Federal Cooperative agency, Cooperative Promotion and Regulation Coordination Core Pro.

The Federal Democratic Republic of Ethiopia Cooperative Agency

Materials Management Training Material for Cooperative Promoters

Cooperative Promotion and Regulation Core Process Coordination, Addis Ababa March 2009
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Federal Cooperative agency, Cooperative Promotion and Regulation Coordination Core Pro.

• •

Course Title: Materials Management Total lecture Hours: 21

• Course Objectives:
• To equip trainers with the knowledge and skills of the importance of materials management so as to mange the flow of materials within and from the organization demand, availability, price, supplier performance, quality storage and transportation are also given due emphasis in relation to cooperative enterprises.

• Lecture Schedule



Lecture Hours


Introduction to materials management Purchasing management Store management Inventory management

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Federal Cooperative agency, Cooperative Promotion and Regulation Coordination Core Pro.

CHAPTER - I Introduction to materials management Materials Management: An Overview Materials are the physical items that are needed for producing goods and services. Materials can be raw materials, components, sub-assemblies, parts, tool consumables, services, or any other type of item. Materials are one of the main inputs to a process, and typically account for 60% of costs. The significance of materials to the efficient operation of organizations is increasing more than ever. Shortages of raw materials, components, and products have been experienced on a global scale. With demand exceeding supply, the price of many materials has increased significantly. Every organization requires materials for its operation, and there will always be the necessity for some stores and stock to be maintained, either for immediate consumption, re-use, or conversion manufacturing organizations require a variety of raw and other materials that must be acquired, stored, and handled. Similarly service organizations need materials equipment, and some stores to run their operations. In both cases enough stocks of materials and equipment have to be maintained to meet at least short-run requirements. These stocks or inventory are cash in kind that need at most care. Therefore their safe custody, up keep and maintenance, handling and proper supply is of great importance. Almost all organizations, regardless of their nature, are demanding proper and efficient management of materials. Furthermore, both real and contrived shortage of materials, including foodstuffs, metals, and energy resources, have made materials management an important and difficult organizational function. The reason is that material; especially components and sub-assemblies have specific uses and have low flexibility. And they need more care in procurement, storage handling, and distribution. What is Materials Management? Materials management is concerned with the flow of materials from suppliers to a firm's store, to production department and the subsequent flow of products through distribution centers to the user. Materials management is, thus, an activity that involves planning acquisition, storage, control and disposition of inputs like raw materials and in-process goods which go into the production process directly and also capital equipment tools and accessories, spare parts and other indirect materials which are required for everyday operations. It is designed to ensure supply of materials of the right quality, in the right quantity, at the right time, at the right price, and at the right place acquired from the right source in order to ensure economy, efficiency, and smooth operation of an organization. Definition: ''Materials management deals with controlling & regulating the flow of material in relation to changes in variables like demand, prices, availability, quality, delivery schedules etc.'' '' Materials management is the planning, directing, controlling and coordinating those activities which are concerned with materials and inventory requirements, from the point of their inception to their introduction in to the manufacturing process. It begins with the determination of materials quality and quantity and ends with its issuance to production to meet customer's demand as per schedule and at the lowest cost. Essentially, materials management is the process of uniting the activities involved in the acquisition and use of materials employed in the production of finished goods. The Objectives of Materials Management/Functional objectives Poor performance may jeopardize any plant’s capacity to provide the goods and services that the society so urgently requires. The primary objective of materials management is thus to provide service
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Federal Cooperative agency, Cooperative Promotion and Regulation Coordination Core Pro.

and support to operating functions, mainly to production and operations, accordingly, materials management is established to achieve the following objectives. Purchasing and Procurement Materials should be purchased in required quality and quantity, at a minimum cost, and to be made available in time. However, as purchasing objectives vary in relative importance from one organization to another, one may concentrate efforts more on one rather than the other. When raw materials are available at a price, price objective is paramount. Here the key objective is to procure raw materials at a minimum price and such depends on intelligent timing of purchases. When the materials to be procured for the manufacture of some components and parts that are to be used in complex machines are scarce, timely availability dominates. Still in others such as aircraft and ship building industries, consistency in quality and reliability may be the sole criterion because of the complexity of the end products. Stores and Inventory Management Although inventory function is more complex, more subtle, and the balances of costs and gains is much more difficult to find out, one of the objectives of materials management is to have the correct quantity and right quality of material on hand at the time required. Keeping the right balance of inventory is important because when inventory turnover is high, storage and carrying cost are low. Sometimes, however, inventory turnover may be the turning point because we stock not because thousands of spares and parts go to make a complicated machine but because we keep them ready for after sale customer service. Here striking a balance between stock-outs and built-in- inventory becomes the most important materials management objective. The objective of stores and inventory management is achieved by proper receipt and inspection of materials, issue and dispatch, storage and storekeeping, stock records and stores accounting, identification and coding, materials control, handling and traffic, and disposals of surpluses, wastes and obsolete materials. Continuity of Supply In automated processes where costs are rigid and are not easily amenable to reduction due to lack of production materials, continuity of supply is of paramount importance. This fore shadows all other objectives, because idle time costs of men and machines push up overall costs of production and expediting supply means additional transport costs. Quality of materials Where quality of materials presents cost plus production engineering problems, it may well become one of the prime objectives of materials management, where other objectives are sacrificed at quality cost. Good supplier relations Good supplier relations greatly depend on the product or service reputation of the company. However, suppliers respond favorably to fair treatment, they are uncooperative and unwilling if indifferently treated. The materials management can thus improve relations by providing the required stimuli and reward for their better performance. Product development and new products The discovery and improvements of materials frequently leads to new products development and lower costs on existing products. Materials and components that will do better or equivalent jobs at a lower cost. Product efficiency is basically a compromise between engineering design and economic objective of management. Again a program designed to find ways and means of utilizing the by products or wastes is always profitable and materials management can render substantial help by
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It has significant potential for increasing company profits or social service. adding new products to the existing products-line. Many companies rank customer service second in importance only to product quality. Therefore by analyzing and interpreting data of past sales. but each manager recognizes that future success in the organization is dependent upon the achievements of her or his own department. production and inventory control. the other trying to prevent materials form accumulating ahead of production.Federal Cooperative agency. materials managers “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 5 of 40 . they fail to cooperate with other groups in order to achieve their own immediate objectives. John J. materials management is responsible for minimizing operating costs or maximizing company profit or improving customer and social service. machines and materials). Davin discusses the problem of conflicting objectives as follows: There is a natural tendency for functional. departments purchasing. In a fragmented materials organization.to look in ward to accomplish their objectives. demand and requirements fore casting.” iii) Interaction of individual manager objectives Every manager is responsible for meeting the overall objectives of the organization. Materials management has intimate knowledge of the market conditions through daily contacts with suppliers. individual supervisors concentrate on the immediate objectives at the sacrifice of long-term goals. Through coordinated control of resources. The purchasing manager prepares his budget. Lowering transportation costs as a result of using minimum cost shipping methods. Likewise the inventory manager is expected to improve turns in order to make his profit contribution. Materials management is a natural solution to the dilemma. Cooperative Promotion and Regulation Coordination Core Pro. Without coordination these two managers may end up working against each other-one trying to bring materials into the plant on a volume basis. A common saying is that "the customer is the king. seasonal variations in prices. Instead two managers reporting to different supervisors with dissimilar goals. it helps to forecast the future trends and plane material requirement accordingly. 1) Benefits of Materials Management The major benefits or materials management are described below. Lowering purchase prices and total acquisition costs through the use of quantity buying and other techniques. Like any other organization function. whether it a profit oriented company or a non-profit organization. Reducing materials obsolescence through greater control of inventory. Besides materials management can also help in price. ii) Improved customer service Customer service can be defined as a customer-oriented company philosophy that integrates and manages all elements of customer relations within a predetermined optimum cost-service mix so as to build goodwill. i) Maximum Company profits or Minimum operating costs. and physical distribution. Cost reduction can be achieved by the following means: Decreasing parts shortages (resulting in more efficient use of labor. iv) Improvement of resource control A goal of any organization. is control of the organizations resources. availability and demand for materials. and objectives each year and is held accountable for his accomplishments. plans. a materials manager becomes the sole decision maker for materials as they flow through the organization. Reducing inventory levels through improved controls.

All of the materials sub functions are interrelated. overtime hours and improved facilities. Also. Materials: . Money: . efficient scheduling of machines. Materials Planning and inventory control: . As the same every effort must be expended to provide optimum use facilities by efficient operation control techniques (i. individuals within each group have less chance for broad development. Inventory control may be responsible of controlling thousands of items.Control of materials is crucial for any organization with a materials management function. engineering. and the routing of the materials to the place of use or storage. The materials group tries to achieve optimum inventory turnover and minimum inventory levels while maintaining fully supplied company operations. Usually with a fragmented materials management organization. overall production plan. e. Generally these resources are grouped into the fours M'S: Materials. Planning must be an ongoing activity to assure capacity availability when required. and issuing requisitions to the purchasing department.This is the aggregate planning of material requirements to meet the broad. the preparation of reports.Materials management provides a systems-oriented structure of minimizing monetary expenditures and controlling the management of money. Duplications are not unusual in records and data. reducing total cost of procurements. Personnel can be rotated and promoted between the sub functions. The need for new buildings and equipment can be eliminated or minimized big effective control of operations. Machines (Facilities): .Capacity requirements planning.Federal Cooperative agency. but as members of an integrated materials organization have a great opportunity to gain knowledge of the various areas. It also involves keeping detailed records of parts and production inventories and non-production materials-such as expendable tools. and this control relates to all areas. the identification of such material. and Money. maintenance and any other department or function requiring materials. Machines. Manpower: .Purchasing department has the responsibility of acquiring the kinds and quantities of the right quality materials authorized by the requisitions issued by Production scheduling. instituting effective programs for measuring and controlling the various sub function activities.The receiving department is responsible for the physical handling of incoming shipments. successfully contribute to overall company objectives. Cooperative Promotion and Regulation Coordination Core Pro. In many companies the materials management organization decreases monetary problems by minimizing inventories. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 6 of 40 . duplication commonly occurs when many people in the company are expediting orders. Manpower. Material lead times can be shortened with good communication among materials sub functions. The purchasing group is responsible for procurement of materials to provide on-time deliveries. and the overlap of activities inevitably contributes to repetition of efforts. diminishing costs of materials handling and physical distribution. Functions included in Materials Management The following are typical functions of Materials management Purchasing: . thus preventing costly disruptions in operations. the verification of quantities. Greater control of materials will reduce obsolescence. office supplies and maintenance of physical stocks. Receiving: . inventory control. in which each group maintains its own information.No Company can grow or prosper without capable people. planning can contribute significantly to the maximum use of company capacity). for both the short term and the long term will develop new facilities needs. v)Reduction of duplicated efforts A fragmented materials organization has a natural duplication of activities built into it. manpower.

