are occasionally required for replacement. Capital equipments are characterized by their nonrepetitive nature and, therefore, one-time inventory, which form the fixed capital asset of the company installed to earn revenue. They are charged as capital expenditure and depreciated over a fixed period for recovery of investment and replacement.
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 As compared to stocks and stores, they involve an investment of a large amount of money and also a longer duration.
Capital equipment purchases are decided at topmanagement level, and generally, a committee is formed represented by: production, finance, engineering , design and purchase managers.

The recommendations of the committee are forwarded to top-management and when finally approved, they are pushed to purchase management level for necessary action and final procurement.

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 Capital goods are those that are not bought or sold as a regular course

of the business Used for over 1 year, depreciated

Examples design of equipment and buildings, real estate purchase, enterprise wide hardware and software

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Components for Decision Making (a) Negotiating Time

With the increase in the number of contacts and available alternative sources, negotiating time varies greatly and generally it is greater than for other purchases. (b) Source availability Due to specific and stringent requirements of engineering and design features, sources quite often are limited. Therefore, purchase decisions would be based on the requirements.
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(c) Quantum of investment Since this criterion greatly influences manufacturing capability, availability of finance and the cost of capital weighs more with top management. (d) Lead-time requirement Keeping in view the operating characteristics and engineering features, special plant and machinery are custom built . Therefore, they require longer lead time than standard equipment, plant and machinery. (e) Evaluation of bids Operating characteristics and engineering features Rate of obsolescence in the industry Economic analysis of the proposal.
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Operating characteristics and engineering features Generally the production department or the user department establishes the need and defines the functions which form the basis of its performance characteristics and design features. Selection is done on the basis of one which is best suited to the existing process.

Rate of obsolescence In many industries the rate of obsolescence is much higher due to technological advancement and innovations. In such cases, rate of expected return on investment has to be higher .
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Economic analysis of the investment proposal

Depends upon the number of acceptable offers available in the market for the same kind of equipment and machines. Initial cost involved may not always be the deciding factor. The cost of operation as well as the cost of maintenance have to be weighed. The cost of operation can be more accurately estimated, but the cost of maintenance being

subjective in nature, cannot be accurately gauged. Therefore, it is included in the cost of operation for the purpose of economic analysis of the total cost.
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(a) Payback period method

Most simple and widely used, wherein the length of the time required for cash inflow as a result of investment is calculated. The shorter the payback period, the better the investment from economic viewpoint. (b) Return on investment In this method return on investment is stressed. There can be two methods to calculate ROI. (1) Return on investment is calculated on the actual value of original outlay.
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(2) Calculated on the average value of the investment i.e. mean of original value over the time period plus expected salvage value at the end of useful life. (c) Internal rate of return A procedure is established to find out a rate of interest that will make the present value of cash proceeds expected from the investment to equate the present value of investment. The rate of discount, when applied to the future cash inflows, will equate the original value of the investment. This is also known as discounted rate of return or yield method.
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Year 01 - 22000 Y 02- Rs 22000 Y 3- Rs 16000 Y4 13000 Y5 11000 Y6- 9000 Y7 8000 Y8 -8000 Y9- 6000 Y10- 5000 Total Profit- 120000
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 Year 10 years

Average revenue Rs 12000 Initial Investment in machine is 100000/Salvage value is Rs 5000 Thus payback is . Return on Investment is Profit / investment = 12000/10000 return on avg investment = avg invetsment is Rs 100000/10 = 10000
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 10000 x 8. 3 (payback) = 83000 Add 5000 Hence 83000 + 5000 = 88000 Hence 12000/88000 = 13.6 %

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 Discounted Cash Flow:

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(d) Discounted cash flow (DCF) method It takes into account differences of times when revenues are generated from an investment. In using present value concept in evaluating an investment , all future revenues are discounted in order to find out the total present value of the future earnings and compared with the present value of the investment. Thus, if it is found that the total present value of the future revenues is greater than the present value of investment , then it is worthwhile to invest in the equipment or the machine, otherwise not.
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 Present value simply means a rupee earned today is worth more than a rupee earned in future.
Similarly, it means a rupee earned in future years is less than a rupee earned today..

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Week 05 B Purchasing versus Leasing

Capital equipments are often available on lease and rent basis. The need of leasing of capital equipment arises due to short period requirements and non-availability of funds. When the equipment is urgently required, it is easier to get it on lease. Purchase involves procedural immediate release of funds.

delay

and

needs

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 The points to be considered when lease to be resorted to instead of purchasing. 1. When equipment is needed for shorter period. - It is most economical method of procurement. - As lease agreements can be terminated at a short notice. 2. When the technology is fast changing and because of resultant obsolescence the particular equipment becomes less efficient. 3. In case of a lease, the lessee bears the dismantling charges including transportation on its return as well as the installation charges
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- Whereas in purchase, the equipment is almost always sold at delivered price, unless specifically mentioned in the purchase contract.
4. In case of lease, lease-rent is treated as revenue expense for tax purposes, whereas in case of purchase it is treated as capital expenditure to be depreciated over years of useful life.

5. In case of a lease, lessor retains control over the equipment during lease period.

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Advantages Of Leasing: 1) Lease rentals become expenses for income tax purposes. 2) There is a smaller initial outlay 3) Obsolescence risk is reduced. 4) Expert services are available 5) A test period is generally provided before purchase 6) The burden of investment is shifted to the supplier Disadvantage; 1) Less freedom of control and use

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Import Procedure
First the point to be checked is if the item is allowed to be imported . To check from local manufacturers if they are in a position to supply. If

not a written statement to be presented to the government . Then government will clear. Steps 1) Locating the foreign source Of Supply - to be done through Ministry of Trade and Commerce, Consulates, Trade attaches etc 2) Procurement Of the Item- At this stage the importing firm is involved with the foreign source of supply, his own user departments and governmental agencies like DGTD 3) Documentation-

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Why Global Purchase

Global supply chain imapcts of supply and demand. Unavailability in local market Price, quality Technical support, service, Technology Example: Li Feng Issues: Lead time, source identification Expediting, currency fluctuations Hidden costs, govt regulations Tariffs, duties, legal issues Language, cultural etc

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-Imports-Terms of Sale
International Commercial Terms (INCOTERMS) define - The duties of the buyer and seller at each step in the movement -

of goods. Indicate which party must arrange transportation, Which part handles export and import clearance, Which party absorbs costs and risks. Obligations of the buyer and seller in international transactions

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 The International Chamber of Commerce has

internationalized these terms. From a sellers view point, ex works offers maximum protection, in that the liability and all transportation costs are transferred to the buyer at the sellers origin dock- at the plant door. A buyer would normally prefer delivered duty paid where the seller is basically handling all the risks and costs of the shipment to the final destination.
157

 Ex Works (EXW named place) - The seller makes the goods available at the named place, usually -

the sellers docks. The buyer is responsible for all costs and risks involved in taking the goods from the named place to the destination. The INCOTERM provides minimum risk for the seller. Free Carrier (FCA named place) The seller fulfills his/her duties when the goods cleared for export, are given to the carrier chosen by the buyer at the named place. The named place is domestic for the seller The buyer assumes risk at the point of exchange and pays for all freight.

