Chapter four

Materials management

Part I: Introduction
Part II: Purchasing
Part III: Inventory control
Introduction
Materials management: the function responsible for the coordination
of planning, purchasing, transporting, storing, and controlling the
material in an optimum manner, so as to provide a predecided service
to the customer at a minimum cost.
Materials management deals with materials costs, materials supply,
utilization and its handling.
It is concerned with
 Part I: Purchasing
Meaning: the activity responsible for getting or
buying the right materials, tools, parts, store, etc.
 to the right place,
 at the right time,
 in the right quantity,
 in the right quality,
 with right procedure,
 from the right contract,
 from the right source,
 at the right price.
Functions of purchasing department
1. To purchase materials on properly authorized requisition
2. To place orders of the requisitioned goods with right suppliers
3. To obtain right type and quality of goods at cheapest price
4. To purchase right quantities in right time
5. To see that deliveries of all goods are received within time
6. To check that the goods are received in accordance with the orders
placed in respect of quality, quantity and specification
7. To advice the management about the economies of items as to
manufacture or to purchase
8. Studying the market condition and enter into rate contract with
suppliers to ensure availability of materials all the time
9. To study the various sources of supply and decide upon the most
convenient as well as alternate suppliers
10. To maintain the list of available and reliable suppliers
Functions of purchasing… cont’d
11. To keep the list of articles needed in the organization up to date
with their quantities for placing order
12. Preparing specifications, obtaining quotations and compare these
quotations for placing order
13. To ensure better relations are maintained with suppliers
concerning cost
14. To purchase all small value items directly, which do not require
quotations.
15. To assist purchasing agents, cooperate and guide them, and raise
the development and purchasing standards
Methods of purchasing
a) Purchasing by requirement
b) Purchasing for specific period
c) Market Purchasing
d) Contract Purchasing
Purchasing by requirement
This is known as hand to mouth purchasing
When the job is taken in hand only, then the required quantity of
materials for that particular job is purchased
Advantages:
i. market fluctuation will not affect the business,
ii. small storage space will be required
iii. Less inventory carrying cost
Methods of purchasing… Cont’d
Purchasing by requirement…
Disadvantages:
i. Distribution cost will be high
ii. Sudden demands cannot be met
iii. Bargaining cannot be held due to small amount involved
Purchasing for specific period
The standard items, which are regularly used are purchased in
quantities that will be sufficient for a particular future period
Advantages:
i. Production can at once be started as soon as the order is received
ii. Short duration market fluctuations will not affect much
iii. The involved working capital will be less
iv. Less storage space is needed
v. Cost analysis is easier
Methods of purchasing… cont’d
Market purchasing
 The reasonable requirements based on production planning are
calculated, market trends are analyzed and then purchasing is
done.
 Raw materials in process of manufacturing are purchased by this
method
Advantages: as purchasing is done in lot, distribution cost is less
Disadvantages:
i. If the market topples, there is big loss
ii. Large space is required
iii. Large capital is required
Methods of purchasing… cont’d
Contract purchasing
Contracts will be given for suppliers for large amount of future
requirements for certain period (say 2, 3 years)
i. Rate contract
 Rates are fixed for certain items of stock or component
part of products for certain period.
 No need of inviting tenders but rates are fixed by
analyzing the market trends by the purchaser.
 Any firm whosever interested in supplying the material at
these fixed rates for that duration can make the supply.
ii. Running contract
 The rates as well as quantity for certain period by buyer and
supplier is fixed
 As soon as the desired quantity is supplied by the supplier, the
contract is automatically terminated.
Methods of purchasing… cont’d
Advantages:
i. It avoids necessity for keeping stock
ii. It gives a measure of safety to suppliers
iii. The purchase is not affected by market fluctuations and the
supply is ensured
iv. Work load or routine work will be reduced and hence the
purchase department can pay more attention on the major works
v. It ensures quick purchase, because no time to be wasted in
calling quotations and finalizing the purchase.
vi. There is no change in price rate.
Methods of purchasing… cont’d
Central purchasing
Large concerns or certain big section-wise stores at different places
may be there and each section may have a separate store.