efficient and profitable disposal of scrap surpluses. Pitfalls and Problems of Materials Management The following review of pitfalls and problems of surrounding materials management programs can help managers. materials management is responsible to protect the environment from pollution. Maintenance department must keep its equipment in good operating condition long beyond what could be considered “ beyond economical repair’’. Records must be maintained which enable immediate location of items. No one should presume that because a company has established a materials management fully understands the principles and functions involved. Material handling and maintenance: . Management requires extensive education and understanding regarding the program's philosophy. Stores: . avoiding the effort “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 7 of 40 .This functions physically controls and maintains all inventory items appropriate physical safeguards must be established to protect items from damage. Material requirements determined by production control are checked against the inventory records before requisitions are sent to the purchasing department. Improved education and cross-training personnel within the materials organization have alleviated this problem. obsolete. to cope with such situations Lack of qualified managers Capable managers with broad experience and knowledge of various materials sub functions generally have not been available. Lack of credibility The performance of the materials function might be criticized for two shortcomings: trouble avoidance and opportunism. and waste materials generated within the firm. It also includes the transportation of materials from their point of recent or storage to the point of usage. Traffic: . In addition to the desire to obtain good value for disposals. unnecessary subsloescence due to poor stock rotation procedures etc. What it is and what it is not. The trouble avoidance context is the more familiar one: many people inside an organization are inconvenienced to varying degrees because the materials function. This is especially true of the time needed to successfully implement new functions. Programs can achieve only mediocre success without executive level support. which required and produced a shotgun approach disorganized management looked for immediate solutions at the expense of planned improvement followed by the innovations of new systems. Cooperative Promotion and Regulation Coordination Core Pro.Material managers are concerned with the effective. More efficient distribution and smoother workflow are some of the results of efficient handling. maintenance of materials is also included in the group of the functions of materials management.Federal Cooperative agency.Materials management concerns itself with the physical movement of materials from their original source to their point of use. Management must understand the full requirements of instituting a total materials programs. This is especially true in establishing a new organization. Failures have been traced to a desire for immediate results. Insufficient upper management support The success of an integrated materials management program is dependent upon upper management's understanding and continuous support.Transportation costs have an increasing influence on material costs in recent years Traffic is responsible for transporting various materials from suppliers’ stores to a firm’s stores. Scrap and Surplus Disposal: . Improper planning and implementation Ineffective planning and implementation can destroy programs. Desire alone or the use of a new life for an unchanged organization will not ensure success.

etc. big or small. and activities involved in the acquisition of goods and services in exchange for money. gift. Buyers who acquire materials for resale are known as merchants. Operation supervisors are unhappy because of frequent part shortages machines and employees are idle because of poor scheduling.Federal Cooperative agency. such as. and what components or parts should be purchased from outside suppliers. mass-distribution and mass consumption the function of purchasing has also grown into complexity with the recognition of the fact that industries depend to a great extension a steady flow of materials supplied by others. required or providing in accurate information does not meet minimum expectations. and not an end in itself. Finance The capital acquisition and financial record function. marketing is repeatedly called by customers whose orders were not shipped on the date set by materials management. states. In such situations. business or non business. 1. and the cost of purchasing is a major component of the cost of the final product. Industrial buying is more complicated than buying for resale because industrial buying requires the involvement of many People in the organization. our detailed discussions are directed towards purchasing which involve the acquisition of materials and services in exchange for money. production. Purchasing can be carried out for resale or for consumption or conversion. With the growing complexity of modern industrial organization for mass-production. that involves exchange transaction. what manufacture. CHAPTER II Purchasing/procurement management The Role and Scope of Purchasing All organization. marketing engineering and so on. Cooperative Promotion and Regulation Coordination Core Pro. they integrate the efforts of their departments with those of other departments of the firm including finance. Country. Finance and engineering complain about materials management not meeting commitments. Purchasing managers who buy materials for internal operation or conversion are called industrial buyers. Regional administration etc. depend to a varying degree on materials and services acquired through a group of activities known as procurement. aid. All businesses operate by coordinating and integrating these six main functions. Or the function will opportunistically satisfy only requests that can be resolved easily. Creation The idea or design function 2. etc. Procurement thus includes purchasing and other means of acquiring that do not require exchange transaction however.) and government buyers (City. policies. Goods and services may be acquired through purchasing. Personnel The human resources and labour relations function “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 8 of 40 . other groups within the company should be able to reply upon the information it provides. Industrial buyers participate in determining what products their organization should make. The Place of Purchasing in Business Purchasing is one of the basic functions common to all business. 3. School Hospital. The materials organization must establish a record of dependable performance. or other means of procurement. It should be noted that institutional buyers (College. They correlate their purchasing actions with sales forecasts and production schedules they select suppliers from whom purchases can be made on continuing and mutually profitable basis and most important. Purchasing is a management function that consists of all the decisions. It should also clearly understand that purchasing is a supportive function to production and other user departments and is only a means to a given end.) are included in the definition of industrial buyers.

Good supplier relations are invaluable because they are the chief sources of information for a firm and suppliers naturally direct their research. Distribution The marketing and selling of goods produced. Cooperative Promotion and Regulation Coordination Core Pro. quality and service. To keep inventory investment and losses (due to deterioration. its goals its economic circumstances. 4. and give better service to their permanent customers. or if they are too late behind the production schedule. causing a shutdown of a production line on the other hand. By its very nature. For business to successful. 5. Maintain the organizations competitive position. and services. An organization will be competitive if only it can control costs in order to protect profit margins. A buyer who purchases silver when copper could perform the function just as well is not buying wisely. all its individual parts must be successful. analyze vender capabilities and select the appropriate supplier who is responsible for the uninterrupted provision of materials at a reasonably minimum cost. 5. give advance information on new products and prices. To buy competitively involves keeping abreast of the forces of supply and demand that regulate prices and availability of materials. 6. To develop and foster good vendor relations. Their importance varies widely depending on various factors such as the type of business. which cannot be invested elsewhere resulting in capital tie up. the right price may be a much higher than normal price if the item in question is an emergency requirement on which the buyer can not afford the luxury of adhering to the normal lead time. for delivery at the right time and right place from the right source (a vendor who is reliable and will meet its commitments in a timely fashion) with the right service (both before and after sale) and at the right price. More specifically the overall objectives of purchasing will be described as follows: 1. the purchasing function must be still performed. if the goods delivered are unsatisfactory from the viewpoint of quality/performance. Conversion The transformation of materials in economic goods. Purchase costs are the largest 2. materials. But inventory assets require use of capital. and how the enterprise operates to achieve these goals. However it should be clearly understood that all purchasing departments are not of equal importance to their respective organizations. purchasing is a basic and integral part of business management. For example a buyer who pays more for a product than a competitor is not buying competitively. Stock outs of raw materials and production parts would shut down an 0peration and be extremely costly in terms of lost production and inability to satisfy delivery promises to customers To buy competitively and wisely. 3. 1) The Objectives of Purchasing The standard statement of the overall objectives of the purchasing function is obtaining the right materials (meeting quality requirements) in the right quantity. The success of purchasing department greatly depends on its capacity to locate or develop vendors. pilferage. To support company operations by providing with an uninterrupted flow of materials supply and services. It is not efficient to buy at lower price. to buy wisely involves a constant search for better values that yield the best combination of price. To find or develop reliable and competent alternative sources of supply. It is impossible for any organization to achieve its full potential without a successful purchasing effort. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 9 of 40 . The purchasing decision-maker thus deals with these conflicting objectives and should attempt to obtain the optimum mix of the seven rights. Purchasing Acquisition of required equipment. 4. Depending on company’s size these basic functions may be supervised by a single manager or by individual managers for each function Regardless of how they are put in the organization structure and supervised. 6. at a practical minimum keeping too much inventory may assure an uninterrupted material flow. obsolescence.Federal Cooperative agency.

3. For example. 7. Purchasing must determine which trends are relevant to company operations and monitor and evaluate them. Environmental Analysis Environmental analysis consists of searching the environment for signals that may be early warnings of significant change. This requires understanding the needs of the other departments so that these needs can be translated into support actions. not a profit contributor. Cooperative Promotion and Regulation Coordination Core Pro. There are several reasons for this lag: 1. Purchasing is seen only as a clerical function 2. including: • • • • • • Threat to supply assurance Improper supplier selection for new products Problems with environmental or regulatory constraints Improper protection against potential company liability Lead-time uncertainty Price uncertainty For these reasons and others it is important to include purchasing in the strategic planning cycle. product revisions. meeting delivering commitments to the suppliers on which the success of any organization depends. and deletion or product line. Other research has indicated several issues pertaining to environmental analysis that must be studied: 1. Environmental analysis should consider supply. Essentially. The purchasing departments is required to support the other departments in one or more of its responsibilities it should be integrated and coordinated with the previously mentioned six functions of business so that the firm will successful in its operations. To develop policies and procedures which permit accomplishment of the preceding seven objectives at the lowest reasonable operating cost. The objective is to provide the firm with a larger degree of control over uncertain environmental forces. Day–to–day operating pressures leave little time for strategic thinking. both input side and market output side. There are substantial risks to not having the purchasing function included in the strategic–planning process. Purchasing must develop supply options to fulfill the company's needs. Management views purchasing as a support function. The purchasing function is responsible for assuring the smooth flow of materials necessary to enable the production of goods and services and provision of services as required. This is where contacts with key suppliers and reading of market journals in the specific field are useful. environmental analysis both internally and externally will lead to the formulation of commodity strategic–action plans. and 3. single element in the operation of a firm.Federal Cooperative agency. To achieve maximum integration with the other departments of the firm. a long-term contract for drills with a major manufacturer may help the wholesale buyer control an uncertain supply variable. 2) Purchasing Strategies Purchasing strategic role has lagged behind that of other departments. Effective strategic planning by purchasing requires that purchasers constantly scan their external supply markets and be aware of corporate plans for new products. 2. 8. Key Commodity Planning “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 10 of 40 .

If supply is ample and the purchaser is buying a standard product. Review lease versus purchase. and so forth. Provide supplier assistance.Federal Cooperative agency. Develop new supply sources. Develop international sources. Cooperative Promotion and Regulation Coordination Core Pro. 9. A sudden change in the stable market condition could push the purchaser into quadrant 3 (critical). The second category is a purchased commodity's internal substitutability. External Negotiate Critical Supply No substitutable Partnership assurance Safe Area Monitor Market Internal Substitutability Cost–reduction Explore Alternates Emphasis Substitutable Stable Unstable Supply–Market Stability Market Substitutability Matrix Strategic–Action Plans Many alternative strategies are available to the purchasing manager. Color-coding could be done in same manner. financial or technical. For non-substitutable products in a stable market. 10. Vertical integration internally 5. Review product redesign. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 11 of 40 . Strengthen inventory control. Cost reduction/substitutions can be freely explored. the buyer should constantly explore new–product alternatives and negotiate long–term relationships. as shown in Figure market stability refers to the degree that one feels supply is uncertain. such as number or color classifications. the purchaser must assure supply combining unstable market condition with a non substitutable product could lead to serious production stoppages. 2. The buyer has maximum flexibility on these commodities. one would receive immediate attention. From a strategic–planning view there is a need to categorize purchased commodities and services in a way that reflects market realities. The goal is to move commodities into the quadrant 1 position. red representing critical. Thus commodities would be classified into a 2x2 matrix. and unstable market condition may require long–term commitment. A climate that encourages creative thinking will help ensure that alternative courses of action are considered. 11. Develop long–term contracts. Realign supplier purchase patterns. Thus it would be much easier to formulate a hand–to–mouth buying strategy for standard off–the shelf items with short lead times. 6. if one is purchasing a special electronic component (CMOS device) on which no substitutions are allowable. and green routine commodities. to assure availability. In a number classification. 4. Specific supply strategies include: 1. Purchase products that are in stable supply and can be easily substituted offer maximum flexibility in planning. 3. Unstable markets also tend to produce larger price fluctuations than stable markets. Quadrant 3 requires purchasing strategies that assure availability and require constant monitoring. One of the authors suggests dividing commodities into two categories based on (1) market stability and (2) internal substitutability. Similarly. 8. not so critical but need monitoring. 7. Part ownership of suppliers. Encourage supplier stocking. the supply market is stable. For example.