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 Free Alongside Ship (FAS named port and vessel)

- The sellers obligation is to deliver the goods

alongside the ship on the quay. - The buyer then assumes all the risks and costs from that dock (port of export). - The seller must also provide export clearance. Free on Board (FOB named port) - The seller delivers the goods to the ship and has fulfilled his/her duty when the goods pass over the ships rail at the named port.
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- This means that the seller pays for loading charges, pays

freight charges to the named port, and provides export clearance. The title passes to the buyer when the goods pass over the ships rails The buyer bears all costs and risks from that port on. Carriage Paid To (CPT named port of destination) The seller pays the freight costs to the named destination as well provides export clearance. Once the goods are delivered to the carrier, risk is transferred to the buyer. The named port of destination is domestic to the buyer but not necessarily the final delivery point

160

 Carriage and Insurance Paid To (CIP named place of -

destination) This means that the seller has the same duties as under CPT. In addition, must also purchase cargo insurance in the name of the buyer while the goods are in transit to the named port of destination. Cost and Freight (CFR named port of destination) The seller arranges and pays for the transportation to the named port of destination. Risk and any other costs while on the ship are passed to the buyer as the goods pass over the ships rail at the port of shipment. CFR is used for ocean and inland water transport and the named port of destination is domestic for the buyer
161

- Seller provides export clearance. - The seller must also pay for unloading/loading

charges at the named port of destination and are included in the freight cost. Cost, Insurance and Freight (CIF named port of destination) - The seller has the identical obligations as in CFR. - In addition, must also provide marine insurance while the goods are in transit in the name of buyer.
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- At the port of destination, the seller pays for

unloading/loading costs and are included in the freight costs . - Buyer assumes all risks and costs from the port of destination. Delivered at Frontier (DAF named place) - The seller fulfills his/her risk and costs duties when the goods are made available, cleared for export at the named point, and placed at the frontier, but prior to the customs border of adjoining country. - The buyer takes delivery at the named frontier.
163

 Delivered Ex Ship (DES named place of

destination) - The seller meets his/her duties when the goods have been made available to the buyer on the board the ship-not cleared for importat the port of destination. - All risks and costs involved in getting the goods to the named port of destination are the sellers. - The buyer takes delivery at the port of destination, provides import clearance and pays port fee, if any.
164

 Delivered Ex Quay (DEQ) named port of

destination - Seller meets his/her obligations when the goods are made available to the buyer on the wharf (quay) at the named port of destination and cleared for importation. - The seller assumes all the risks and costs, including duties, taxes, and any other charges in delivering the goods. - The buyers obligations begin after taking the delivery from the quay at the port of destination.
165

 Delivered Duty Unpaid (DDU named place of

destination ) - The sellers duties end after the goods have been made available to the buyer at the named place in the country of importation. - Seller has to pay the costs and assume the risks involved in bringing the goods to the named place of destination. - The buyer pays the duties, taxes, and other charges along with costs and risks of carrying out custom formalities.
166

 Delivered Duty Paid (DDP named place of

destination) - The seller must deliver the goods at the named place of destination and provide import clearance, including duties, taxes, and fees. - The buyer simply takes the delivery at the named place, and costs and risks transfer here. - In terms of sellers obligations, this is the maximum obligation that can be assumed by the seller. INCOTERMS were revised in 2000 to recognize the way international trade is now conducted.
167

Global Documentation
Air Way Bill - The AWB serves as the contract between the carrier and the

shipper. - It is non-negotiable, and three original bills are issued. - It is equivalent of an ocean bill of lading and is issued by the airliner or a consolidator. Ocean Bill of Lading - Serves as the contract of carriage, receipt for the goods, and evidence of the title to the goods. - Provides shipment details such as weights, volumes, quantities, destination, legal responsibilities, and liability limits for all parties.
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Global Documentation
Bill of lading is evidence of the fact that goods have been dispatched by

the exporter and gives the importer the title to the goods and enables him to claim them on arrival at the destination. Bill of lading are prepared by the Shipper on the forms that given to him by the shipping company. Normally bill of lading shows date and place of shipment, the name of the carrying vessel, the name of the consignee , port of destination, the number, contents and identification of the goods., the amount of freight paid or to be paid.
Shipping Bill
- This document helps Custom Authorities evaluate the consignment

and let the shipper export the same. - This documents also enables government to collect trade statistics.

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 Commercial Invoice

- Invoice is always issued by the seller of the goods.

- Payment is made on the basis of invoice and is also required for clearing

products through customs. The commercial invoice describes the merchandise, indicates the price of goods, trade discounts if any and other details of the transaction. Whether goods are sold under letter of credit Name and address of the buyer and seller Other charges to be includes as per the contract such as for packing, freight, insurance are added to the totals.

170

Global Documentation
marine Insurance Policy . Is a contract between the insurer and insured The former in consideration of payment of premium by the latter Agrees to indemnify the insured against loss incurred in respect of

goods while being transported by sea.

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 Certificate of Origin

- Issued by a Chambers of Commerce, the exporter has to get this to comply with

the requirements of some countries to certify the origin of the products and/or its components. The data included are used for statistical research or for assessing duties. The laws of some countries require a certificate of origin of the imported goods to be produced before clearance Importer may hence request the exporter to send such a certificate Required when goods from some countries receive preferential treatment or if the import of goods from some countries is prohibited. The country where the goods are produced should be known to the custom authorities.

Dock Receipt

- Describes the shipment including physical details and shipping information.

