Materials Managment (EIILM)

8/8/2019 Materials Managment (EIILM)

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Materials Management for Beginners
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What is Materials Management?Materials Management involves:

Procurement of Raw Materials (in coordination with Production and PlanningDepartment);Storage of Raw Materials and Inventory Control (in coordination withProduction and Planning Department);Despatch of Raw Materials for Production (in coordination with Production andPlanning Department)Storage of Finished Goods and Inventory Control (in coordination with Salesand Marketing)Distribution of Finished Goods (in coordination with Sales and Marketing)Customer Administration/Feedback Management & Action

Materials Management Department must therefore ensure effective procurement of raw materials of right quality in right quantities and at right Times and prices; it must then ensure appropriate storage and ensureavailability of the Raw materials for production as and when required and inquantities required. And finally, it must ensure smooth flow of the finished goods to the final customer/supply partner.


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Corporate Profitability & MaterialsManagement


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Internal and External InformationFlow to Purchasing


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Objectives of Materials ManagementTo ensure continuous and uninterrupted production or operation by maintaining asteady flow of materialsTo achieve the above objective in an efficient and economical manner To effect economies in the cost of materials by purchasing materials of the rightquality in the right quantity at the right time from the right source and at the rightprice;To effect economies in the costs incurred on materials after they have beenpurchased, through storage, processing and warehousing till the finished goodsultimately reach the customer;To reduce working capital requirements through proper and scientific inventorycontrol;To be alive to the changes in the market in respect of new productsTo improve the quality of manufactured goods by use of better raw materials or components and thereby increase the competitiveness of such goods put on sale.To increase the competitiveness of manufactured goods by reducing their pricesthrough cost reduction and value analysis;To ensure cooperation among all departments of the enterprise to meet materialsmanagement objectives, both at the corporate and functional levels, and to ensureproper coordination in respect in such activities; andTo conserve material resources within the enterprise, thereby contributing to theconservation of national resources


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Key Materials Management Functions

Purchasing Inventory Control

Stores Management Logistics/Distribution


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Need for Integration Relationship with other key functions:

Sales & Marketing Production

Finance


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New Connotations Supply Management Supply Chain Management


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Importance of MMIn the earlier years, Materials Management was treated as a Cost Centre,since Purchasing Department was spending money on materials whileStores was holding huge inventory of materials, blocking money and space.

However, with the process of liberalization and opening up of globaleconomy, there has been a drastic change in the business environment,

resulting in manufacturing organizations exposed to intense competition inthe market place. Indian manufacturers have been working out variousstrategies to face the above challenges and to cut down manufacturingcosts to remain competitive. Progressive Management have sincerecognized that Materials Management can provide opportunities to reducemanufacturing costs and can be treated as a Profit Centre.


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On an average, half the Sales income is spent on Materials.Suppose a firm is spending 50% of its volume on materialsand the profits are 10% of sales volume. A 2% reduction inmaterials cost will boost the profits to 11% of sales or theprofits will be increased by 10%.

To achieve the same increase in profit through salesefforts, a 10% increase in sales volume will be necessary. Inother words, compared to sales volume, material cost hasfive times the average on profits. Organizations earn or loose large sums depending on how effective are their Materials Management.

Importance of MM


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Sales 100.0 100.0 200.0

Materials 70.0 63.0 126.0

Inventory 20.0 10.0 20.0

Interest @ 15% 3.0 1.5 3.0

Other expenses 17.0 17.0 30.0

Manf. Costs 90.0 81.5 159.0

PBT 10.0 18.0 41.0

% on Sales 10.0 18.5 20.5

% Increase 85.0 105.0

The Purchase Department can control the prices by effective Negotiations.However, the question is, whether Materials Management can control the totalcost, including the Consumption? Yes, it is possible, by controlling the issue from

the Stores, based on the norms for Production. Now let us see how MaterialsManagement can improve the PROFITABILITY of an organization

It may be seen from

the above table, that just by reducing thematerial cost by 10%,the Profit hasincreased by 85%.Similarly, by reducing

the materials costand other expenses,for increased Sales,the profit hasincreased by 105%.