Cooperative Promotion and Regulation Coordination Core Pro. Purchasing policies-characteristics • Policies limit an area within which a decision is to be made and assure that the decision will be consistent and contribute to objectives. For the purpose of this course we shall discuss the policy area of centralization and decentralization. plans typically are modified. which will contain all the pertinent purchase practices. • Clarity and improve relationship with other functions • Promote supplier understanding and cooperation • Fulfill management and/or government's requirements. an evaluation needs to be made to determine if plans were in fact met. complete. Then manuals will then be distributed to purchase personnel and other users. 15. Improve supplier quality control. Purchasing policy areas Purchasing policies may be developed for more than 10 areas and form a very general to specific one.Federal Cooperative agency. Purchasing policies a. revised. Stockpiling. steps must be taken to implement them. Centralization versus Decentralization “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 12 of 40 . After evaluation. and concise concrete and objective manner. 13. They should prepare a purchasing policy and/or procedure manual. Some of the areas in purchasing which require policy formulation are: • • • • • • • • • • • • • • • • Centralization VS decentralization Back orders Bid evaluation Buyers' assignments Cancellation & claims Capital purchase Cash discount Change orders Competitive bidding Conflict of interest Consignment purchase Personnel purchase Foreign purchase Inspection Insurance Interplant transfer • • • • • • • • • • • • • • • Blanket ordering Invoice approval long-term agreement Patents Petty cash orders Samples Advance payment Sole sourcing Speculative buying Supplier evaluation Supplier relations Supplier selection Terms and condition Verbal order Trial order Organizations should write their purchasing policies in simple. Material substitution. etc. Strike hedging After strategic–action plans are formulated. 14. 12. Purchasing policies: Meaning and characteristics Purchasing policies are general statement of undertakings which guide or channel thinking and action in carrying out purchasing transactions and objectives in an optional manner. Implementation involves actions such as developing a new supply source or consolidating the number of suppliers. taking into account market conditions and environmental changes. Finally. or extended.

It has either to invest capital to manufacture the materials required by the firm or use the external supply source. rewarded. It also results in unified procurement policy. 5. Every industrial organization has two primary sources of supply.Federal Cooperative agency. 8. sources of supply. on time delivery. Quantity discounts are made possible by combining the requirements of different department for the same and similar materials. for shipments can be made in carload quantities. More effective inventory control is possible because of company wide knowledge of stock levels material usage. marketing. If the right supplier is selected. It may also be faster because departments directly place orders. Cooperative Promotion and Regulation Coordination Core Pro. markets and prices. then competitive pricing. When a firm uses a decentralized purchasing policy. When used properly. 1. The extent to which the efficiencies functional specialization is realized when a firm creates a purchasing department depends largely on the authority delegated to that department. reliable quality. thereby facilitating management control. 3) Supplier Selection a. centralized purchasing results in the following benefits.e. they decide on sources of supply. Transportation savings are realized by consolidation of orders and delivery schedules. 2. engineering. And by making periodical evaluations inefficient suppliers should be eliminated and new efficient supplier should be developed. 6. Duplication of selling effort is minimized. 3. Centralization exists when the entire purchasing function is made the responsibility of a single department or person. This topic concerns itself with the second alternative-external source. finance. It reduces record keeping and at the sometime record keeping is made significantly more effective. good technical service and other goals of purchasing are more likely to be achieved. available and new materials and manufacturing processes. 4. The advantage of decentralization is that users know their departmental needs better than anyone else. A full time buyer who can devote undivided attention to purchasing will rapidly develop expert knowledge of purchasing techniques. and motivated. lead times and prices 7. individual departments production. Sourcing One of the responsibilities of purchasing is to establish and maintain a satisfactory group of suppliers because it is impossible to run a high quality business operation without satisfactory suppliers. or perform and other major function of purchasing. However the buyer has work to do that a good supplier must be assisted. It enables lines department managers to devote full time and effort to their basic responsibilities. 9. Supplier Relations “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 13 of 40 . Centralization of purchasing refers to the degree of delegation of purchasing authority rather than to the location of buying personnel. Duplication of effort and haphazard purchasing practices are minimized by the central coordination of a firms' purchases. The advantages of centralized purchasing are so great in comparison with decentralized purchasing that almost all large firms are centralized. Selecting capable suppliers is one of a purchasing manager’s most important responsibilities. Responsibility for the performance of purchasing function is fixed with a single department head. i. negotiate with vendors directly. Centralized purchasing enables the development of specialization and expertise in purchasing decisions and operations. This development of expertise is the primary reason why almost all firms have gone to centralization of the purchasing function. and personnel handle their own purchasing. Suppliers are able to offer better prices and better service because their expenses are reduced.

therefore. The art to a good purchasing department is. therefore. Trade from suppliers. Filing of mailing pieces. evaluation of current sources is vital. service problems and any other legitimate requests the good suppliers takes the initiative in suggesting better ways of developing products and services which will allow customers to perform their operations more economically. New sources need to be screened and a selected list of suppliers is developed with whom the buyer may desire to negotiate or solicit bids. Cooperative Promotion and Regulation Coordination Core Pro. 3. competent buyers more correctly rely on their records. It will remain competitive on a continuing basis. Visits from suppliers 10. 4. 9. strikes and anything else that may affect the buyer’s operations. 2. Supplier’s information purchasing file. The good supplier warns ahead of time at material shortages. The evaluation of suppliers is a continuing purchasing task current suppliers have also to be monitored to see if expected performance Materializes since most organizations tend to place a significant portion of repetitive business with the same suppliers. It develops supplier goodwill by being open. Evaluating Potential suppliers Once a company has successfully developed a comprehensive list of potential suppliers. to find and keep top suppliers over time. His/her delivery service. which include: • • • • Name and address each supplier. changes in specifications. Trade registers and directors. Supplier catalogs.Federal Cooperative agency. A good or preferred supplier reacts to unforeseen needs’ such as accelerated or decelerated volumes of business. 7. it has to evaluate and rate each prospective supplier individually. Trade journals. 6. Sources of Information about suppliers Knowledge of sources is a primary qualification for any effective buyer. 5. delivery time. Good sources of supply. 1. General information concerning his plant and management. Good sources of supply are one assurance of good quality production today and progressive thinking and planning is a further assurance of improved quality tomorrow. Sales personnel. published material and personal contacts. The following information sources should prove helpful to a buyer in establishing a list of potential suppliers. service. 8. List of materials (including specifications) he can supply. A company develops customer goodwill by selling acceptable products at a fair price supported by good service with the customer’s interest in mind. an important company asset-like customer goodwill. Telephone directories (The yellow pages). important and scrupulously fair in all of its dealings with its suppliers. Visits to suppliers 11. Advertisements. Source of information concerning suppliers is plentiful. There are several types of rating systems as to price. It is not always easy to evaluate potential suppliers because it often requires an extensive amount of time and resources. A relevant Source of supplier information a list of past and present suppliers. based on statistically measurable criteria again no system can be of value unless it actually “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 14 of 40 . Although some buyers rely on memory and experience for knowledge of sources of supply. quality. etc.

To exert some control over the manner in which the contract is performed. negotiation must be utilized in its broadest context.Federal Cooperative agency. To obtain a fair and reasonable price for the quality specified To get the supplier to perform the contract on time. It includes both presale service such as installations and training of personnel post. for the sources of competition are used to bring their price down to a level at which the efficient vendor will only be able to cover production and distribution costs plus make a minimum profit. But sometimes it may not be possible or advantages to of effect competitive bidding for various reasons such as. 4. To develop a sound and continuing relationship with competent suppliers. Good service by the supplier is found to reduce the buyer workload. incoming inspections. Cooperative Promotion and Regulation Coordination Core Pro. Object of negotiation Five major objectives are common to all negotiations: 1.e. quality. A consideration of the location of the supplier is also important service. should also be rated. 2. etc. Technical Capabilities The capability of the supplier to provide engineering and design assistance should also be evaluated the capability to handle special needs and contribute to improve product efficiency or basic service and the strength to go with new technological advances are also very important factors to be considered. and diminish the uncertainty associated with the buying decision.sale services such as maintenance and other technical assistance. i. as a decision making process of planning reviewing. An effective supplier should be capable of offering related product and helping to reduce acquisition costs through personal visits. 5. Packaging and materials considered in vendor rating. discussing or bargaining to reach agreement in business transactions. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 15 of 40 . increase the usefulness or availability of the product. financial stability and strength are also indicators of good management and reliable competitive ability. rejection of defects. Negotiation Negotiation may define as conferring. potential sources the most common factors are stated below reliability of the vendor. To be fully effective in purchasing. It also includes the availability of stocks locally or at short notice to effect emergency orders. absence of not more than one competitive. The supplier’s competitive strength as to price. etc. To persuade the supplier to give maximum cooperation to the buyer’s company. The financial strengths and weaknesses of a supplier obviously affect its capability to respond to the needs of customers. Delivery Performance This refers to the ability of the potential supplier to provide materials on the scheduled time. telephone calls. spoilage. Stability and reputability are also other factors to be considered in rating the reliability of the vendor Finally. 3. Vendors. and analyzing used by a buyer and seller to reach acceptable agreements or compromise. Fair and Reasonable Price Competitive bidding is the most efficient means of obtaining a fair price for items bought. However the evaluation of the vendor should focus not only on current capability but also on the vendor’s future strength.

When used alone. increase price. and in some cases completely disrupt. When a buyer is contracting for a portion of the seller’s production capacity rather than for a product the seller has designed and manufactured. For this reason. When to Negotiate Negotiation is the appropriate method of purchasing when competitive bidding is impractical. which permit buyers to take unfair advantage of sellers invariably with time. Delivery Schedules Inability to meet delivery schedules for the quantity and quality specified is the single greatest supplier failure in purchasing operations. which will assure compliance with the quality. many high value industrial and government contracts fall in to this category. Supplier Performance Deficiencies in supplier performance can seriously affect. or to assure quality. pleasant working relations. He then negotiates with the two or three vendors who submit the best bids. and cooperation from their customers. some of the most common circumstances dictating the use of negotiation are: 1. A supplier with a large backlog of business is simply unable t schedule or expedite orders. timely payment. the operations of a buyer’s firm. 2. and service terms of the contract supplier cooperation. Continuing supplier Relationships When negotiating with suppliers. Supplier cooperation is best obtained by rewarding those who perform well with future orders. a buyer should recognize that current actions usually constitute only a part of a continuing relationship. Negotiation is the most sophisticated and most expensive means of price determination. it is important that buyers negotiate delivery schedules which supplier can actually realistically meet without endangering the other requirements of the purchase. with the reliability of supplier who has available production capacity. delivery. however. the buyer first attempts to get a reasonable number of competitive bids. When many variable factors bear not only on price. When competitive bidding is used in conjunction with negotiation. It is the most difficult of all the contract terms to be negotiated –Negotiation may be used alone or in conjunction with competitive bidding is used in conjunction with competitive bidding to determine price. jeopardize quality. on the hand their interest in the supplier’s long. Buyers should know with certainty that a supplier’s plant is not overloaded and that its production is not running behind schedule. which allow sellers to hold up buyers. Cooperative Promotion and Regulation Coordination Core Pro. In addition to subsequent orders. For this reason the buyer must realize that any advantage not honestly won will in all likelihood be recovered by the supplier at a later date thus. an important contracts buyers should negotiate for controls. buyers must maintain a proper balance between their concern for a suppliers immediate performance. as a matter of self-interest. but also on quality and service. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 16 of 40 . change to conditions.run performance on the other. Because unrealistic delivery schedules reduce competition. it should be preceded by cost and price. good suppliers also expect courtesy.Federal Cooperative agency. In such cases the buyer designs the product and assumes all the risks of salability and specifications. Even when these conditions cannot exist buyers too often prefer to negotiate with their suppliers concerning delivery schedules. This is often caused by inefficient material planning and failure of buyers to plan the delivery part of negotiations properly. Negotiating conditions. quantity.