- The shipper and carrier use it to verify shipment particulars , conditions, and

delivery to the carrier.

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- It is issued by the exporter and signed by the receiving clerk on behalf of

-

the carrier. Packing List Normally issued by the exporter. Packing list provides details of the contents of each package in the shipment.- indicates the exact nature, quantity and quality of the goods The list helps the importer to identify the goods and check them against his order. Custom authorities use this document for clearance and inspection. Also used when filing claims for damage and/or shortage.

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 Markings on the Packages

The packages must be suitably marked with the address, dimensions , weight and other particulars in conformance of the instructions of the buyer It helps in quick customs clearance Import License: 1) Income tax clearance has to be produced before getting the import license. 2) Under the import trade control act, every import license is required to be registered with customs authorities 3) Application of import has to be made on the prescribed forms Basis Of Licensing; 1) Quantity of materials /goods/machinery available from indigenous sources 2) Availability of foreign exchange as per rules
174

3)Installed capacity, actual production and planned production 4) Import policy of the government of india in respect of the item in question

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Week 06 A Letters of Credit

A Letter of Credit (L/C) is issued by a bank on behalf of a buyer

of the goods to the seller and authorizes payment to the seller. A L/C is basically a contract guaranteeing that the buyer can pay the invoice upon receipt. The obligation to pay an exporter Is undertaken by the bank. When a LC is received form a bank the credit standing of the importer is less significant L/Cs can be revocable or irrevocable. A revocable letter can be changed or cancelled at any time by the opening bank at the request of the buyer or account holder. Payment is not guaranteed because the buyer can back out.

176

 Irrevocable letters cannot be amended in any way

without consent of the buyer and the seller. This offers better protection to the seller than the revocable letter of credit.

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How a Letter of Credit Operates

The seller asks the buyer for a letter of credit. 2. The buyer (importer) asks its bank to issue a letter of credit in agreement with the sellers terms requested, in favour of the seller (exporter) 3. Having approved the buyers line of credit, the buyers bank informs the sellers bank that it has issued the letter of credit in favour of the exporter 4. The sellers bank either adds a confirmation (guarantees payment to the seller) or just advises the seller that the letter of credit has been issued. The liability for payment is that of the bank issuingh the LC and the bank of the seller gets reimbursed by the issuing bank
1.
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5. The seller makes the shipment and presents the documents to its
bank in agreement with the terms in the letter of credit. 6. The sellers bank inspects and approves the documents, and then sends them to the buyers bank by air mail or courier service. 7. The buyers bank inspects and approves the documents. Once approved, it debits the buyers account and wires transfer of money to the sellers bank. 8. Upon receipt of money, the sellers bank credits the sellers account. If this was a confirmed letter of credit, the sellers bank would have paid the seller after step 6.

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Inventory Management
What is Inventory? Refers to the stock in hand at a particular time of raw materials, goods in process of manufacture, finished products, merchandise purchased for resale that can be seen, measured and counted. Types of Inventories 1. Production inventories Raw materials, parts an components that enter the firms product in the production process.

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Types of Production Inventories

Special items manufactured to companys specification

Standard industrial Items purchased Off the shelf.

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2. MRO Inventories - Maintenance, repair, and operating supplies, which are consumed in the production process, but do not become the part of product e.g. lubricating oil, soap, machine repair parts. 3. In-process Inventories - Semi-finished products found at various stages in the production operations. 4. Finished Goods Inventories - Completed products ready for shipment.

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Objectives of Inventories
Raw material inventories are held for facilitating

conversion into semi-finished or finished goods. Raw material inventories are essential as generally it may not be economically feasible either to purchase or schedule deliveries as per their requirement in the production process. As manufacturing/processing takes time there is need for finished goods inventory. If the material must be processed in lots or batches inventories usually will be required.

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Steady flow of work-in-process inventory is required in order to ensure uninterrupted production flow. Sometimes, nature of the product prohibits finished goods inventories e.g. fresh fruits and vegetables etc have limited storage life, so extensive inventories of these products are not desirable. Inventories also serve to isolate (a) Producer from the supplier (b) Various departments/work stations within the plant. (c) Consumer from the producer.
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(d)

Isolating, also called decoupling reduces dependencies of one another and enables each organization to schedule its operations independently of each other. Another purpose of holding inventories is to reduce material handling costs by accumulating parts between operations particularly in intermittent process. In continuous manufacturing, automated material handling systems, rather than larger work-in-process inventories are used to reduce material handling costs. Inventories are also held to facilitate product display and service to customers, batching in production to take advantage of longer production runs and flexibility in production scheduling.
185

Week 06 B Inventory Costs.

1. Ordering Costs

A. Cost of placing an order with a vendor of materials (a) Preparing purchase order (b) Processing payments (c) Receiving and inspecting the material. B. Ordering from the plant (a) Machine set up. (b) Start up scrap generated from getting a production run started.
186

2. Inventory

Carrying Costs A. Costs connected directly (a) Obsolescence, deterioration and pilferage. (b) Taxes, insurance, storage rent, interest on capital borrowed. (c) Material handling costs. (d) Salaries of security and other warehouse personnel.
3. Out-of-stock costs

(a) Back ordering

(b) Lost sales
187

4. Capacity costs (a) Overtime payments when capacity is too small (b) Lay-offs and idle time when capacity is too large

Conflicting inventory costs

Ordering costs and carrying cost move in the opposite direction. If ordering costs are more, carrying costs are less and vice versa.
188

Economic Ordering Quantity

Quite often materials department is accused of

stock outs as well as large investments in inventories. The optimum quantity should be sufficient to achieve maximum production. It should not be so excessive resulting into locking of working capital thereby reducing the ability of organization to earn higher rate of return.
189

 The determination of the right quantity assumes

tremendous importance, satisfying the conflicting views of (a) not too much, (b) not too little, and (c) at minimum total cost, and for (d) increased profitability. > An Example of selective inventory control - Consider some items accounting for an annual consumption of Rs 60,000, Rs 4000 and Rs 1000 respectively, each being ordered quarterly. An average inventory will emerge as under:
Item No Annual consumptio n value 60,000 4000 1000 No. of orders per year 4 4 4 Value per order (Rs) 15,000 1000 250 Average Inventory (Rs) 7,500 500 125 8125
190

1 2 3

Total Average Inventory

 If the principle of selective control is applied, then we place

eight orders for the first, three orders for the second and one order for the third, the value of the average inventory gets reduced to Rs 4917.
After Selective Control
Item No Annual consumption value 60,000 4000 1000 No. of orders per year 8 3 1 Value per order Average (Rs) Inventory (Rs) 7500 1333 1000 3750 667 500 4917

1 2 3

Total Average Inventory

The usage/consumption value is a key guide in determining

the size and frequency of various orders that must be placed. Based on the concept that additional controls must be placed on higher value stocks.
191

 Under fixed

order quantity system of inventory management, an order is placed when the existing stock reaches re-order point. The relevant question now is-What should be the size of the order? Buying in large quantities would lead to high carrying cost. Similarly, buying in small quantities reduces holding cost but adds to ordering cost. EOQ is the order size at which the total cost, comprising of ordering cost plus carrying cost is the least.