Advantages:
i. Since purchasing is made on large scale, it can obtain a good
bargain and the things will be cheaper.
ii. A strict control and check is possible. Therefore there will be a
little malpractices
iii. It can have a direct contract with manufacturers and can get
things as per specifications
iv. Suitable arrangement for storage can be made.
Possible problem: There may be delay in getting materials from the
central store but this may be minimized by supplying sufficient
quantities to sectional stores
Purchasing parameters (principles of purchase)
The following are the main purchasing parameters
i. Right time
ii. Right source
iii. Right price
iv. Right quality
v. Right quantity
vi. Right place of delivery/transportation- the place of delivery
should be clearly mentioned in the supply order
vii. Right procedure
viii. Right contract
Purchasing procedure
Following procedure is commonly used in medium size organization:
1. After receiving the purchase requisition, exact quantity of material to be
purchased and its specifications are decided
2. Prepare a list of suppliers who deal with the business of the items to be
purchased and are reliable
3. If the material to be purchased is of small amount and required
urgently, it may be purchased locally.
4. If necessary, prepare and issue NIT (Notice Inviting Tenders) to the
concerning suppliers
5. Open the tenders at prescribed time on the prescribed date and at
prescribed place
6. Prepare a comparative statement indicating the rates, terms and
conditions mentioned in the tenders, and then study them
7. If required, samples may be obtained from the firms, who have quoted
the lowest rates ( and or cost)
8. Place the purchase order to the firm selected after the study of samples,
rates, terms and other necessary conditions, mentioning the date by
which the materials must be received
Purchasing procedure… cont’d
9. Copy of the purchase order must be sent to the stores, to the
department who has sent the requisition, to accounts section and to
inspection department
10. A detailed inspection is carried out after the material is received. If
the materials is found to be satisfactory the bill of the supplier is passed
and the payment is made to the firm.
Introduction
 Inventories are assets of the firm/ industry and required
investment
 The inventories need not be viewed as an idle asset rather
these are an integral part of firm’s operation.
 Inventory control is the technique of maintaining stock
keeping items at the desired level, whether they are raw materials,
goods in process or finished products.
 Inventory control makes use of available capital in a most
effective way and ensures adequate supply of goods for production.
 Inventory control keeps track of inventory
 The balance between high level and low level can be done
by means of effective inventory control
 Cont’d
Thus the inventory control includes the following aspects:
i. Size of inventory: determining maximum and minimum levels
ii. Providing proper storage facilities, arranging the receipts,
disbursements (payment) and procurement of materials,
developing the forms of recording these transaction
iii. Assigning responsibilities for carrying out inventory control
functions
iv. Providing the reports necessary for providing the overall
activity
 Inventory control is concerned with achieving an optimum
balance between two competing objectives:
 Minimizing the investment in inventory (Inventory
cost).
 Maximizing the service levels to customer’s and it’s
operating departments.
 Cont’d
Precisely
Types of inventory
According to nature of materials, Inventory type can be grouped into:
i. Raw material (RM)/Production inventories (PI) :- are inventory items
that are used in manufacturer’s conversion process to produce
components, subassemblies, or finished products.
 It may be commodities or extracted materials that the firm or its
subsidiary has produced or extracted
 It may be objects, or elements that the firm has purchased from
outside organization.
 Assume the item is partially assembled or is considered as
finished good to the supplier, the purchaser may classify it as a raw
material if his or her firm had no input into its production.
 Typically, raw materials are commodities such as ore, grain,
minerals, petroleum, chemicals, paper, wood, paint, steel, and food items.
However, items such as nuts and bolts, ball bearings, key stock, casters,
seats, wheels, and even engines may be regarded as raw materials if they are
purchased outside the firm.
Cont’d
Levels Of Inventory (EOQ) (tools)
I. Minimum Inventory Level, II. Maximum Inventory Level, III.
Re-order or Ordering Inventory level, IV. Average Inventory
Level and V. Danger Inventory level (reserve stock)
i. Minimum Inventory Level
 Cont’d
Lead or procurement time involves the time taken by
the following activities:
 Requisitioning of materials,
 Quotations, scrutiny, negotiation and approval
 Import formalities, in case of imported items
 Placing an order
 Time taken by supplier for making the goods ready
 Transportation,
 Receipt of goods
 Inspection
 Taking the materials into stock
ii. Maximum Inventory Level
iii. Reorder or Ordering Inventory level
iv. Average Inventory Level
Functions Of Inventory Control
1. To ensure smooth production operation by ensuring timely
availability of material
2. To minimize capital investment in inventory by better use of
financial resources
3. To helps in minimising loss by obsolescence, deterioration,
damage, thefts, wastages, etc.