Cooperative Promotion and Regulation Coordination Core Pro. Description of the desired need No purchaser can be expected to buy without knowing exactly what the user departments want. At best an inaccurate description may result in some loss of time. the commodity. The purchasing department is responsible of helping to anticipate the needs of user departments. Recognition of the need Description of the need Flow of purchase requisition Determination and analysis of possible sources of supply. The division of special tooling costs between a buyer and a seller is subject to negotiation. When a long period of time is required to produce the items purchased. The person responsible for a particular activity should know what the individual requirements of the unit is-what. Also opportunities for various improvements develop-for example. does. new plant layouts and evaluation of all these potential improvements. This may result in a material requisition on the stores department. When tooling and setup costs represent a large percentage of total costs for many contracts. 8. the purchasing department should inform user departments about price trends. 4. or the service. gauges. substitute materials. but also that requirements be anticipated far enough in advance to prevent an excessive number of rush orders. which is required. and any other major changes for all standard purchased items. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 17 of 40 . Under these circumstances suitable economic price adjustment clauses must be negotiated. molds. must be negotiated to prevent unreasonable dictation by the seller. 5. The purchasing manager should urge not only that the requirements be as nearly standard in character as possible and that a minimum of special or unusual orders be placed. 6. Also. fixtures. 4) Purchasing procedures The acquisition process is closely tied to almost all other functions included in an organization and also to the external environment. 9. Preparation and placement of purchase order Acknowledgement and follow-up of the order Receipt and inspection of materials Auditing the invoice and payment of the supplier Maintenance of records Recognition of need The need for a purchase typically originates in one of a firm's operating departments or in its inventory control section. hard feelings internally. Terms and prices therefore. creating a need for complete information systems. competition is totally lacking. because of their special nature. and loss of supplier respect and trust. 7. For this reason. at worst it may have serious financial consequences and cause disruption of supply. the article. new packaging possibilities. these materials are primarily limited in use to the buyers contract. However. 3. 3. In this case. it is essential to have an accurate description of the need. 4. 5. the supplier must either make or buy many costlyjigs. etc. When the products of a specific supplier are desired to the exclusion of others.Federal Cooperative agency. Any questions regarding the accuracy of the description and specification of the materials should be referred back to the requisitioner and should not be settled unilaterally in the purchasing department. how much and when it is needed. 2. A purchasing department buys many different types of materials and services and the procedures used in completing a total transaction normally vary among the different types of purchases. general market conditions. the general procedures followed in sound purchasing systems are outlined below: 1.

The essential information. It is important for the purchasing department to establish definitely who has the power to requisition or authorize.Federal Cooperative agency. and transferred to the purchasing department a buyer begins the investigation of vendors to select a source of supply. includes the following: Date Serial number (identification) Originating department Budget account to be charged Description and quantity of the material Date the material required Any special shipping instructions Signature of authorized requisitioner Flow of the purchase requisition The user department generally makes a minimum of two copies. which every requisition should contain. however. the buyer may employ the techniques of competitive bidding or negotiation or both. The purchase of a new or a high-value item may require a lengthy investigation of potential suppliers. described. Competitive bidding is a discussed form of purchasing. The original is forwarded to the purchasing department and the duplicate is retained in the requistioner's file. or the date would involve additional expense. After selecting a preliminary group of potential sources. The terms used to describe similar materials should be uniform. requests for bids are traditionally sent to three to eight vendors. If insufficient time is allowed. Determination and analysis of possible sources of supply As soon as a need has been established. if necessary and to execute the purchase order and obtain delivery. When competitive bidding is used by private industry. This uniformity can be achieved by maintaining a file listing the articles usually purchased. Supplier selection constitutes an important part of the purchasing function. and it facilitates accounting the stores procedures. Purchase requisition formats vary widely because each company designs its own format to simplify its own particular communication problems. But government buyers generally are not able to restrict the number of bidders to only eight. depending on the money value of the purchase. and involves the location of qualified vendors and assessing the probability that a purchase agreement would result in on time delivery of satisfactory product and needed services before and after the sale. should they be the successful bidder. It is one of the basic methods by which price can be determined. Requests for bids ask vendors to quote the price at which they will perform in accordance with the terms and conditions of the order or contract. Under no circumstances should the purchasing department accept requisition form anyone other than those specifically authorized. All requisitions should be checked carefully before any action is taken. It is more often used by government organizations. Cooperative Promotion and Regulation Coordination Core Pro. Uniformity of description enables to standardize the materials requisitioned. The requested quantity should be based on anticipated needs and should be compared to economical purchasing quantities. The delivery date requested should allow for sufficient time to secure quotations and samples. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 18 of 40 . this should be brought to the attention of the requisitioner immediately.

Contract acceptance . which are unique to each contract. For this reason. Engineering drawings.Delivery performance and contract termination . The market consists of an adequate number of sellers. sampling plans and conditions of acceptance should be stated on the order. Preparation and placement of purchase order Once a supplier has been selected. as the best method. The proper use of competitive bidding. therefore. any other important factor affecting the acceptability of the product should be precisely stated. It should be emphasized that in most cases the purchase order becomes a binding contract if it is accepted by the supplier. As discussed earlier in detail. Accordingly.invoicing and payment procedure Most firms prepare their purchase orders on multipart snap-out forms.Warranties . to both buyer and seller that accompanies this method of pricing. Quantity requirements. the purchasing department issues a serially numbered purchase order. which enable competitive bidding to assure the buyer of obtaining the lowest possible price. government buyers are routinely required to give the order to the lowest bidder. The money value of the specific purchase is large enough to justify the expense. Under competitive bidding.Shipment rejections . the purchasing department should take great care in preparing and wording the order. industrial buyers generally. These multipart forms provide enough copies of the order to satisfy both internal and external communication needs. provided the lowest bidder is deemed qualified to perform the contract. By law. is subject to the following criteria. Cooperative Promotion and Regulation Coordination Core Pro. These terms are legal protections to the buyer concerning: .Compliance with legal regulations . In addition to those provisions. quality of work and other relevant factors are also considered in rating and determining the best source of supply.Assignment and subcontracting of the order . Similarly. price. the bids are reviewed in terms of prices. reciprocity. and quality specifications must be described accurately. The reliability of the supplier. The order should include all data required to ensure a satisfactory contract. The specifications of the material or service to be purchased are explicitly clear to both buyer and seller so that the seller knows the cost of producing the item or rendering the service. are willing to price competitively to get it. In the event sampling inspection is to be used. discounts. after the quotations of the prospective suppliers are analyzed. but not always. most firms also include as part of every contract a series of terms and conditions that are designed to govern the relations between the buyer and the seller. and obtaining the best price should be considered. and it should be worded in a manner which leaves little room for misinterpretation by either party. mailing.Federal Cooperative agency. These conditions are extremely important and the question of what should and what should not be included is the subject to a good deal of discussion. The time available is sufficient for using this method of pricing. In the case of Ethiopian government organizations.patent rights and infringements . delivery requirements. the minimum Birr value to use competitive bidding was birr 250. The sellers comprising the market are technically qualified and actively want the contract and. evaluation of bidders follows to select the best supplier. opening and evaluating bids. and shipping and delivery times. must be incorporated clearly by reference. give the order to the lowest bidder. if necessary. The time required for preparing. The minimum number of copies most commonly used is five: Original copy is sent to the supplier “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 19 of 40 .

the receiving clerk prepares a receiving report using the purchase order along with the packing list. If a supplier ships the ordered item immediately from stock.Third copy is sent to inventory control section for stock control purposes . A letter. - - Second copy informs the accounting department for use in checking and issuing payment for the seller's invoice. Purchasing bears full responsibility of order until the material is received. he frequently disregards the acknowledgement form. Cooperative Promotion and Regulation Coordination Core Pro. Original copy used by accounting department in reviewing the order for payment and settling the account . In the systems.Fourth copy is retained in the receiving department's operating record file. At the same time. the buyer tracks an order to assure that the vendor will be able to meet delivery promises and other requirements of the purchase order. The receiving clerk uses this packing slip in conjunction with his copy of the purchase order to verify that the correct material has been received. an appropriate follow-up date is often specified simultaneously. he can indicate whether or not he is able to meet the desired delivery date. Receiving uses its copy to identify and check the incoming shipment. and inspection of materials are of vital importance. Copy 5 remains in the purchasing department open order file and is often used for purposes of order follow-up and expediting. inspected and accepted. he includes in the shipping container a pacing list that itemizes and describes the contents of the shipment. Follow-up and expediting the order When an order is a vendor. At the time the order is placed. Receipt and Inspection The proper arrival. After a shipment has been inspected for quantity and for other general conditions of the contract.Federal Cooperative agency. When a supplier ships the materials as per order. acknowledging acceptance of the order. it can take one of two forms: (1) Performance of the contract or (2) formal notification that he accepts the offer Sometimes firms may prepare one additional copy of the purchase order that is to be sent to the supplier. Routine followup for the less critical orders is usually accomplished by mailing an inquiry or postal card to the supplier. After a purchase order has been issued to a vendor. Copy 4 informs the user department of the details of the order so it can plan its work and budget accordingly. Clearing the Invoices and Payment - “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 20 of 40 .Second copy is used by the purchasing department in closing out its working file of the order . Copy 3 advises the receiving department that can expect receipt of shipment at a particular date. or a visit to the supplier plant is typically used for most critical orders. Copies of the receiving are often prepared in four copies and their distribution is as follows. The purpose of sending the supplier an acknowledgement copy is two fold. follow-up communication with the supplier usually takes two forms. receipt. a telephone call. With the help of the follow-up copy of the purchase order. the responsibility of purchasing does not terminate with making a satisfactory contract. First it is a form he can conveniently complete and return to the buyer. Receiving report is usually accompanied by technical inspection.