192

 In manufacturing parlance, it is known as economic lot size,

with set-up cost replacing ordering cost. The set-up is the cost incurred due to job changes , resetting, setting jigs, fixtures, cleaning etc. The inventory charges will continue to be same as manufacturing department produces the goods which will be stocked for some duration. - The following assumptions are implied in EOQ calculations (a) Demand for the product is constant and uniform throughout the period. (b) Lead time (time from ordering to receipt) is constant. (c) Price per unit of product is constant

193

 Inventory holding cost is based on average inventory.

Ordering costs are constant. All demands for the product will be satisfied (no -

back orders are allowed) The following are the restrictions to application of EOQ Materials purchased to order, and those subject to rapid product improvement. Materials which have a short shelf life. Materials with unusual sales.

194

A few terms used in Inventory Management

Buffer stock= {Average lead time}x{Average

usage rate}. Safety stock= Average usage during the extension of lead time. Reserve stock= Excess usage requirement during the average lead time. Re-order level= B.S.+ S.S.+ R.S.

195

 Minimum Inventory Level= S.S.+R.S. Max. Inventory Level= {Minimum Level} +

{Order quantity} Average Inventory Level= (Min. level + Max.level)/ 2 In case of periodic review the buffer stock will be modified to {Average consumption rate}x{Average lead time + Review period}

196

Inventory Control Procedures

Perpetual Review

Periodic Review

197

Perpetual Review
Inventory status is replenishment needs.

reviewed

to

determine

Implemented through a reorder point and order quantity.

ROP= D x T + SS, where ROP= reorder point in units D= average daily demand in units T= average performance-cycle length in days SS=safety or buffer stock in units

198

 The following are considered in perpetual

review: - On hand inventory represents quantity that is physically present in the particular distribution facility. - On-order inventory represents quantities that have been ordered from suppliers. - If on-hand plus on-order quantity is less than or equal to the established reorder point, inventory control process will initiate another replenishment order.
199

Mathematically, this can be stated as If I+q ROP then order Q, where I= inventory on hand q= inventory on order from suppliers ROP = re-order point in units Q= order quantity in units. Average inventory level for a perpetual review system is calculated as (a) I = Q/2 + SS, where I= average inventory in units Q= order quantity in units, and SS= safety stock in units The assumption is that P.O. will be placed when the reorder point is reached and there is a continuous monitoring of inventory system.
(a) (b) (c) (d)
200

 The inventory status is reviewed at regular intervals such as weekly or monthly. The re-order point is adjusted to consider the extended intervals between reviews. The formula for calculating the periodic review reorder point is

Periodic Review

ROP= D( T + P/2) +SS, where - ROP= re-order point - D=average daily demand - T= average performance cycle length - P=review period in days - SS= safety stock
201

 Average inventory for periodic review is

represented as I= Q/2 + (P x D)/2 + SS, - I= average inventory in units - Q= order quantity in units - P= review period in days - D= average daily demand - SS= safety stock. Because of the time interval introduced by periodic review, periodic control systems generally require larger average inventories than perpetual system.
202

Week 07 A Selective Inventory Control

Materials executives have to handle a large

number of items in actual practice, in ay organization. For instance, a refinery has over 50,000 items consisting of spares, refractories, consumables, components, chemicals, stationery, and other items, whereas defence services deal in millions of items. The importance of each item is a major parameter while procuring it.
203

 Some of these items may be very critical, or difficult to procure, or may have to be imported, while others are easily available. For instance, a housewife does not pay the same attention to salt as she pays to the purchase of oil. As the number of items increases, the effective time spent on each diminishes.

To overcome this problem, we adopt selective control techniques to improve purchase efficiency.
The materials are classified according to their

importance and increased attention is paid to these important items.

204

ABC Classification
ABC classification is based on the annual consumption

value. It has been found that about 10 per cent of the number of items contribute to about 70 per cent of the consumption value known as A category. The middle 20 per cent in number accounts for about 20 per cent in value, and is known as the B category. The remaining 70 per cent in number accounts for about 10 per cent of annual consumption value, and is the C category. Efforts to follow-up and control will be more in case of A class materials.
205

 Another way of selective inventory control is HML- high

price, medium price and low price. ABC analysis includes HML as well as the quantity consumed. By the above process, we can reduce all items into two categories, namely (a) High consumption value, and (b) Low consumption value.

206

XYZ and FSN Classification

One important way of finding the usage of materials is

according to their movement. For this purpose, we have fast moving, slow moving and non moving or FSN analysis. Items moved once in a year in case of spares, or regularly consumed in case of raw materials can be classified as fast moving items. Spares moved once in two years or five years, or raw materials moved once a year can be called slow moving. Spares, other than real insurance variety, which have not been drawn from the stores even once, are called nonmoving items.
207

 While ABC analysis is based on annual consumption

value, XYZ is based on the year-end stores inventory value. X items are top 10 percent of items, accounting for about 70 percent of stock value. Y the middle 20 percent accounting for middle 20 percent of the stock value , and Z the remaining items. Combining XYZ and FSN, the action for identification of obsolescence should be initially taken on category N and X, i.e. Non-moving with high inventory value. Thus movement analysis combined with inventory value helps to plan the purchase quantities by not purchasing items falling under N category, and going slow with regard to the slow moving items. 208

Movement Analysis
Inventory Value Fast Slow Non-moving X Top 10% number 70% stock value Y Medium 20% FX SX NX