4. To protect against the uncertainties of demand and supply
5. To help managers in decision making better utilization of storing
capacity
6. Better utilization of storing capacity.
7. To maintain reasonable stocks of materials at all times
8. To facilitate regular and timely supply to customers increasing
customer satisfaction
9. To prepare accurate material reports.
10. To help in checking national wastage
Elements of a good inventory control system
The following elements are essential for a good inventory control
system:
Proper Co-ordination: There should be a proper co-ordination between
all the departments who use materials, such as purchase, store,
inspection, accounting, production department and sales departments.
There should neither be a scarcity of materials nor excess of material at
all the times
Proper Classification: Classification and identification of inventories by
allotting proper code number to each item and group should be done.
This facilitates prompt recordings, locating and dealing of materials.
Use of Standard Forms: Standard forms should be used so that any
information can be sent to all department uniformly.
Internal Check System: Audit should be done by an independent
party to check effectiveness of the inventory control system
Proper Storing System: Such facilities will reduce the wastage due to
leakage, wear and tear, sustained dust and mishandling of materials.
Proper Store Accounting: proper inventory records uses for quick
information on each items.
 Cont’d
Proper Issuing system: There should be a well organised issuing
system of material so that production process does not suffer.
Fixing of various stock Levels: Minimum stock level, maximum
stock level, re-order point, safety level, etc. should be pre-determined
to ensure the continuity of smooth production.
Determination of Economic order Quantity: Economic order
quantity should be determined to minimize the cost of inventory.
Regular Reporting System: The information regarding the stock
position, material quantity, etc. should be available to management
regularly
Process of inventory control
I. Process of purchasing of materials or ordering
II. Inventory storing process
 I. Process of Purchasing of Materials
1. Establishment of Purchase Department
2. Preparation of Purchasing Budget
3. Preparation of Purchase Requisition slip
4. obtaining the Tender or Quotations
5. sending Purchase order
6. Receiving and. inspection of Materials
7. Returning the Defective Material
8. Payment of Purchased Material
ii. Inventory Storing Procedure
1. Receipt of Material in Store
 The storekeeper receives the material along with the goods received
note from the receiving section
 The material are classified according to the nature of the material.
 The material should be arranged in bins especially meant for the
materials.
 A bin card is attached with each bin or rack displaying the
identification mark or code, minimum, maximum and ordering levels
of materials and receipts, issues and balance of materials in
hand, so that the exact position may be known at any time whenever
desired
2. Issue of Material from Store:
 issuing the material to the using departments with authorized
requisition slips by properly checked and scrutinized of it to avoid
over-issue of materials
 All requisitions must be posted daily on the bin cards and on the stock
control cards
 Cont’d
Generally three copies of requisition slips are prepared-first
Two copies are given to the stores and third copy kept with the
demanding department.
Store in charge keeps one copy of requisition slip for himself and
other copy is sent to accounts department.
3. Return of Material to Store
 If a department uses less materials than its demand, then it returns
the materials to stores with goods return slips with same
specifications and details of materials as were mentioned in
requisition slips.
 First two copies are sent to stores department and third copy is kept
by the goods returning department itself.
 Store keeper sends one copy to accounts department.
 The color of both requisition slip and return slips are kept different
to identify them easily
 Cont’d
4. Transfer of Materials (difficult process)
 The department transferring the material makes four copies of
material transfer slips.
 First copy is sent to the needy department along with material.
Second and third copies are sent to stores department and accounts
department for their information and further necessary action.
 Fourth copy is retained by the department transferring the material
 5. Material Abstract
Material abstract is a summary of materials received, issued and
transferred, for a given time period.
 In big industries where large quantity of materials are
received, issued and transferred daily, "material abstract" is prepared
weekly or fortnightly to control the inventory.
 A physical verification of quantity in stores and other
departments is done by material abstract
 If any discrepancy is found in physical verification of
quantity in store or other department, it is brought to the notice of top
management.