The record need not be elaborate. immediate action can be taken by purchasing. and competitive quotations. which is an internal memorandum. In some firms checking and approval of the invoice is the function of purchasing. Purchase log. are not uniform. the following basic records are essential for the effective operation of most purchasing departments. and total orders issued. the returned acknowledgement form. and the invoice. If discrepancies exist. and if the receiving report and invoice agree. The log serves as a source of basic data without looking deep in to each file. the working copy of the order. a brief description of the material purchased. and the total value of the order. rush orders. Finally. File of closed orders. the invoice is retained in the purchasing department until it receives notification form the receiving department in the form of receiving report. Since the invoice constitutes a definite claim against the buyer. Procedures related to invoice clearance however. it needs to be handled with great care. Cooperative Promotion and Regulation Coordination Core Pro. the purchasing department keeps both documents until it receives assurance form inspection that the goods are acceptable. It also serves as a convenient record form which summary administrative data can be extracted concerning such matters as the number of small orders. Whichever procedure is followed. Most companies differentiate between the various forms and records as to their importance. Maintenance of records The next step is to close the order by completing the records of the purchasing department. a list of approved suppliers and their price lists. and so forth. the value of outstanding commitments. which identifies the supplier's name in a separate folder that contains purchase requisition. The prime reason for having invoices checked in the purchasing department is that this is where the original agreement was made. the purchasing department forwards the original receiving report from the receiving department and the invoice to the accounting department to effect payment.Federal Cooperative agency. Then it checks the report against the invoice. follow-up data. Although the unique needs of each purchasing department dictate the specific structure of its records system. File of open orders. and notes and correspondence that pertain to the order. By checking the receiving report against the purchase order. the volume of purchase form various suppliers. but it should contain the purchase order. which provide a historical record of all completed purchases that enable to provide with a historical data to guide future decisions. Every purchasing department should maintain a numerical record of all purchase orders issued. Besides it should indicate the open or closed status of each. This operation involves little more than assembling and filing the purchasing department's copies of the documents relating to the order and transferring to appropriate records of the information the department may wish to keep. the purchaser determines whether the quantity and type of material ordered was infact received. Commodity record. showing the description of all purchases of each major commodity or item with full reference to necessary engineering drawings and specifications. the supplier's name. A typical procedure involves a simultaneous review of the purchase order. For example a purchase order constitutes evidence of a contract with an outside party and as such may well be retained much longer than the requisition. the receiving report. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 21 of 40 . the invoice must be checked and audited. In cases where purchasing does the invoice checking the following procedure applies: after being checked and adjusted for any necessary corrections. Then by comparing the invoice with the purchase order and receiving report he verifies that the supplier's bill is priced correctly and that it covers the proper quantity of acceptable material. In others it is the responsibility of accounting department.

the purchasing department should not allow user departments to take unfair advantage of its emergency service. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 22 of 40 . When experience shows that the same supply items are ordered in small quantities time after time. systematic analysis and processing of orders is effected through the use of the purchasing procedures discussed earlier. They consist of those requisitions. for rush orders always cost more than if they were handled in the normal purchasing system. Similarly. Usually. The first involves a concerted effort to coordinate the activities of materials management. Only justifiable requests should receive this service. Sudden changes in style or design and unexpected market conditions may upset a most carefully planned material schedule. Every department executive tries to develop an orderly and systematic pattern of operation that efficiently uses the resources of that department. in a well-established and well-managed purchasing department. Clearly. vendor's delivery. Still another approach assesses the requisitioning department a predetermined service change for each emergency requisition processed. 1.Federal Cooperative agency. Sometimes. To hold small requisitions as received until a justifiable total in Birr has been accumulated. and the names of personnel to contact on specific matters of inquiry. There are rush orders that cannot be justified on any basis. the logical solution is to increase the number of standardized items requested and order these items in large quantities and place them in a centralized inventory for withdrawal as needed. Many approaches can be used to discourage and minimize the small order problem. and quality performance may also be included. which arise because of: a) b) c) d) Faulty inventory control Poor production planning and budgeting lack of confidence in the ability f the purchasing department to acquire materials at the right time The sheer habit of making the requests “rushes". Breakdowns seemingly are inevitable. no manager wants to devote more buying and clerical effort to the expenditure of ten percent of the funds than to the expenditure of the other ninety percent. In fact formal and proper training of personnel in purchasing procedures is also considered as a fourth factor to discourage unreasonable rush orders. The following are among the various methods a purchasing manager can use to minimize the small-order problem. purchasing is also required to issue periodic lead-time reports to production control for all major classes of materials. a sizable percentage of a company's purchases constitute a small percentage of the firm's annual purchase expenditure. Some companies require that realistic order points for inventory materials be established jointly by production control and purchasing. Thus. which it would be quite unreasonable to carry in stock regularly. However. Terms and routing instructions. Cooperative Promotion and Regulation Coordination Core Pro. telephone number. The following are the conditions in which we may not follow the general procedures of purchasing. Emergency and Rush Orders Rush orders cannot always be avoided because emergencies do arise which justify their use. necessary measures should be taken to discourage all rush orders that arise from poor planning in the using departments. Vendor history file. with a separate card for each supplier showing his address. Yet this is frequently what happens because the very nature of business requires the purchase of many low value items. 2. with an accompanying demand for materials. The second approach requires the requisitioner to obtain approval form a general management executive for all emergency requisitions. Small orders Small orders are a continuing matter of concern in every organization. There are three ways in which we can minimize unreasonable rush orders.

The store’s function must be managed and operated in a highly efficient way. CHAPTER III Stores management 1) Determination of Storage Needs and Storage Cost a. This order system helps to solve the problem for thousands of items a firm cannot carry in inventory. Still firms can also make use of the blanket or open-end order system. A big automobile factory can use hundreds of thousands worth of material each week. Some firms find it economical to make small-one-time purchases on a C. It is often less expensive for an individual user to buy minor items personally and pay for them form a petty cash fund. vast quantities of materials and component parts have to be provided every day large sums of moneys are involved and it is essential to organize the stores functions so that the investment is kept to the minimum. The main objective behind the stores functions is to render service to user departments. The Storage System Once Materials are acquired they neither directly enter in to production nor are provided to user departments immediately. the item number. 3. The blanket order typically indicates an estimated usage during the period of converge. The management of inputs and output flow will require a good deal characteristics and volume of transaction the reporting. for storage guarantees continuity of supply or uninterrupted service to user departments. and the quantity to be delivered. It also states that all requirements are to be delivered upon receipt of an authorized release form the buyer.Federal Cooperative agency. organized and operated in such a way that the life-time of each stock item is as short as possible consistent with economic operation. and verifying system should be devised. and issues a blanket order to each supplier. 6. materials specification. Most firms today use a petty cash fund for making small-one-time purchases. In a mass production unit. At the same time “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 23 of 40 . (cash on delivery) system basis in which materials can be ordered by telephone and paid for on arrival. 4. The only good reason for carrying operating stocks is that the material needed is obsolete redundant or surplus material is simply money sitting on a shelf requiring more money to be spent on its custody. From the stores point view the most important thing to keep the quantities of incoming goods as near as possible to the departments and the machine shops and assembly shops will use them daily. It is not unusual for an open order to remain in effect for a year. and should be planned. Cooperative Promotion and Regulation Coordination Core Pro. After bidding or negotiation the buyer selects a supplier for each item or family of items. then we should store for very short periods. To establish a requisition calendar. The very nature of the storage system is thus to act as a buffer between acquisition and other various consuming departments. or until changes in design. They should be stored until time of requirement. The stores should be considered as a temporary location for materials needed for operational purposes. the buyer merely sends a brief release form the supplier noting the blanket order number. than it is to buy them through the conventional purchasing system. so that all requests for a given item are received during a reasonable period that allows to make a small number of orders with large quantities. On receiving requisition for one of the materials.O. The stores function is responsible for receipt. In general depending on the nature of the materials if demand is steady or highly predictable. when demand is not highly predictable then storage for longer periods may be required.D. On the basis of analysis of past purchases the buyer determines which materials should be handled in this manner. setting aside specific days of the requisitioning of specific supplies. 5. accounting. physical upkeep and maintenance. No specific order quantities are noted. Shortages must be avoided or production lines will have to stop. and distribution of larger sums of moneys in the form of stocks. as well as some that it does carry. or conditions affecting price or delivery make new negotiations desirable or necessary.

Reduction in need of materials handling equipments To offset delays in transportation. 4. too much must not be delivered or/it will clop up the warehouses and perhaps also the production area. 2. A closed store More security Tight accounting control Small & costly items Only stores personnel entry 2. sand bricks etc. It eliminates chances of duplication of items likely to be presented under different names. components tools. 9. 8. Each item stored must bear name. 5. It helps in easy. 1. To maintain sufficient stock of materials to level out irregularities of procurement. Permit quantity purchases at comparatively lower prices To maintain efficient quantity records of movement of stock and to account for all goods that is kept in stores. coke. 6. apart form the fact that excess deliveries will tie up more capital. equipments and any other items necessary to meet the production requirements. Type of stores: 1. 3. 11.Federal Cooperative agency. Storage is thus established with the following objectives: 1. quick identification. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 24 of 40 . Materials should be stored at proper safe place to prevent these from damage and mishaps 4. Awareness of limited shelf-life items with a view to stock turnover in time to prevent deterioration. class and reference number. It also helps in standardization and reducing the variety of the materials. Ready accessibility of major materials permitting efficient service to users. 14. 5. labeled and coded properly. Principles of storing: Efficient control of stores is possible by applying following principle. wastage or deterioration of stored items. Efficient space utilization and flexibility of arrangement. All the materials must be identified. Cooperative Promotion and Regulation Coordination Core Pro. 6. To add flexibility to production schedules. 12. When material codification is accompanied by location codes. So the emphasis is on the manufacturing schedule and everything is governed by that fact. it facilitates exact location of the materials inside the storeroom. 7. The storeroom should be divided into sections and materials belonging to particular class should be stored in it. An open store All has access Chances of damage Less accounting control Fast moving items Iron ore. 3. damage. It eliminates waste and helps in easy location of material. Floor plan must be provided at convenient places in storeroom. must have signs and tags attached to them. For bulky or expensive materials or components. Prevention of waste and/or misappropriation of materials Reduced need for material handling equipment Provision of better storage facilities. shelves etc. provide easy location and quick identification of items. 10. All the bins. To make available a balanced flow of raw materials. 13. racks. the flow will have to be managed hour by hour by hour and this demands a very high degree of cooperation and efficiency. limestone. To prevent any theft. 2.

b) Random method: under this method. shelves. column number. shelf or bin number etc. '' There should be a place for everything and everything should be in its place''. Receipt: The storekeeper unloads the goods supplied. Location coding is desirable especially where the large number of items is stocked in big god owns located at different places. 2. rack number. this methods is useful when few types of items are to be stored. approval of higher authority may be required. With in each block every raw of shelves is given a number. 4. Issue of Materials: . Production of good identification system in stores assists those who try to keep everything in place. Coding is a technique of assigning brief name to the items stocked in the storeroom. Different types of containers such as drum.Materials should be issued by the storekeeper only on the presentation of on indent. numerals or a combination of the two is used for codification of items. 3. known as stores issue requisition. A goods received note or goods inward sheet is then prepared. The following methods can be used for code construction. supplies etc. flexible racks. duplicate retained by the storekeeper and triplicate in the bound book by the indentor by way of permanent record. Cooperative Promotion and Regulation Coordination Core Pro. The original copy is sent to cost department for costing. Storage of materials: The most important function of the store department is to store and preserve the materials. boxes. Identification can be done by: i) Tagging some piece of paper or cloth with the items ii) By fixing labels on the items iii) Painting colour coding of items iv) The coded number or any other identification mark may be embossed on the items.g. and supplied to each department. It is flexible as it is possible to add the new number or letter in sequence in case of addition of new items. a) Mnemonic method: In this method alphabets closely associated with the name of the item are used e. Such indent stores are made out in triplicate form bound book. moulding sand. pallets.g. Metallic items (MT). Each group may be further sub-divided until the individual item is identified. The location is identified in terms of number of ware house. coal. plastic items (PT). Identification of materials: when large numbers of different items are stocked in the storeroom. Before storing the quality & quantity are tested. row number. bins etc. the total stock of items is divided into number of groups or classes and a symbol is assigned to each group.Federal Cooperative agency. and verifies the content with the packing ship and the purchase order. tools. the numerical and alphabets are used on random basis. Each raw is divided vertically into columns and horizontally into shelves. But this method is rather arbitrary. till they are issue to the production and other departments. Generally alphabets. it is essential to codify them for their quick identification. c) Scientific method: under this method. Blocks and row are identified by painted signs. Functions of stores: 1. etc. d) Location coding: store room is divided into blocks of storage units and each block is identified by lateral block letter and longitudinal block letter. The requisition is usually signed by the foreman but in same cases where extra large quantities are required for production. iron ore etc. are used for storing different types of materials some materials are also stored in the floor in the form of heaps e. These materials should be stored in suitable containers. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 25 of 40 .