FY

SY

NY

Z Low 70% number 10% stock value

FZ

SZ

NZ

209

Availability- SDE/GOLF/SOS
Materials can be classified

according to the problems

faced in the procurement. There may be monopoly items or limited number of suppliers, leading to demand outstripping the supply. Thus, we have items that are scarce to obtain, difficult to obtain, easy to obtain- called SDE analysis. The category E indicates the existence of large number of suppliers and the order quantity may be small. Similarly, imported items have long lead time; so depending upon the nature of items, we have GOLF, that stands for Government controlled, ordinarily available in open market, locally available and foreign supplier or import purchase. 210

 Some items, are available only n certain seasons, like agro

based commodities and buying strategy has to be different; for this we have SOS- seasonal and offseasonable type. Combining all the above parameters, we can have long lead-time items, with the total lead-time being more than a year and short lead-time items, where the leadtime could be less than a year or even less. Thus, all the items to be purchased can be classified into two categories according to the lead time (a) Less than a particular time limit , say one year, - short lead-time items, and (b) More than a time of one year or long lead-time items.
211

Criticality VEIN/VED/RAM
Equipments

are usually classified into VEIN-vital equipment, essential equipment, important equipment and normal equipment, depending upon their utility to the organization. For instance, a standby equipment can be considered as normal, while a generator, when a power cut is on, can be considered as vital as compared to other machineries. Similarly, parts constituting the equipments can be classified into VED vital, essential, and desirable categories. If a vital part is not available, that too on a vital equipment, the stock out cost would be very high.
212

 Combining these two categories, we have RAM-reliability,

availability and maintainability, which is useful in determination of spare parts requirements while acquiring new machineries.
In these

cases, nonavailability of a part or stock out cost can

be enormous as the operations would come to a grinding halt. The degree of importance reduces from vital equipment- vital part to a desirable part-normal equipment and procurement action needs to be planned accordingly. The classification of equipments into VEIN and spares parts into VED has to be carried out only by technical persons viz., maintenance executives, production managers, and the design engineers. Attempts should be made to classify all items-particularly , spare parts-into critical and non-critical.
213

3-D Inventory Analysis

All items in the factory can be grouped in three

dimensions on the basis of, (a) Consumption value (b) Availability, and (c) Criticality If we adopt three levels for each, such as ABC, SDE, and VED, then we get 27 groups and it becomes a difficult job in practice to follow up. Thus, two levels for each of the three dimensions are advocated- high consumption value/ low consumption value; long lead time/short lead time and critical/ non critical categories.
214

High consumption value

Low consumption value

Long lead time Short lead time Long lead time Short lead time Critical Critical LLT HCV Critical Critical Critical

#1

SLT HCV

#2

LLT LCV

#3

SLT LCV

#4

Non critical

Non Critical LLT HCV

Non Critical SLT HCV

Non Critical LLT LCV

Non Critical SLT LCV

#5

#6

#7

#8

215

 Cell #1 contains items with high consumption value, long

lead time, and critical in nature. Cell # 2 consists of items with high consumption value, short lead time and critical in nature. Cell # 8 consists items with low consumption value, short lead-time and, non-critical in nature. For all items falling in cell# 3,4, 7 and 8, the annual consumption is very small, even though the number of items is large as they belong to B and C categories. How do we interpret the above categories from material control point of view?

216

Interpretation of 3-D Analysis

Having grouped all items on the basis of consumption value, criticality and lead-time, let us now consider the item in cell# 3. These are critical from operational view, take a long lead-time for procuring, but with low consumption

value. For this category, the purchase quantity must be very large with annual ordering. The coverage can be even two years, as the working capital is small, provided there is adequate space and the items are not perishable.
217

 The power of delegation for purchase of such

items should be at appropriate level, though decentralized, as the items are highly critical. Controls should be minimum as sometimes the cost of control may be more than the cost of items. Let us now consider items falling in group 6. These items have short lead time, high consumption value and are non-critical. The purchase quantity should be low as the items are non-critical and have high consumption value.
218

 Preferably, these items should be bought as

and when needed, with the concurrence of competent authority. In other words, purchase will be done just at the time of requirement basis, and delegated to higher level with the associated delays in procurement. The concept of zero inventory, that too in a central warehouse can be applied here as the consumption value of the item is very high but non-critical in nature.
219

 All cost reduction techniques should be

applied on items in this cell to gain experience, as mistakes do not matter, since the item is non-critical. The problem before the purchase manager are the items falling in cell 1 and 2, which are critical in nature and have high consumption value. A very strict control is required with accurate forecasts and adequate consumption norms for these items.
220

 The ordering may be on a staggered basis, with frequent orders or weekly deliveries.
The expediting and follow up has to be maximum for

these items. The requirement of number of sources may also be relatively more. The recording of such items should be immediate and up-to-date. The information on stock status, consumption, withdrawal, delivery, supply status, transport status, etc must be continuously monitored for items falling in cell #1 and cell #2
221

 Accurate materials planning for the items

falling under cell #1 and cell#2 needs to be done so as to minimize inventory without any stock outs. One should use eight different colours on bin cards for the eight different categories, so that even the lowest level employee can know the stock status and purchase position e.g. by seeing red colour bin card for item falling in cell#1.

222

Usage of 3-D analysis

The 3-D analysis is useful to purchase executive, to take -

decisions on a scientific and practical basis on the following aspects: Purchase quantity Follow-up Closer controls Safety stock Average inventory Power of delegation Information systems and purchase intelligence. Application of value engineering and other cost reduction techniques.
223

- Record keeping - Development of new sources - Disposal of obsolete items. - Centralization/decentralization of purchases. - Stocking pattern. - Service levels - Vendor rating - Monitoring price trends. - Consumption norms. - Estimation of working capital requirements and purchase budgetary control.
224

Summary
The conventional ABC

analysis is not an effective selective control mechanism. There are other factors equally significant such as criticality, and availability that influence a great deal on controlling the materials. The three dimensional approach classifies all materials into eight categories and helps in controlling the materials effectively on all aspects and achieve cost reduction leading to establishment of materials department as a profit centre.
225

Week 07 B- Store Management and Operations

Storage Systems

The Receipt System

Physical Upkeep and Maintenance System

Issue system

226

 System

design should not only permit matching of present requirements with the existing supplies, but also must take care of the future growth potential and demands. Stores must act as a buffer between procurement and various other consuming departments to ensure timely receipts, storage, upkeep, handling, accounting, issues and disposals. Primarily stores must render effective services to all internal customers.
227

