Purchasing

Meaning Purchasing refers to a business or

organization attempting to acquire goods or services to accomplish the goals of the enterprise

Requires input from:◦Marketing◦Engineering◦Manufacturing◦Manufacturing Planning and Control

what materials to order when to order them

Objectives of PurchasingObtain goods and services:

◦of the required quantity and quality◦at the lowest possible cost◦at the best possible service and

delivery◦while maintaining and developing

suppliers

Purchasing FunctionsDetermining purchasing

specifications◦right quality◦right quantity◦right time (delivery)◦right place (delivery)

Selecting supplier◦right source

Purchasing Functions (continued)Negotiating terms and conditions

◦right price

Issuing and administering purchase orders

Purchasing Cycle

1. Receive and analyse purchase requisitions

2. Select suppliers, issue quotations

3. Determine the right price

4. Issue purchase orders

5. Followup to assure correct delivery

6. Receive and accept the goods

7. Approve invoice for payment

Receiving and Analyzing RequisitionsFrom planners (MRP system) and

all other usersPurchasing will:

◦ Identify originator, account number, approvals

◦ Check material specifications◦ Verify quantity and unit of measure◦ Verify delivery date and place◦ Ensure all supplemental information

Selecting SuppliersOften from a list of approved

suppliersFor small items:

◦internet◦catalogues◦trade journals

For large items, issue a request for quotation

Requesting QuotationsWritten inquiries sent to enough

suppliers◦to ensure competitive and reliable

quotes are receivedQuotes are analyzed

◦price◦compliance to specification◦technical suitability◦often with the involvement of the

originator

Determining the Right PriceUsually the lowestMay involve negotiations

Responsibility of the Purchasing Department

Issuing a Purchase OrderLegal documentForms a contract with the

supplier upon acceptance Copies to:

Supplier Originator Accounting Receiving Purchasing file

Follow-up and DeliveryEnsure on-time deliveryNegotiate any changesTake corrective action:

◦expedite as required◦find alternative sources of supply◦work with suppliers to resolve

problems◦reschedule production?

Receiving and Accepting GoodsReceiving inspects goods for

correct quantity and any damageAccepts goods and generates a

receiving report◦send to quality for further inspection◦hold goods damaged in transit

Copies to Accounting, Purchasing

Approving Invoice for PaymentAgreement with:

◦Original Purchase Order◦Receiving Report

Invoice◦price including discounts◦quantity

Send approval to Accounts Payable

CHOOSING SUPPLIERS

Selecting SuppliersThe right supplier:

◦can supply the quality needed◦has the capacity to deliver the

quantity need and on time (JIT deliveries?)

◦makes a profit, but at a good price◦contributes to the improvement of

your product

Factors in Selecting SuppliersTechnical abilityManufacturing capabilityReliabilityAfter-sales serviceLocationOther considerationsPrice

Technical AbilityDo they have the technical

capability?Is there a program of product

development and improvement?Can they assist in improving your

product?

Their products become part of your product

Manufacturing CapabilityCan they consistently meet the

specifications and quality desired?◦quality control programs◦competent personnel

Do they have good manufacturing planning and control systems?◦to supply information on delivery

ReliabilityReputable StableFinancially strong We’re in

thistogether

After-Sales ServiceService organizationSupply of spare partsTechnical support

Supplier LocationLocation may effect delivery timeLocal inventoriesMay be required for after-sales

service◦will your customers require service?

Other ConsiderationsCredit termsWillingness to hold inventoryJITInformation technologyReciprocal business

PriceNot always the lowestMay include other services

Supplier SelectionOn-going relationshipMutual benefitSupplier can depend on future

businessBuyer can be:

◦assured supply of quality products◦technical support◦product improvements / problem

solving

Supplier Selection: Weighted-Point Plan

Factors: Things that must be considered as part of what we will be buying

Weights: The relative importance of each of the factors

Rating: How well each supplier compares on each factor

Ranking: The weight times the rating

Weighted-Point Plan

1.Select the factors2.Assign a weight to each factor3. Rate the suppliers for each

factor4. Rank each supplier

(multiply the weight by the rate for each factor)

Weighted-Point Plan

Figure 7.1 Supplier rating

Price NegotiationBuyer needs knowledge of

seller’s costsBuyer must have sufficient cloutShould benefit both supplier and

buyerSavings must justify the time and

effort required

Negotiations - Type of ProductCommodities

◦ price is determined by the market◦ concern for future contracts

Standard products◦ price set by catalogue listings◦ little room for negotiation

Small value items◦ try to reduce ordering costs or increase volume

Made-to-order items (negotiation possible)◦ quotations from a number of sources

Supplier Responsiveness and ReliabilityMaterial requirements often

changeSuppliers must be able to react

to changeFlexibility

◦in volume◦in products needed

Reliable◦in delivery promises

INVENTORY CONTROL (STOCK CONTROL)

Inventory- meaningInventory is actually money,

which is available in the shape of materials (raw materials, in-process and finished products), equipment, storage space, work-time etc.

Inventory control Inventory control is concerned

with achieving an optimum balance between two competing objectives.

1) Minimizing the investment in inventory.

2) Maximizing the service levels to customer’s and it’s operating departments.

OBJECTIVES The specific objectives of inventory management are as follow:

1. Utilizing of scare resources (capital) and investment judiciously.

2. Keeping the production on as on-going basis.3. Preventing idleness of men, machine and

morale.4. Avoiding risk of loss of life (moral & social).5. Reducing administrative workload.6. Giving satisfaction to customers in terms of

quality-care, competitive price and prompt delivery.