The control is related to: 1. metallic goods etc. It is maintained in loose-leaf book or card file. This note is an authorization to return to the storekeeper raw materials. rubber goods. Tools register Bin Card:. Record of receipts 2. It shows details of quantities of each type of material received. 5. Ordering level or safety level. leather. probable requirements of particular contracts and other details. the following books and these are maintained separately for different types of materials: a) b) c) d) e) f) Bin card Stores record card Materials transfer note Materials return note Inward & out ward register Stock registers 1. The material should be safeguarded against fire.Federal Cooperative agency. deterioration of quality. issued and balance each day. It may also show the details of interdepartmental transfers as distinct from issues to the shops. It is helpful for production control purposes. Store control: It refers to preservation of materials stored in the stores room. evaporation. theft. Max. Material Return Note: the excess material lying around departments should be returned to the stores. shelf or a container used for storing the materials. 1. finished parts. Cooperative Promotion and Regulation Coordination Core Pro. Record keeping:. since it leads to deterioration in value of the materials as well as to congestion in the departments. This material is returned to the stress with a note called material return note. An advantage of this card is that the storekeeper has all details close at hand and can note in it such information as quantities ordered. Protection of goods from fire 2. Bin card usually contains the following information. the details of material transfer showing all necessary data for crediting and debiting the cost accounts is recorded in the stock register. Store Record card:. And min. For each kind of material a separate record is kept on a BIN CARD. Protection of goods from weather conditions “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 26 of 40 . Such transfer occurs where an urgent order has to be made and work started on less urgent order may be appropriated. Protection of goods from dust 3. 5. Bin cards are usually made in duplicate. or other items no longer required by the department concerned. Materials transfer note: The transfer of material from one shop to other or from are job to another some times becomes a necessity though this is strictly prohibited. For this purpose. Normal quantity of each material to be ordered. since it shows not only the present balance but also what an order is. rack. Bin card are checked by the store inspector to see that they are accurately maintained. of each material to be carried out 4. Dead stock register 2.store record card is an alternative to the bin card. Record of issues 3.A bin card is attached to each bin. one card is attached to the bin and the other remains with the store keeper on his table for ready reference to the quantity of any materials on hand at particular time.In order to maintain an efficient record of stores. When the stock of materials reaches the ordering level orders may be placed for purchase of materials. Consumable register 3. dust. require different care.

a wholesale distributor. limit the expansion of an organization due to lack of capital. Inventories are a sort of lubrication for the supply-production-distribution system that protects it from excessive friction. Poor control in inventories can create a negative cash flow. Finished goods are the final product. 4. absorb the shock of forecast errors. varnish. Inventory problems have proliferated as technological progress has increased the organization's ability to produce goods in greater quantities. and so forth. The pressure for capital and the effective utilization of resources has made decision makers more aware of its significance. screws. available of sale. Raw materials are inputs into the production process that will be modified or transformed into finished goods. or another manufacturer. non-profit institutions. Supplies are inventory items consumed in the normal functioning of an organization that are not a part of the final product. or storage. nails. varnish is a final product for a chemical factory. paper. and finished goods. Inventories tie up money. Protection of goods from against deterioration 5. The control and maintenance of inventories is a problem common to all organizations in any sector of the economy. light bulbs. Protection of goods from against theft' 6. a retail organization. the investment in inventories represents a sizable sum. Reasons for holding inventories Inventory exists because organizations cannot function without it. a furniture manufacturer considers it as a raw material. stain. The customer for finished goods inventory may be the ultimate consumer. They represent both the accumulation of partially completed work and the queue of material awaiting further work. The problem is encountered by profit making organizations. in-process goods. The assignment of inventory to any of these categories is dependent on the nature of the organization. For many organizations. It may consist of supplies.IV Inventory management 1) The significance of inventories in a firm's operation The word inventory refers to any stock on hand at a given time (a tangible asset which can be seen. typewriter ribbons. Maintenance of the level of the inventories CHAPTER . This is because one entity's finished product may be another entity's raw material. glue. Because it is either impractical or “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 27 of 40 . It is an objective of inventory management to control the lot sizes so that the overall costs associated with the purchase or the manufacture are at a minimum. tie up large amounts of capital. Cooperative Promotion and Regulation Coordination Core Pro. and permit the effective utilization of resources when demand undulations are experienced. Inprocess goods are partially completed final products that are still in the production process. and reduce the return of investment by broadening the investment base. It is material held for future use in an idle or unproductive state awaiting its intended purpose. raw materials. Inventories isolate one part of the system from the next to allow each work independently. For example. distribution. Inventory refers to any material held in storage for latter use of sale. Proper inventory management implies having enough items available when needed but not so much that an unnecessarily costly surplus incurred.Federal Cooperative agency. It would be ideal if demand and supply could be so coordinated that no inventories would be needed. paint. and other social institutions. Typical supplies are pencils. faster and in multiple design variations. weighed. and counted). and facility maintenance items. The relative significance of inventory management to an organization can be gagged by the overall investment in inventory and the magnitude of the material costs for all products. Typical raw materials for a furniture manufacturer are lumber.

Another source of anticipation is planned market promotion where a large amount of finished goods may be stocked prior to sale. more constant output than fluctuating demand might otherwise allow. demand. the level of demand on a logistic system and the time required for resupply cannot be known for sure. Inventories act as buffers between demands and supply so that production can be geared to a. especially for those products that are service sensitive. One case is where the price or availability of raw materials is expected to change. there are uncertainties in supply. Likewise many purchases on small quantities can mean that the highest transportation rates are paid. Every organization stores materials of one kind or another for the following purposes. This is an advantage to the customers who desire or must have immediate stock availability or short delivery times. To improve customer service Inventories are an aid to the marketing of a firm's products. floods. one purpose for establishing an inventory would be to allow shipping to or form the inventory under the lower per unit rates of full vehicle load quantities. impossible to know future demand with full certainty. In a similar way. price and delivery be vendors. it often economical to purchase in large lots because more can be purchased at one time than is immediately needed. To assure product availability at a reasonable price safety stocks are maintained to provide this protection. transportation and production Due to ordering costs and quantity discounts. 2) Relevant inventory costs Inventory is any material or stock in an idle or unproductive state held for future use. To the supplying firm this can mean a competitive edge and reduced lost sales. the lowest per unit cost for producing products generally occurs with long or continuous production runs at constant quantities. Labour strikes. and earthquake are just a few of the contingencies that can befall an organization. To achieve economies of scale in purchasing. To hedge against contingencies. In most cases. Products can be spotted near where customers purchase them and in the quantities that they wish to but.Federal Cooperative agency. There are several types of situations where changes in demand and supply may be anticipated. Safety stocks of raw materials are maintained to absorb uncertainties in demand. Safety stocks are maintained in inventory to protect against those uncertainties. Safety stocks of in-process inventories are maintained to allow for fast schedule changes. Maintaining backup inventories is one way in which normal supplies can be maintained for a period of a time. The control and maintenance of inventories is a problem to all organizations including profit making. and lead-time of materials. finally. Cooperative Promotion and Regulation Coordination Core Pro. non-profit “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 28 of 40 . price. and because the availability of supplies can not be guaranteed at a given moment inventories are accumulated to ensure an availability of goods and to minimize the overall costs of production and distributing the goods. fires. This makes it possible to spread the setup cost of the production machines over a large number of items. In a similar way a firm also stocks finished goods inventories to absorb changes in demand without immediately changing production. To protect against uncertainties In inventory systems. companies in seasonal businesses often anticipate demand in order to smooth employment. To cover anticipated changes in demand and supply.

expediting. The purchase cost The purchase cost of an item is the unit purchase price if it is obtained from an external source. transmitting the order to the supplier. The need for greater amount and a greater variety of materials has aggravated inventory problem. scheduling the work. The order (setup) cost The ordering cost is associated with ordering a batch or a lot of items.to minimize investment in inventories. Inventories tie up money. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 29 of 40 . It originates from the expense of issuing a purchase order to an outside supplier or from the internal production setup. and other social institutions.to maximize customer (beneficiary) service.to assure efficient (low cost) operation It is plain to see that these goals can be inconsistent or even in direct conflict. . and factory overhead. This cost is usually assumed to vary directly with the number of orders or setups placed and not at all with the size of the order. The cost usually represents three components: Cost of capital. and quality acceptance. For manufactured items. The order cost includes the costs of making requisitions. it is the purchase price plus any freight cost. and poor control in inventories can limit the expansion of an organization due to lack of capital and reduce the return on investment. analyzing vendors. The inventory carrying/ holding cost Carrying costs refer to all the costs associated with keeping items in inventory for a period of time. receiving and inspecting materials.Federal Cooperative agency. The goals associated with materials management are neither monolithic nor easily delineated. It usually includes preparing the shop order. the basic objective of inventory management is to maximize service through maintaining enough amounts of items when needed but no so much that unnecessarily costly supplies incurred. The purchase cost is modified for different quantity levels when a supplier offers quantity discounts. direct material. following up orders. In preserving the continuity of supply. institutions. Reduction of inventory costs thus calls for the analyses of relevant cost structure of inventories that primarily includes: • Purchase (item) cost • Ordering (setup) cost • Carrying (holding) cost • Stock out (depletion) cost. pre production setup. the unit cost includes direct labor. or the unit production costs if it is produced. and . The setup cost comprises the cost of changing over the production process to produce the ordered time. The pressure for capital and the effective utilization of resources has made decision-makers more aware of its significance. The role of the materials manager is thus to balance the objectives in relation to existing conditions and environmental limitations. Internally For the purchased items. The major goals of materials management are: . The relative significance of inventory management to an organization can be gagged by the overall investment in inventories and the magnitude of the material costs for all products. Cooperative Promotion and Regulation Coordination Core Pro.