Regular Activities of Stores

To receive the materials, check them for quantity, coordinate for inspection and quality checks and

prepare the goods receipt note. To approve the accepted materials, prepare the rejection notes, and complete the formalities for bill payment. To take into stock the accepted materials; store them in respective locations as predetermined. To prepare issue vouchers; make actual issues for disposals and account for them. To keep the purchasing people well informed through systematic indents and other reports. 228

 To keep the storage place clean for facilitating

handling movements and observe all safety measures and security regulations. To ensure easy storage, minimum pilferage, proper identification, and quick retreival with minimum waste of time and efforts. To establish, maintain and update rationalized system of codification. To analyze the consumption and issues from stock records and establishing norms. To highlight abnormal consumption, accumulation, obsolescence and surpluses. To arrange for periodic review, physical verification, and ensure proper accounting. To supervise for smooth functioning.
229

Any storage system is a compromise between the use of space and the use of time. The basic systems of storage are: Fixed location Random location Zoned location Fixed location means that stock can be found immediately without a complex system of recording but there can be a considerable waste of space.
230

Choosing the most suitable storage system

Random location means space is better utilized, but accurate and elaborate records have to be kept about where the materials are. Zonal location means that goods of a particular group are stored in a given area. They may be either randomly stored in a zoned location or stored according to fixed location. A large mechanized stores is characterized by grouping together the fast moving or high turnover goods, and medium and slow moving items. Fast moving materials are usually positioned near the input and output end of a store with the objective of reducing travel time and thus speeding the process throughout. 231

Centralization and Decentralization of Stores

Centralization helps to ensure economy, effect

better control, reduce manpower needs and is suitable for small installations. Centralization makes it difficult to provide service to various work centres scattered in different locations. Decentralization on the other hand is advantageous to workshops lying scattered in wide areas so that the various stores may be kept near production shop floors.
232

Variety Reduction
Many times purchases are made to meet urgent requirements

and these materials become slow moving or even totally dead stock within a short period. Quite often, purchases are not linked with stock availability because of the fact that many items are not properly identified and included in the stores catalog. Variety reduction would require Periodic review of non-moving and slow moving items. Eliminating non-moving and obsolete items. Deliberate elimination of duplicate and unnecessary items held in the stock.

233

Standardization
Mass production techniques are based on the principle of uniformity and interchangeability of

many parts, components and materials used in production process. Standard products can be manufactured on a mass scale and their production cost can be kept to minimum. Standardization leads to cheaper and easier procurement and the cost of replacement can also be reduced.

234

 In India, Bureau of Indian Standards/ Indian Standards

Institution is the national body that deals with standardization at national level. The standardization can be done in respect of products, processes, materials, parts, components etc. With the help of frequency distribution, it is easy to ascertain the sizes and types most frequently used and which can be retained as standard sizes and types. Standardization enables industry to have a better control on inventory, achieves economy of materials and parts, avoids wastages, plans for disposal of unwanted stock, and overall reduction in stocks. Through standardization and variety reduction, rationalized codification becomes easier.

235

Week 08 A- Classification and Codification

Invariably, a large number of unnecessary items in inventory can be traced to different and misleading

nomenclature, faulty numbering and use of trade or brand names to describe the same items. It is useful to classify the materials in relation to their basic characteristics thereby bringing together all closely similar materials and parts together irrespective of their functions. A standard numerical coding is used for the purpose of purchase, stores and issue thus resulting in reduction of long, and ambiguous descriptions.
236

Ways to classify and codify

The first step is to know the basic nature and characteristics of all materials used in an enterprise. Classify the materials in broad categories and then group and subgroup them in logical progression of kinds, types and sizes etc. The examples are: (a) Raw materials (b) Semi-processed materials (c) Mechanical products and equipments
237

(d) Electrical products and equipments (e) Chemicals, allied products, chemical processing equipments (f) Laboratory chemicals and supplies (g) Office equipments and supplies After classification as per the nature and use, a code or symbol is allocated to each of them. The code or symbol should be simple, flexible and adaptable to changing situations.

238

Codification System
1. Alphabetic system

2. Numeric system
3. Decimal system 4. Alphanumeric system- a combination of

alphabetical and numeric system 5. Brisch system 6. Kodak system

239

Alphabetical system
Alphabets become the basis for allotting

the codes. The first alphabet of the name of the material becomes the starting point of codification. This system is suitable when the numbers of items are not very large and also availability of codes is limited.

240

Class Group Code Raw Materials Iron Bars, M.S. IR-BS-MS Iron Bars, Bright Steel IR-BA-BS
Iron Iron Iron Iron Iron Iron Melted Mould Ore Pig Sheets, M.S. Sheets, Bright Steel IR-MEL IR-MLD IR-OR IR-PG IR-SH-MS IR-SH-BS
241

Numerical System

System is based on numbers-either simple numbers, or block number or dash or stroke numbers. (a) Simple numbers One number is allotted against each material, while certain other numbers are kept as provision of other items. (b) Block number The numbers are designed so that materials of similar nature or block come under one block e.g. raw materials under one block of 1-1000; consumables and lubricants under 1001-2000; packing materials under 2001-3000.

242

Materials Raw materials Iron ore Iron, melted Iron, bright Iron, steel Iron, pig Iron, sheets Iron, bars Iron, mould

Simple number 01 05 07 08 09 06 10 11 12
243

Materials Raw materials Iron, ore Iron, pig Iron, melted Iron, bright Iron, steel Iron, sheets Iron, bars Iron, mould

Block numbers 1-1000 1-10 11-20 21-30 31-40 41-50 51-60 61-70 71-80
244

Codification according to the category of materials

Iron Copper Nickel Alloy

1-100 201-300 301-400 401-500

245

Steel & allied products 101-200

(c) Dash/Stroke number

Materials Raw materials Iron ore Iron, pig Iron, melted Iron, bright Iron, steel Iron, sheets Iron, bars Iron, moulds

Dash/stroke number 15 15-1, or 15/1 15-2, or 15/2 15-3, or 15/3 15-4, or 15/4 15-5, or 15/5 15-6, or 15/6 15-7, or 15/7 15-8, or 15/8
246