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Impact of Purchasing onProfitability


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Materials Management Costs Materials Management Costs involves:

Cost OF Materials Cost ON Materials


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Scope of Cost Savings The cost savings which are possible in Purchasing are

as follows:

a) By obtaining materials at lower prices through:

Development of new sources Price negotiations with vendors Using modern techniques like cost-price analysis todetermine the right or reasonable price for the materialsb) By managing taxes payablec) By reducing the cost of packagingd) By optimizing the transportation costse) By ensuring the right quality of materialsf) By value analysisg) By import substitution


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Profitability and MM- Then & Now Profitability

Till the last decade, the equation in business could be stated as

Selling Price = Manufacturing Cost + Profit

In view of the current competitive pressures in the market, theequation has changed to:

Selling Price - Manufacturing Cost = Profit

In the current situation, the Selling Price is determined by the marketforces and as such, Profit can be ensured only by reducing theManufacturing Cost. In most of the organizations, materials costcontribute to 60% of manufacturing cost and as such there is asignificant importance to Materials Management. Materials Cost isdivided into two segments:


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Economies of Scale

A firm can realize economies of scale inmanufacturing, purchasing and transportation byholding inventory.

If purchasing buys large amounts, the firm getsquantity discounts. In turn, transportation , can move larger volumes and

get economies of scale through better equipment

utilization. Manufacturing can have longer production runs if more material is inventoried, allowing per unit fixedcost reductions.


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Cost ON Materials (Hidden Costs)Cost of PurchasingTaxesPacking CostsTransportation Costs

Insurance, premiaReceivingInspection CostsMaterials Handling CostsLoss Caused by Scrap

Loss Suffered on finished goods rejected by QCInventory Carrying CostsSalaries


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Materials Requirements Planning

Technique for determining how muchquantity to buy or stock

MRP uses a slightly different method inhandling the problem of ordering.


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Purchase Budget A purchase budget is a plan showing how

much money will be spent on procurementof materials to fulfill the plans for production

vis--vis sales. The budget is prepared withtwo objectives: To Forecast the amount that the company will

have to provide for procurement of materialsduring a given period; and

To provide for a basis performance appraisalfor the purpose of control


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Purchase Budget The purchase budget indicates

a) the quantities of each type of raw material tobe purchased;

b) the timing of the purchases; andc) the estimated cost of material purchases.


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Budgeting Problems Determination of the number of

units/quantity of each raw material to bepurchased

Estimating the unit cost of each type of material to be purchased.


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Budget Factors Price Trends in Market Sources of supply and whether alternative sources are

possible which can have effect on costs. Import Substitution Cost should include basic price, excise duty, if applicable,

sales tax and any other known or anticipated charges/levies

The credit terms which are available or could be expectedshould be indicated clearly. Efforts should be made to increasecredit factors. Cash discounts for immediate payments.

Care should be taken while procuring stocks to ensure thatitems which are likely to become obsolete are purchased onlyin exact quantities.

Purchase quantities should be decided after considering thequantity discounts or minimum batch quantities offered bysuppliers.


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Budgeting Sample


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Inventory Categories Production: a) purchased from market like rawmaterials, spares, components; b) special parts

and components manufactured in ones own co.and kept in stock for use

Maintenance, Repairs, and Operating Supplies(MRO)- bought out materials required for maintenance of production process; do not formpart of finished products. Eg. Petrol, Lubricants,Tools etc

Work In Process/Progress: Semi FinishedProducts Finished Goods


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Types of Inventory

Work inprocess

Work inprocess

Work inprocess

Finishedgoods

RawMaterials

Vendors Customer


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Why Control Inventory

Profits get eliminated due to poor controlof inventory

With larger range of inventory, greater number of inventory problems: investment,procurement, handling, accounting,obsolescence, deterioration.

High Idle Time Cost of machines and labor


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Reasons To Hold InventoryReasons To Hold Inventory Meet variations in customer demand:

Meet unexpected demand Smooth seasonal or cyclical demand

Pricing related: Temporary price discounts

Hedge against price increases Take advantage of quantity discounts Process & supply surprises

Internal upsets in parts of or our own processes External delays in incoming goods

Transit


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Reasons ToReasons To NOTNOTHold InventoryHold Inventory Carrying cost

Financially calculable

Takes up valuable factory space Especially for in-process inventory

Inventory covers up problems That are best exposed and solved

Driver for increasing inventory turns (finishedgoods) and lean production/Just in time for work inprocess

T i l I C i CT i l I C i C


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Typical Inventory Carrying CostsTypical Inventory Carrying Costs Housing cost:

Building rent or depreciation Building operating cost Taxes on building Insurance

Material handling costs: Equipment, lease, or depreciation Power Equipment operating cost

Manpower cost from extra handling and supervision

Investment costs:

Borrowing costs Taxes on inventory Insurance on inventory

Pilferage, scrap, and obsolescence

Overall carrying cost

6% (3% - 10%)

3% (1% - 4%)

3% (3% - 5%)

10% (6% - 24%)

5% (2% - 10%) (15% - 50%)

Costs as % of Inventory Value


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Major Questions in Inventory

Should the item be stocked at all? If so, when to order?