Also. 3) Classification of inventories Inventories may be classified on various ways i) Based on criticality. every item is treated the same in terms of the level of stock availability. In another situation. Normal. The costs are based on the concept of foregone profits. inventory investment and operation costs can be kept down if we recognize that not every item in inventory deserves the same attention or requires the same level of availability to satisfy customers. every item in stock is checked constantly or periodically for level. In the one situation the sale is not lost but only delayed a few days. When items are carried in inventory. A firm would institute an emergency expediting order to get the items as a backorder. present profit loss (lost sales). Stock out/Depletion costs Stocks out costs reflect the economic consequences of running out of stock. Slow moving. Desirable) analysis ii) Based on scarcity. SDE (Scare. Inventory control procedures should insolate those items that require detailed and precise control from those that do not. Deterioration is change in properties due to age or other factors such as environmental degradation. They result form external and internal shortages. These costs include the costs of obsolescence. Internal shortages can result in lost production (idle men and machines) and a delay in completion date. If no adjustment is made. FNSD (Fast moving. and frequently special shipping and packaging costs. The risk associated with these factors it directly proportional with the level of inventories. If demand occurs for an item out-of-stock. Easily Available) analysis iii) Based on movement or transaction. the capital invested is not available for other purposes. It is often uneconomical to apply detailed inventory control analysis to all items carried in an inventory. handling costs. Obsolescence is loss of value of inventories because of shift in style or consumer preference. Dead items) analysis. VED (Vital. the sale is lost. Inventory risk costs. Inventories tie up capital that could be put to use for other purposes inside or outside the organization. Essential. But the most common way to classify inventories is value analysis or ABC analysis ABC Analysis of inventories A few products in a firm can result in most of the value or a few usually account for most of the inventory value as measured by dollar usage (the product of annual usage times unit purchase cost or production cost. theft or pilferage. an internal shortage occurs when users within the organization do not have their orders filled. The backorder case results in expediting costs. Difficult. This represents a cost of foregone opportunities for other investments. taxes. Shrinkage is the decrease in inventory quantities over time from loss. deterioration. This cost includes space cost. the economic loss depends on whether the shortage is back ordered or cancelled.Federal Cooperative agency. shrinkage. An external shortage occurs when a customer does not have his order filled.) Inventory control managers should avoid the distraction of unimportant details and concentrate on significant matters. The stock out cost depends on the reaction of the customer to the out-of-stock condition. Insurance premiums vary with the size of the inventory investment. and damage. and insurance. In that case the stock out cost ranges from the profit loss on the sale to some unspecifiable loss of goodwill. It is usually economical to purchase large supply of low value items and maintain little control over them “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 30 of 40 . and future profit loss (loss of potential sales and erosion of goodwill). Storage space costs are the recurring costs for storage that relate to the amount of inventory stored. Storage cost. However. Cooperative Promotion and Regulation Coordination Core Pro. External shortages result in backorder costs.

100% 90 80 Typical ABC Inventory 70 model 60 A B C 40 20 0 20 40 60 80 100% The breakdown in to A. small quantities of high value items are purchased. conversely. Summary of ABC inventory management Percentage of Percentage of Degree Ite total total No. looser control might be used for C class items. and C. The same degree of control is not justified for all items. which are relatively insignificant. Cooperative Promotion and Regulation Coordination Core Pro. A periodic review system could be used to consolidate orders form the same supplier and need no special calculations. Also the exact percentage of items in each class will vary form one inventory to another. The important factors are the two extremes: a few items. One of the chief methods to practice selective inventory control is through ABC classification scheme.Federal Cooperative agency. a significant reduction in inventor investment will result. B. At the other extreme class C contains 5-10 of the inventory value but 60-65% of the inventory items. less safety stock and close attention to record accuracy might be used. It therefore represents the most significant few. and a large number of items. Most of the dollar usage in inventory (80 percent) can be controlled by closely monitoring the A class items (20 percent). a tight control system including continuous review of stock levels. These items are low value items with very little contribution to the dollar value of inventory. there could be any number of classes. The major concern of an ABC classification is to direct attention to those inventory items that represent the largest annual expenditures. of of m inventory value item control A 80 20 Tight Type of records Lot sizes Frequenc Size of y of safety review stocks Continuous Small Accurate & Law “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 31 of 40 . On the other hand. B. and tight control is exercised over them. and representing 20-25% of the inventory items. In inventory it is frequently advantageous to divide inventories in to three classes: A. If inventory levels can be reduced for class A items. which are significant. The class is high value items whose dollar volume typically accounts for 75-80% of the value of the total inventory. In the middle is class B that contains 10-15% of the value of the inventory. For these items. Thus one can manage these few items intensively and control most of the inventory value. This suggests that before a firm policy for inventory control can be established. The B class items require an intermediate level of attention and management control. each product should be classified according to its requirement. while representing only 15-20% of the inventory items. and C items are arbitrary. since they represent a low inventory investment.

These large inventories require excessive expenditure of funds and increase the possibility of obsolescence. Increased inventory investment and decreased customer service may result if a system is overburdened. Manufacturing problems In manufacturing poor inventory management has the same consequences as poor customer service. As a result. B C 15 5 25 55 complete Moderate Good Loose Simple Medium Occasional Moderate Large Infrequent Large 4) Effects of poor Inventory Management All inventory systems are subject to problems in two major areas: Maintaining adequate control over each inventory item and maintaining accurate records of stock on hand. In such situations. lack of concern about measuring performance. if any. the operation must be either stopped or changed to another product line that does not require the stock out material. or deficiencies in. physically or administratively. many problems may a rise in order preparation. Other indications include the existence or few. customer service objectives. Symptoms of these problems are many. actual physical counts may differ form those recorded. setups create scheduling difficulties. and if these differences are always beyond specified tolerances. A lack of regularly planned audits of inventory record. The problem can be attributed to poor inventory management. or careless. high ordering costs stock out avoidance. For example. customers must be willing to wait for receipt of items they will cancel the orders. All of these circumstances lead to excessive expediting. idle time in a facility such as materials handling due to materials and/or component shortages and stock outs of inexpensive items. Such stress to the system may produce some or all of the following problems: material lots are lost. the information system is unable to handle the volume the storage locations. there may be lack of. materials handling throughout the company are inefficient. When poor inventory management prevails in manufacturing. varying in degree from operation to operation. including actual physical counting of the quantities of each item in inventory to verify inventory records. Excessive expediting Excessive expediting to satisfy customers indicates poor inventory management. the following. is also a symptom of inaccurate. High inventory levels Large inventories are required when there are demand and supply time variations due to poor service. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 32 of 40 . Inaccurate inventory records Inaccurate records are a good indication of poor inventory management. and excessive production disruptions. and back orders occur. If problems occur here. Good inventory management has the objective of determining a rational approach for balancing these two-sided risks. When inaccuracies occur. materials management will have difficulty in maintaining efficient operations because of inaccurate information. management has taken the easy way out by having excess inventory. High inventory levels indicate inadequate attention to the application of inventory management techniques. resulting in unfilled orders. Specifications.Federal Cooperative agency. Poor customer service The most obvious sign of poor service is late of deliveries. record keeping. Cooperative Promotion and Regulation Coordination Core Pro. When a stock out occurs during production. scheduled shipping dates are not met. Another indication of poor record keeping is that management seems to be more concerned about C items in the typical ABC classification than A items.

Prevents duplication of items 4. Assists in simplification. a very long and complicated description may be required. with frame made of beech. Serves as a basis for sorting and recoding of documents. It requires the cooperation of all concerned for the promotion of overall economy with due regard to functional and safety requirements. All of these problems produce delays and increase production costs. even this is not the whole story. Cost variances occur when actual costs are higher than standard costs. processing of invoices or plant reports. 3. orders for internal fabrication of items. Standardization Standardization is the process of reducing the number of varieties stocked to a controlled workable minimum. They should be flexible enough to accommodate future additions. in order to identify some articles accurately. spring seat back and arms. etc. It would. Simplifies data processing or mechanical recording 8. 7. alphabets. therefore. But several different names may be used for the same thing. In fact codification can be made on the basis of color making and technical spares. polished carved walnut legs. which is more precise and less cumbersome. The most common methods to classify and code materials are by the nature and end use of the item. Provides a foundation for an efficient purchasing organization because suppliers can give different names for similar items. Codification is the process of representing each item by a number or a letter or a combination of both in the form of a stores code. By adopting a well designed codification system. In its simplest form. the stores manager will have a unique precise. The design of the system should be such that the codes are compact and concise and are not unduly long. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 33 of 40 . types and sizes.Federal Cooperative agency. finished in sage-green moquette and fitted with two foam rubber cushions. It helps to identify all items accurately. order flows-up. recording orders.g. and financial arrangements. Avoids repeated use of long descriptive titles and the confusion caused by these long descriptions 2. Can be employed as a basis for stock control accounts. but there are many kinds of chairs. to identify only one of them properly. Mass production techniques of industrial production are based on the principle of uniformity and interchangeability of many parts. components. In coding materials. 6. 5. Cooperative Promotion and Regulation Coordination Core Pro. 5) Codification and standardization Codification The normal way of identifying an article is by simple description. This can be made by the process of codification. modern standardization has been recognized and used since the vent of mass production techniques. we first classify materials. The principal advantages of a rationalized codification system are outlined below: 1. it is necessary to say that it is an armchair. required setup. and materials used in the production process. for nothing has been said about the quality of the materials or the dimensions of the various parts. It is necessary to have some logical basis of identification. As mentioned earlier coding can be done with the help of figures. be useful to know the basic nature and characteristics of all materials used in an organization and then classify them in broad categories and then to group and sub-group them in logical progression of kinds. group and subgroup them. simple and consistent method of identifying the items in his custody. reduction of varieties and standardization. e. Everyone knows what is meant by a chair. staffed with horse-char. or a combination of both.

Standardization enables an organization to proceed on scientific lines to locate factors influencing preparation of inventory control programs. carrying and purchasing. Cooperative Promotion and Regulation Coordination Core Pro. avoiding wastage. a store manager has to select a few appropriate colors and sizes. To determine the optimum order quantity. shapes or grades. or end use of the materials. shapes. and the demand rate is constant. Codification can be the starting point for standardization because we can standardize materials required by an organization on the basis of the codes given to each item. the same number of units is always maintained. sizes. 5. Fixed order size system/ deterministic models The problem of balancing the costs associated with inventories is a complex one due to the numerous and sometimes intangible costs that are relevant. Inadequate inventories can result in costs due to production delays and inefficiencies. In a fixed order size system. disposal of unwanted stores and reduction stock covers without much problem. The conduct of a program of standardization involves a complete examination of the list of materials stocked. functional and safety requirements. referred to as perpetual inventory system. characteristics. information is needed regarding the following parameters: “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 34 of 40 . However. to determine: 1. achieving economy of materials and parts. Materials codification is usually made on the basis of their similarity and interchangeability. Atypical fixed order size system is termed a Qsystem. In the field of materials management. More than adequate inventories result in excessive expenditures to hold the inventories. The grouping of like items together makes it easier to examine the complete range of any given type of stores and consider whether the number of varieties held can be reduced and standardization achieved on the minimum number of the most suitable types. He can also select a few appropriate grades by taking into account cost. The size of an order that minimizes the total inventory cost is known as the economic order quantity (EOQ). Therefore by analyzing their nature. Production also wants large idle stocks in order to reduce the ordering and setup costs. finance is interested in minimizing capital costs and thus prefers small inventories. since the size of the order (Q) is fixed for each replenishment. An order for a fixed number of units is placed whenever the inventory reaches a reorder point. etc. for. 4.Federal Cooperative agency. What range of sizes is essential Which items can be eliminated What specifications are necessary for retained items? Inventory Models and Control Techniques a. models. 3. Which items have similar characteristics and can be used as substitutes for each other. 2. Sound inventory management should consider all viewpoints and then develop a policy that minimizes the total inventory related costs with out affecting the smooth operation of the firm. grades. The use or uses for which each item is intended. these issues warrant serious considerations. Economic order quantity An optimal inventory policy is one that would provide adequate inventory levels when needed at the minimum total cost of ordering. The basic issues are how much and when to order (or produce). These costs are often very difficult to measure directly. smooth operations and minimize idle time. Marketing wants large inventories to ensure the satisfaction of consumer demand. Since inventory expenses are a substantial cost of doing business for most companies. Inventory policy involves an organizational dilemma. as well as the shortage costs of lost orders or even lost customers. It is the best known and most fundamental inventory decision tool. which is also. For instance we can have the same size or volume material with different colors.