Decimal system
Within the range of ten numerals 0-9, some

significance is attached to every digit in the code and whole range of items in stores can be codified. Generally 7 to 8 digits are found to be sufficient for all practical purposes but it may be extended up to 10 digits in order to accommodate any other characteristics of the material. As a first step, the entire range is classified under broad categories.
247

 Further, classification is done for type, size,

grade, shape, conditions, etc. The first digit signifies the broad class, the second digit signifies the group, the third digit signifies the sub-group. fourth digit signifies the type, the fifth digit signifies the size, sixth digit signifies the grade, seventh digit signifies the shape, the eighth digit signifies the condition etc. Generally the primary classification should not be extended to more than 10 broad classes.
248

Materials Raw Materials including ferrous & non-ferrous metals

Code Materials Number 0 Electrical equipment, accessories and fittings

Code Number 5

Steel sections-rolled, flat and 1 square

Capital machinery 6 including spares and parts

Castings and forgings

Jigs, tools and fixtures-production tools

Fuels, lubricants, chemicals and allied items

Mechanical assemblies, subassemblies, components and accessories

Work in progress, comprising 4 of sub-assemblies, components and semi finished goods

Miscellaneous stores 10

249

Combined alphabetic and numeric system

Main class Carbon Carbonic acid Carbon Monoxide Carbon Dioxide Manganese Manganese Acetate Manganese Dioxide Manganese Oxalate MN 21 22 23 MN-21 MN-22 MN-23
250

Sub group-I CB

Sub group-II 11 12 13

Code CB-11 CB-12 CB-13

Main class
Phosphorus Phosphoric acid Phosphorus Pent oxide

Subgroup-I
PH

Subgroup-II

Code

51 52

PH-51 PH-52

Phosphorus Trioxide
Sulphur Sulpherous Acid Sulphuric Acid Sulphur Oxide SP

53

PH-53

81 82 83

SP-81 SP-82 SP-83

251

Brisch System
Quite similar to numerical system in which 7-digit numerical code assigned to each item. The materials are grouped as under: Primary materials Over the shelf items purchased Components according to companys own design. Assemblies and subassemblies. Tools, jigs and fixtures etc. Materials are further subdivided according to their class characteristics. By establishing differences at various levels, they are again sub-divided at still lower levels.
252

(a) (b) (c) (d) (e)

Kodak system
First step is to classify on the basis of purchase category. In the second step, sub classification details of the materials,

say, class code 21-30 i.e. mechanical products and loose tools

is provided.
Class code 00-10 Materials Raw and semi-processed materials

11-20
21-30 31-40 41-50 51-60 61-70 71-80

Machinery and mechanical equipment

Mechanical products and loose tools Electrical products and equipments Chemicals and chemical processing equipments Chemicals and allied products Furniture and fixtures Office, laboratory equipments and stationeries

81-90

Fuels and lubricants

253

Scrap/Waste Disposal
Material input Material processing Material output

Recycle
Scrap

Disposal

254

A. Scrap

Scrap is a waste created while processing the materials. The process scrap is unavoidable extra material removed from the stock of material while generating a component. For example, while making a machined component some material has to be removed in the form of chips. Quite often, while manufacturing any component some dimensions are not maintained and the lot is scrapped as these cannot be used in the assembly of the product.
255

B. Surplus When the project or product needs a specific quantity of the item, extra leftover cannot be used and this quantity is called surplus. The surplus quantity has to be disposed off. C. Obsolete When the item cannot be used in the product/ project due to changes that might have taken place in respect of dimensions, shape, colour etc, these are called obsolete items. Changes say occur due to defect in product design, or shelf life etc. These components have to be scrapped/ disposed off.
256

Wastivity of a System
Wastivity of the system is defined as the ratio of the waste to the input. Wastivity= Waste / Input Gross wastivity= Total waste generated/ Total input. All waste is not the waste, some part of it can be recycled. Net waste={Total waste generated}-{Waste recycled within the system}. Net wastivity= Waste which cannot be recycled/ Total

input. Wastivity assesses the productivity for each type of input. Both wastivity and productivity are complementary to each other.
257

Issues to be addressed
Quick identification of the waste generated. Separation of different types of waste. Economic reduction. Efficient collection and handling.

Recycling, and effective disposal without

affecting the environment. Designing a suitable programme.

waste

control

258

Recycling /reusing/ disposal of waste/ surplus/ scrap.

- Recycling refers to the use of bad quality outputs -

(rejects) or wastes as inputs to the same process or system e.g. reusing plastic scrap. Use the scrap for producing by-products. Transfer the surplus from one department to another. Sell the scrap/surplus as raw materials to other user factories, external agents, or even to the employees. Sell scrap through advertisement and auctioning. Return the surplus to the vendor, if possible. Donate rejected material to charitable organizations to gain social respect.
259

Week 08 B - Materials Management Information Systems and Computers

The efficient functioning of any organizational

system largely depends upon continuous process of information flow, in which information are received, stored, processed and exchanged. Such a system is the combined effort of the people, equipment used (hardware), processing facilities (software) and the procedures. Aimed at meeting the information requirement of the organization.

260

Information flow vs. Materials flow

Purchase Inventory Availability Integrated Materials Management System Checking

Order processing
Requirements planning Production planning Vendor registration Technical information

261

 In order to implement the integrated MIS, the system for recording and controlling of stocks, movement and flow of materials must be analyzed by splitting up information in such areas as under: - Materials, suppliers, components and/or parts list information.
- Capacity planning and manufacturing instructions.

- BOM explosion and materials requirement planning.