Cont’d
6. Periodical Checking of Materials
7. Physical Stock Checking of Materials
The possible reasons for discrepancy may be wear and tear of materials,
absorption of moisture, evaporation, waste, breakage, theft or wrong
recordings.
Inventory control systems
For the proper control of level of inventory, two issues are important:
i. Order quantity: the issue here is how much to order of each
material. This is also called “Lot-Size” or Economic order
quantity (EOQ)
ii. Order points: The issue here is when to place the order. It is also
called reorder point.
Based on these two issues, there are two inventory control systems or
approaches:
1) Q-system (2) P-system
Fixed quantity system (Q-system)
Inventory is continuously checked and a new order is placed when the
level of inventory reaches a certain point, called reorder point.
The order quantity Q is always constant and the order is placed
when the level of inventory reaches the reorder point.
This system is also referred to as reorder point system
The quantity to be ordered is determined by demand and cost
consideration.
The fixed order quantity system assumes that the demand for
inventories over a period of time is constant. Or usage rate of
materials is constant, i.e. lead-time for replenishment of inventories
is zero. ( materials are received immediately after they are ordered)
 Cont’d
Advantages
i. Each individual item can be purchased in its most EOQ.
Ii. Record of the current stock balance of each inventory item is
maintained
iii. Helps in preparing the pattern of demand data
iv. Most useful for low-valued inventory items.
Disadvantages:
i. Requires continuous reviewing of item and maintenance of
inventory balance records
ii. Each item is ordered at a different time . Therefore, economic
advantages of bulk-buying is lost
iii. System becomes difficult to operate in case the prices of items
and demand varies rapidly and continuously
The quantity is fixed.
Fixed Order Period System (P-System)
 Cont’d
Disadvantages:
i. Periodic review of all items is required
ii. Leads to peak purchasing workload around the review dates
iii. Inventory carrying cost are higher as compared to Q-system because
reserve stock maintained is usually higher in P-system as compared to
Q-system
Inventory Control Models (EOQ)
Three deterministic model:
1. MODEL-I (Basic EOQ)
2. MODEL-II(EOQ for LOTS)
3. MODEL-III (EOQ with Quantity Discount)
MODEL-I (BASIC EOQ)
Assumptions:
i. Annual demand, carrying cost and ordering cost for a material can
be estimated
ii. Average inventory level for a material is half of the ordered
quantity i.e. there no safety stock
iii. Stock-out, customer responsiveness and other cost have no effect
and
iv. Quantity discount does not exist.
MODEL-I (BASIC EOQ) … cont’d
Cont’d

Fig. Basic
EOQ Mode
Cont’d
MODEL-II (EOQ FOR LOTS)
 This model is useful to determine the economic size of
orders if the product is procure at one stage stored as an inventory,
and then transmitted to the customers
 In other words, when the rate of flow of the inventory is
greater than the demand rate, this model is most appropriate for
determining the size of lots.
 The major assumptions of this model are :
i. Annual demand, carrying cost, and ordering/procurement cost for a
product/material can be estimated
ii. No safety stock, goods are supplied ate uniform rate (P) and used
at uniform rate (d), and goods are entirely used up when the next
order begins to arrive
iii. Stock-out, customer responsiveness, and other costs have no effect
iv. Quantity discounts do not exist
v. Supply rate (p) is greater than usage rate (d)
Cont’d
Cont’d
Cont’d
 Cont’d
The figure of this model is

Fig. EOQ for Lots Model

The only difference in this model is that it is based on the assumption
that procurement (obtaining or attaining) and supplies are at a uniform
rate than they are in Model-I
MODEL-III (EOQ With Quantity Discount)
Cont’d
Inventory Control Techniques
Inventory control techniques represent the operational aspect of
inventory control management and help realize the objectives of
inventory management and control
 Always Better Control analysis is ABC analysis

ABC analysis
For large number of items in the inventory, so it needs essential
control system. However, greater care should be given to items of
higher value.
Certain manufacturing firms may consist of a small number of items
representing a major portion of inventory value and a large number
of items may represent a minor portion of inventory value.