This tradeoff between ordering frequency and inventory level can be represented by a mathematical equation using the following Symbols: D = annual demand in units C = purchase or production cost an item A= ordering cost per order H = holding cost per unit Z = annual holding cost as a fraction of unit cost “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 35 of 40 Reorder point . a new order is placed for Q units. the ordering frequency will decrease but more inventories will be carried. there is a tradeoff between ordering frequency and inventory level. There is a fixed ordering or setup cost for each lot. which is independent of the number of items in the lot. Upon receipt of an order. Materials is ordered or produced in a lot or batch and the lot is placed into inventory all at one time. The lead-time is constant and known. Where Q is the order size. If larger lots are ordered. 1. Forecasts of demand 3. The vertical lines indicate the receipt of a lot into inventory. is therefore always a fixed number of days. In choosing the lot size. Cooperative Promotion and Regulation Coordination Core Pro. Units are withdrawn form inventory at a constant demand rate. the inventory level is Q units. Knowledge of lead times The classical inventory model assumes the idealized situations shown in the following figure. so the average inventory is (Q+0) /2 or Q/2. Since the demand and lead-time are constant. demand (or wage) is 100 units a day with no random variation. For example. and demand is assumed to continue into the indefinite future. No stock outs are allowed. recurring. Q Maximum inventory average inventory Q/2 R 0 a b c d TIME e f Q= lot size Q/2= average inventory R= Reorder point ROQ ac = ce = interval between orders ab = cd = ef = lead time The derivation of the EOQ is based on the following assumptions: 1. Small lots will lead to frequent reorders but a low average inventory level. and known. 4. A specific cost structure is used as follows. from order placement to order delivery. which is represented by the negative slope lines. The new lot is received just as the inventory level reaches zero. The lead-time. The unit item cost is constant and no discounts are given for large purchases.Federal Cooperative agency. The demand rate is constant. After a fixed lead-time period. one can determine exactly when to order material to avoid stock outs. the goods are received and placed in inventory. 5. 2. Appropriate costs 2. 3. The carrying cost depends linear on the average inventory level. When inventory reaches the reorder point.

18) =0. TC. Given D=81000 = (6750x12) A= 5(=3+1+1) TC=DC+ AD+ HQ/2 Q TC= 81000 (. 3. postage. Notebook can be purchased from a variety of suppliers for 50 cents a unit regardless of the quantity purchased. Annual pilferage. Two-Bin Inventory system “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 36 of 40 . Customers demand 6750 units of notebook each month constantly 2.50x0. stated in the above equation. thus D/Q orders are place in a year Holding cost per unit = (carrying interest rate) (purchase cost) = F x C = FC Total holding cost = (holding cost) x (average inventory) Total carrying cost per year = (annual carrying rate) (unit cost) (average inv.770 by ordering Q= 3000 units each time if requests a shipment. and the product is ordered Q units at a time.045 Q Q H=0.000+0. deterioration.Federal Cooperative agency.09(0. and storage expenses are estimated to be 18% of the value of average inventory 4.000)+0. Cooperative Promotion and Regulation Coordination Core Pro.5) +5(81. The problem can be solved in several ways.09Q/2 Q = 40500+450. Q = lot size Annual ordering cost = (cost per order) (orders per year) = A x D/Q = In the above equation D is the total demand for a year.045Q The data in the table show that the bookstore can minimize total annual inventory cost at TC= 40. Using trial and error.) =F x C x Q/2 = FCQ 2 = HQ 2 Total annual cost = (purchase cost) + (order cost) + (holding cost) = DC + AD + HQ Q 2 Therefore TC= DC + AD + HQ Q 2 Example Suppose you are given the following information concerning a certain notebook distributor company 1. interest. telephone and transportation =1. The company's problem is now to order quantity Q that minimizes the total inventory cost. The cost of preparing and processing an order is 45 minutes (¾ hour) of labor @ Birr 4/hour =3 plus paper. the bookstore can select various possible order quantities and then compute the resulting total cost as shown in the following table. setting up the display requires an additional expense of 15 minutes (¼ hour) of labor @ Birr 4/hour=1.

and the reorder point are variable. The reorder point is determined by visual observation.21 40.774.332.00 Purchasing 40. Periodic Inventory system In a periodic inventory system the number of items in storage is reviewed at a fixed time interval.00 270 67.50 202. issues. The two-bin system is best suited for item of low value. fairly consistent usage.806.00 90.792. so that when the stock is drawn down to the sealed quantity an order is placed. A maximum inventory level E is established for each item. point quantity can also be placed in a bag or container. The most important advantage is the reduction in paperwork. and so forth.781. The size of the replenishment order is variable and depends on the number of units in stock. Figure 1 describes the behavior of the periodic inventory system for a single item. such as office supplies. nuts.50 40.837. bolts. an order is initiated. The periodic system usually accounts for the number of units in stock on the review date by an actual count.00 The system can even be used with only one bin. The reorder point is determined by visual observation. the number of units remaining is not reviewed each time a unit (or units) is issued from stock.50 40.500 40. The most important advantage is the reduction in paperwork. A count must be taken of the goods on hand at the start of each period.50 135.00 202.00 225. With the periodic system the quantity to be ordered is not fixed. Two-Bin Inventory system The distinguishing feature of the two-bin system is the absence of a perpetual inventory record. and balances on hand.500 40. With the periodic system. and it has several advantages. since the inventory records contain receipts.773. The order quantity is the maximum inventory level minus the inventory position on the review date.50 405 45. and the decision maker changes the quantity ordered to reflect changes in the demand rate.000/Q) Q) 810 22.Federal Cooperative agency. An order can be triggered when the inventory level reaches a physical mark such as a painted line or a given volume level (for gasoline or other liquids). and demand is then filled from the second bin or compartment. The reorder.500 40. and short lead-time.500 40.71 157.50 40.500 40. and the lead-time can be fixed or variable.500 40. The two-bin system is a fixed order size system. the review period is fixed.770. Cooperative Promotion and Regulation Coordination Core Pro.045 (405.50 101.500 40. The order quantity varies form period to period and depends upon demand.50 40. and it has several advantages. In the perpetual system an actual count is not required.00 135.00 162. When the stock in one bin or compartment is depleted.950. Under this system. Records are not maintained for each transaction. The distinguishing feature of the two-bin system is the absence of a perpetual inventory record.00 115.25 40.00 112. Quantitative decision-making Order quantity Q 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 Annual Costs Ordering Holding (0.500 40.50 40. the demand rate. Records are not maintained for each transaction.50 90. When the stock in one bin or compartment is The data in the table below show that the bookstore can minimize total annual inventory cost at TC= 40.500 40.25 180.792. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 37 of 40 . the order quantity.770 by ordering Q= 3000 units each time if requests a shipment.50 81.00 40.500 Total 41. The two-bin system is a fixed order size system.00 40.

.....................Federal Cooperative agency........................................ This additional safety stock results in the optimal perpetual system being less expensive than the optimal periodic system..... the periodic system requires safety stock for protection against demand fluctuations during both the review period and the lead-time......... ... This means that the periodic system will require a larger safety stock for a given item than the perpetual system... Figure 1... the periodic system requires safety stock for protection against demand fluctuations during both the review period and the lead-time..... SAFETY STOCK ..... Stock levels are reviewed at regular intervals..C ≠ E-B ≠ E-D 5......... The periodic system is well suited for inventory control when the supply sources are few or the source is a central warehouse.... Cooperative Promotion and Regulation Coordination Core Pro................................. This means that the periodic system will require a larger safety stock for a given item than the perpetual system............................................................................... With a fixed order period... but orders “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 38 of 40 ....... 0 F G H I J K Time The periodic system is completely defined by the order period and the maximum inventory levels......... In the perpetual system the safety stock represented protection against demand fluctuations during the lead-time period..... In the perpetual system the safety stock represented protection against demand fluctuations during the lead-time period...... Variable reorder points C≠ B ≠ D 4................... Variable demand (slope) 2.......... Periodic......... Fixed review period FH =HJ 3... The periodic system is well suited for inventory control when the supply sources are few or the source is a central warehouse.... The periodic system is completely defined by the order period and the maximum inventory levels.................... though this may be offset by the economies of single supplier item amalgamation.................... .... This additional safety stock results in the optimal perpetual system being less expensive than the optimal periodic system..... Safety stock + 0B (Reorder quantity = E-inventory level at review period) ...... is a hybrid of the perpetual and periodic systems... though this may be offset by the economies of single supplier item amalgamation................................................................ Optional replenishment inventory system The optional replenishment inventory system.. With a fixed order period......................................................................... Variable reorder quantities E............ Variable lead time FG ≠ HI ≠ JK 6. which is also referred to as a min-max system................. Inventory system 1....

The reorder point B Not that the perpetual and periodic systems are both defined by only two parameters. Optional replenishment inventory system. Cooperative Promotion and Regulation Coordination Core Pro. The system permits orders to be placed in efficient quantities. Fewer but larger orders are placed than in the periodic system. The optional replenishment system is defined by three parameters: 1. Fixed review period FH =HJ 3. If the inventory position is at or below the reorder point on the review date.C ≠ E-B ≠ E-D 5. Variable reorder points C≠ B ≠ D 4. The length of the review period 2. 1. so order costs are lower. The order quantity is the maximum inventory level minus the inventory level at the review period. are not placed until the inventory position has fallen to a predetermined reorder point. an order is placed.Federal Cooperative agency. Variable reorder quantities E. Figure 2 describes the behavior of the optional replenishment system for a single item. The length of the review period 5. The optional replenishment system is defined by three parameters: 4. When the review period is so long that an order is triggered at almost every review. while the optional replenishment system requires three parameters. The maximum inventory level E 3. The reorder point B Figure 2. Safety stock + 0B (Reorder quantity = E-inventory level at review period) D Inventory Level C B A O F G H I J K L M N P Q Time Not that the perpetual and periodic systems are both defined by only two parameters. The maximum inventory level is established for each item. while the optional replenishment system requires three parameters. and it reduced costs resulting from the frequent placement of small orders. The maximum inventory level E 6. the optional replenishment system is indistinguishable from the periodic inventory system. If the inventory position is above the reorder point on the review date. Variable lead time FG ≠ HI ≠ JK 6. no order is placed. Variable demand (slope) 2. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 39 of 40 .

The review period length is established by procedures appropriate to periodic systems. The safety stock is determined by analyzing the demand variation occurring for the period covered by the lead-time and the review period. When the review period is so long that an order is triggered at almost every review. The material requirements planning system is a derived order quantity system. This system (also referred to in the literature as a requirements planning system) functions by working backward form the scheduled completion dates of end products or major assemblies to determine the dates and quantities of the various component parts and materials that are to be ordered. The system permits orders to be placed in efficient quantities. and it reduced costs resulting from the frequent placement of small orders. so order costs are lower. “Our Vision is to Create Vibrant and Sustainable Cooperative Movement in Our Country” Page 40 of 40 . Material Requirements Planning Inventory system The material requirements planning (MRP) inventory system is used extensively with planned production. If the inventory level at time of review is slightly above the reorder point. coverage is required for two order intervals plus the leadtime. For items that are materials or components used by end items. Fewer but larger orders are placed than in the periodic system. The reorder point will consist of safety stock and the expected demand over the lead-time and the review period. the optional replenishment system is indistinguishable from the periodic inventory system. The system works well when (1) a specific demand for an end product is known in advance and (2) the demand for an item is tied in a predictable fashion to the demand for other items. The optional replenishment system can require substantial safety stocks.Federal Cooperative agency. stock levels are derived form the requirements dictated by the end item. Cooperative Promotion and Regulation Coordination Core Pro.

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