- Production planning and scheduling. - Purchase planning and procurement. The use of computerized information systems, makes it more data based which permits storage and retrieval of information .
262

Computer system for MIS and MM

MIS can be directed for use by different sectors of MM organization for controlling the materials flow

and planning for efficient use of materials for manufacture. The system takes into view the integrative concept of information flow, where each organizational entity is seen as system for information requirements with the components of input, processing and, storage, and output. Each is again connected with the other through the information and communication channel and thus each organizational entity becomes a decisionmaking point. 263

In-process Materials and Movement Control

Provides a reporting system on material

location and order status. Materials and order information necessary from the viewpoint of procurement to final distribution. Traditionally, almost all systems tended to be concerned with inventory levels, unworked, inprocess, semi-finished and/or finished goods inventories.
264

 Modern trend is to design systems that go well

beyond the in-plant material status and are concerned more with information that are related to procurement and in-transit order status. Also, though less frequently, the systems are designed to provide distributional system data. When the distributional data is brought within the scope of system and added to the in-plant and procurement data, the problem of material location and movement control, as well as order status control, get addressed.
265

 Data based on accurate information is only

useful when actions are taken based upon its analysis at the most desirable location and at the most appropriate time. In order to have an accurate information, any system must know: - Materials location points - State of the materials - Succeeding requirements - Availability of equipment as well as personnel required to take actions on materials, as and when they may be required.
266

 One of the major problems facing industries

today is the high rate of material movement and distribution costs. These are dependent more on accounting data collected from accounting and book-keeping functions rather than on operational data. The requirements of any material status, material location and order status control system can partly covered by the following information: 1. Information relating to (a) Event
267

(b) Location (c) Time (d) Quantity. 2. The data must be of value that can be converted into information for decisionmaking. 3. The data must be accurate and timely. 4. Consideration must be given to human factors involved in input information. Information systems must build maximum cost-effectiveness as well as operational efficiency.
268

Operational and Exceptional reports

The following operational reports emanate

from computers.
1. 2. 3. 4. 5. 6. 7. 8. 9.

Bill of materials Price forecasts Purchase budgets ABC analysis Inventory levels Items below safety stocks Movement analysis Material accounting and summary of issues. Stores accounting.
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10. Stock verification

11. Vendor rating 12. Categorywise material purchase list. 13. Outstanding payments. The following exceptional reports can be generated for managerial purposes. 1. Items for which consumption is more than the norms. 2. Items for which there is a supply shortage and anticipated price increase. 3. Items out of stock 4. Items with stock level above maximum norms. 5. Obsolete items.
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Ethics in Buying-code of ethics-problems

The fundamental principles are: - Loyalty to your organization. - Justice to those with whom you deal. - Faith in your profession.

Demonstrate loyalty to the employer by diligently following the lawful instructions of the employer, using reasonable care in exercising granted authority.
Avoid any personal business or professional activity that would create a conflict between personal interests and the interests of the employer.
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 Avoid soliciting or accepting money, loans, or

preferential discounts, gifts, entertainment, favours or services from present or potential suppliers that might influence, or appear to influence, supply management decisions. Handle confidential or proprietary information with due care. Promote positive supplier relationships through courtesy and impartiality. Avoid improper reciprocal agreements. Conduct supply management activities in accordance with national and international laws, customs and practices.
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 Key Questions for the supply manager How to minimize the organisations legal ands ethical exposure

To minimize own personal liability for purchase actions

Avoid legal disputes with the suppliers.

As a strategic player he must always be looking to maximize opportunities and minimize risk for the company. Buyer and seller will take resort to courts only as a LAST option By conducting the supply process in a ethical and socially responsible manner will help the organisation succeed
A Valid purchase order contract is based upon 4 factors: Competent parties Legal subject matter or purpose An offer ands an acceptance Consideration

Acceptance of the order implies accepting all the conditions therein

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 Situations may occur in which, through unanticipated circumstances, a business relationship

Recommended guidelines

transpires with a personal friend. The perception as well as potential of a conflict of interest should be discussed with management, and a reassignment of procurement responsibility should be considered. Business meeting locations should be carefully chosen. Environments other than the office may be perceived as inappropriate by the business community or by co-workers. Conversation that centres around excessively on personal affairs should be avoided.
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 Obtain the maximum value for monies expended as agent for the employer. Avoid using the employers purchasing power to make purchases for specific individuals nonbusiness

use. Conduct to be Avoided Engaging in business or employment in an organization that is a supplier to the employer Lending money to, or borrowing money from any customer or supplier. Using the organizations name (unless authorized) to lend weight or prestige to sponsorship of a political party or cause, or endorsing the product or service of another organization. 275

 Ownership of stocks in a supplier of goods or services should be reported to the employer for review to avoid the potential for impropriety. Interests by members of the professionals immediate family are considered to be of the same significance as direct ownership. How to deal with issues of influence? Exercise extreme caution in evaluating the acceptance of gifts and the frequency of the same. Establish nominal value in organization policy to address suppliers offerings of nominal value as a gesture of goodwill or for public relations purposes. Refuse gifts exceeding nominal value, and return them with a polite explanation.
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 Seek direction of management if it appears that business relationship may be impaired o appear to be impaired by refusal of a gift or entertainment. Occasionally, during the course of business, it may be appropriate to conduct business during meals. Such meals should be for a specific business purpose and frequent meals with the same supplier should be

avoided. The supply management professional should be in a position to pay for meals as frequently as the supplier. Budgeting is recommended for this business activity.
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International practices
In some cultures, business gifts, meals, entertainment are

normal and expected while in other cultures, business is transacted at arms length and business gifts, meals and entertainment are viewed as inappropriate. Supply management professionals must understand such variations and establish policies and procedures to deal effectively with suppliers from different cultures. Suppliers also should be informed of organizations policies with respect to business gifts, meals, and entertainment. Supply management professionals should act courteously to suppliers representatives who may inadvertently act contrary to organization's policies.

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Confidentiality & proprietary information

Confidential & proprietary information would include quotation/ bids, cost sheets, financial information, wage and salary scales, personal information about employees, officers and directors, product design, supply sources or supplier information etc.

It is the responsibility of the individual sharing confidential or proprietary information to ensure that recipient understands his or her obligation to protect such information.
Supply professionals are cautioned not to divulge such information unless it is required to be shared.
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Dealing with reciprocity

When supply management professionals or their organizations give preference to suppliers because they also customers or when organization influences a supplier to become a customer, the professional or the organization is engaging in a practice known as reciprocity.

Dealing with a supplier that is also a customer may not constitute a problem if, in fact, the supplier is one of the best sources. Supply professional should not get influenced by sales or marketing professionals to engage in reciprocity.
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List of suppliers should not be provided to sales or marketing department for their use in pursuing improper reciprocal arrangement. When making sourcing decisions, supply professionals must be especially careful when dealing with suppliers that are customers. Applicable laws Supply management professionals must be aware of the following laws: (a) Contract and commercial laws (b) Trade regulations (c) Government procurement regulations (d) Patents, copyrights, trademark laws. (e) Transportation and logistics laws and regulations (f) Environmental laws. 281

THANK YOU

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