In such cases, a selective approach for inventory control should be
followed
under A-B-C analysis, manufacturers, from their experience, the
materials are divided into three categories. i.e. past experience has
shown that
 10% of items contributes to 70% value of consumption,
category A
 20% of items contributes to 20% value of consumption,
category, B
 70% of items contributes to 10% value of consumption,
category, C
 Cont’d
More clearly,
class Number of Value of
items (%) Items (%)
A 10 70
B 20 20
C 70 10
 Cont’d
Application of ABC analysis
1. Information of items which require higher degree of control.
2. To evolve useful re-ordering strategy.
3. Stock records..
4. Priority treatment to different items.
5. Determination of safety stock items.
6. Stores layout.
7. Value analysis
 Cont’d
Benefits of ABC Analysis
ABC analysis enables the management to improve its materials efficiency by applying
the following eight methods:
1. Level of control: maximum attention should be given accordingly
2. Gradual delivery of material
3. Careful Accounting: Detailed records of goods ordered, received.
issued and goods on hand should be maintained for “A” category of items.
4. Safety stock: safety stock is kept by inventory controllers to take
care of variation in demand, particularly during larger lead time.
This is a must for 'A' as well as 'B' and 'C' category items used in producing an
assembled product.
5. Quantity Discount Factor: Clever suppliers may offer quantity
discount on the purchase of category A items.
6. Layout of Stores: Ready accessibility of fast-moving items is a virtue
of a good layout.
'A' category items are high cost items with a fast consumption and
categorized under F (Fast) as well as H (High cost) category.
 Cont’d
7. Stock-taking (counting items): Management by exception should be
applied to stock taking also. 'A' items may be checked more often than
'C' items. Check ‘A’ items every month, check ‘B’ items every two
months and check ‘C’ items every four months.
8. Value Analysis Projects: Value analysis is a cost reduction project
It is futile to carry out value analysis for 'B' and 'C' category items.
Inventory Costs
The classical inventory analysis identifies four major cost
components:
1) Purchase cost
2) Ordering cost
3) Carrying cost
4) Stock-out cost
Inventory Costs
1) Purchase cost-
is the purchase price for the item that are bought from outside, and the
production cost if items are produced within the organization.
This cost includes the expenditure made for:- during preparing
requisition, filling the specification, calling for vender, preparing
tender, etc
2) Ordering cost/set-up cost
It includes costs associated with the processing and chasing of the
purchase order, transportation, inspection for quality, etc., it is also
called procurement cost.
When units are produced within the organization, the parallel the
ordering cost is set up cost which refers to the incurred in relation to
Developing the production schedules, preparing resources and make it
ready for production, and so on.
Inventory Costs
3) Inventory Carrying Cost
Inventory Costs
4) Stock-out Costs - implies shortages.
If the stock-out is internal (that is in the production system), it would
imply that some production is lost, resulting in idle time for men and
machines, or that the work is delayed which might attract some penalty.
If the stock-out is external, it would result in a loss of potential sales
and/or loss of customer goodwill (loved by customers).
A shortages can evoke different reactions from customers. It would
result in a ‘backorder’ or a ‘lost sale’. In case of backorder, sales would
be delayed.
5) Warehousing Cost
This covers the cost related to product holding in warehouse.
Depending on the kind of warehouse – private, public, or contract -
there will be a cost related to the space occupancy, based on the
duration of storage.
Inventory Costs
5) Damage, Pilferage and Obsolescence Cost
The material stored carries the risk of damage, shrinkage, and loss of
weight.
The product also carries risk of pilferage or obsolescence due to
technology change or availability of substitutes (replacement).
6) Exchange Rate Differentials
In case of imported inventories, the valuation is done based on the
current currency exchange rates in the market.
Scope Of Inventory Control
Inventory control can be used for:
1. Determination of Inventory Policies
2. Determining Various Stock Levels
3. Determining Economic order size
4. Determining safety or Buffer stock
5. Determining Lead Time
 Summary
Purchasing:
Definition and parameters
Functions
Procedures
Methods
Inventory control:
Definition of inventory Inventory control systems
Types of inventory inventory control models
Levels of inventory Inventory Control Techniques
Functions of inventory Inventory Costs
Elements of inventory inventory control process
Processes of inventory scope of inventory control