7. Inducing confidence in customers and to create trust and faith.

INVENTORY - TYPESRaw materials & purchased partsPartially completed goods called

work in progressFinished-goods inventories

◦ (manufacturing firms) or merchandise (retail stores)

Replacement parts, tools, & suppliesGoods-in-transit to warehouses or

customers

FUNCTIONS OF INVENTORY

To meet anticipated demand.

To smoothen production requirements.

To decouple operations.

To protect against stock-outs.

To take advantage of order cycles.

To help hedge against price increases.

To permit operations.

To take advantage of quantity

discounts.

FACTORS INFLUENCING INVENTORY

Manufacture requires relatively long process cycle-time.

Procurement of materials has a long lead-time.

Demand for finished products is sometimes seasonal and prone fluctuation.

Material costs are affected by fluctuations in demand and subsequently by fluctuations in manufacturing.

Inventory Costs Costs associated with ordering too much

(represented by carrying costs). Costs associated with ordering too little

(represented by ordering costs). These costs are opposing costs, i.e., as one

increases the other decreases. The sum of the two costs is the total stocking

cost (TSC). When plotted against order quantity, the

TSC decreases to a minimum cost and then increases.

This cost behavior is the basis for answering the first fundamental question: how much to order.

Balancing Carrying against Ordering Costs

16

Annual Cost ($)Annual Cost ($)

Order QuantityOrder Quantity

MinimumMinimumTotal AnnualTotal Annual

Stocking CostsStocking Costs

AnnualAnnualCarrying CostsCarrying Costs

AnnualAnnualOrdering CostsOrdering Costs

Total AnnualTotal AnnualStocking CostsStocking Costs

SmallerSmaller LargerLarger

Lo

wer

Lo

wer

Hig

her

Hig

her

EOQEOQ

COSTS IN INVENTORY

Inventory costs may vary from 28 to 32% of the total cost. Apart from material costs, several other costs are also involved in inventory. These are given as below:

Ordering Costs Holding Costs/ Carrying CostsStock Out Costs

Ordering Costs

Stationary Clerical and processing,

salaries/rentals Postage Processing of bills Staff work in expedition

/receiving/ inspection and documentation

Holding/Carrying CostsStorage space (rent/depreciation)Property tax on warehousingInsuranceDeterioration/ObsolescenceMaterial handling and maintenance,

equipmentStock taking, security and

documentationCapital blocked (interest/opportunity

cost)Quality control

Stock out CostsLoss of business/ profit/ market/

adviseAdditional expenditure due to

urgency of purchasesa) telegraph / telephone chargesb) purchase at premiumc) air transport charges

Loss of labor hours

SELECTIVE INVENTORY CONTROL

Selective Inventory Control is defined as a process of classifying items into different categories, thereby directing appropriate attention to the materials in the context of company’s viability.

Classification of Materials for Inventory Control

Classification Criteria

A-B-C Annual value of consumption of the items

V-E-D Critical nature of the components with respect to products.

H-M-L Unit price of material

F-S-N Issue from stores

S-D-E Purchasing problems in regard to availability

S-O-S Seasonality

G-O-L-F Channel for procuring the material

X-Y-Z Inventory value of items stored

ABC Classification SystemClassifying inventory according to annual value of consumption of the items. A - very important B - mod. important C - least important

When a large number of items are involved, relatively few items account for a major part of activity, based on annual value of consumption of items.

It is based on the principles of ‘vital few and trivial many’.

ABC Classification System (Cont’d)

A-items : 15% of the items are of the highest value and their inventory accounts for 70% of the total.

B-items : 20% of the items are of the intermediate value and their inventory accounts for 20% of the total.

C-items : 65%(remaining) of the items are lowest value and their inventory accounts for the relatively small balance, i.e., 10%. Annual

$ value of items

A

B

C

High

Low

Few ManyNumber of Items

V-E-D ClassificationBased on the critical nature of items.Applicable to spare parts of equipment,

as they do not follow a predictable demand pattern.

V-Vital :Items without which the activities will come to a halt.

E-Essential :Items which are likely to cause disruption of the normal activity.

D-Desirable : In the absence of which the work does not get hampered.

H-M-L ClassificationBased on the unit value (in

rupees) of items.Similar to A-B-C analysis

H-High M-Medium L -Low

F-S-N ClassificationTakes into account the

distribution and handling patterns of items from stores.

Important when obsolescence is to be controlled.

F – Fast moving S – Slow

movingN – Non moving

S-D-E ClassificationBased on the lead-time analysis

and availability.S – Scarce : longer lead

timeD – Difficult : long lead timeE – Easy : reasonable

lead time

S-O-S ClassificationS-O-S :Seasonal- Off-

SeasonalSome items are seasonal in

nature and hence require special purchasing and stocking strategies.

EOQ formula cannot be applied in these cases.

Inventories at the time of procurement will be extremely high.

G-O-L-F Classification

G-O-L-F stands for:

G – Government O – Ordinary L – Local F – Foreign

X-Y-Z Classification Based on the value of inventory stored.X class items which are critically important and

require close monitoring and tight control – while this may account for large value these will typically comprise a small percentage of the overall inventory count.

Y class are of lower criticality requiring standard  controls and periodic reviews of usage.

Z class require the least controls, are sometimes issues as “free stock” or forward holding.

If the values are high, special efforts should be made to reduce them.

This exercise can be done once a year.