How much to order?


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Inventory Management SystemsInventory Management Systems

Functions of Inventory Management Track inventory How much to order When to order

Prioritization Inventory Management Approach

EOQ Continuous / Periodic


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ABC Prioritization

Based on Pareto concept (80/20 rule)and total usage in dollars of each item.

Classification of items as A, B, or C oftenbased on $ volume.

Purpose: set priorities for management

attention.


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ABC Prioritization A items: 20% of SKUs, 80% of dollars B items: 30 % of SKUs, 15% of dollars C items: 50 % of SKUs, 5% of dollars Three classes is arbitrary; could be any

number. Percents are approximate. Danger: dollar use may not reflect

importance of any given SKU!


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ABC Analysis Example

1010 2020 3030 4040 5050 6060 7070 8080 9090 100100Percentage of itemsPercentage of items

P

ercentageof dollar value

P

ercentageof dollar value

100100

9090

8080

7070

6060

5050

4040

3030

2020

1010

00

+Class C

Class A

+Class B


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I TEM %I TEM %

10 %10 %

20 %20 %

ABC

A

N

A


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ABC Chart For Previous Slide

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

3 6 9 2 4 1 10 8 5 7

Item No.

P e r c e n

t U s a g e

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

C u m u

l a t i v e

% U s a g e

Percentage of Total Dollar Usage Cumulative Percentage

A B C


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Inventory Management Approaches A-items

Track carefully (e.g. continuous review ) Sophisticated forecasting to assure

correct levels

C-items Track less frequently (e.g. periodic review ) Accept risks of too much or too little

(depending on the item)


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ABC ANALYSIS(ABC = Always Better Control)This is based on cost criteria. It helps to exercise selective control when confronted

with large number of items it rationalizes the number of orders, number of items & reduce the inventory .About 10 % of materials consume 70 % of resourcesAbout 20 % of materials consume 20 % of resourcesAbout 70 % of materials consume 10 % of resources


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A ITEMSSmall in number, but consume large amountof resources

Must have:Tight controlRigid estimate of requirementsStrict & closer watchLow safety stocksManaged by top management


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C ITEMSLarger in number, but consume lesser amount of resourcesMust have:

Ordinary control measuresPurchase based on usage estimatesHigh safety stocksABC analysis does not stress on items those areless costly but may be vital


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B ITEMIntermediateMust have:

Moderate controlPurchase based on rigid requirementsReasonably strict watch & controlModerate safety stocks

Managed by middle level management

VED ANALYSIS


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VED ANALYSIS Based on critical value & shortage cost of an item

It is a subjective analysis . Items are classified into :

Vital: Shortage cannot be tolerated .

Essential : Shortage can be tolerated for a short period .

Desirable :Shortage will not adversely affect, but may be using more

resources. These must be strictly Scrutinized

V E D ITEM COST

A AV AE AD CATEGORY 1 10 70%

B BV BE BD CATEGORY 2 20 20%

C CV CE CD CATEGORY 3 70 10%

CATEGORY 1- NEEDS CLOSE MONITORING & CONTROLCATEGORY 2 - MODERATE CONTROL.CATEGORY 3 - NO NEED FOR CONTROL

SDE ANALYIS


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SDE ANALYISBased on availability

ScarceManaged by top level managementMaintain big safety stocks

DifficultMaintain sufficient safety stocksEasily available

Minimum safety stocksFSN ANALYSIS

Based on utilization.Fast moving.Slow moving.Non-moving.Non-moving items must be periodically reviewed to preventexpiry& obsolescence

HML ANALYSISBased on cost per unitHighestMediumLowThis is used to keep control over consumptionat departmental level for deciding the frequency of physical verification.


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Fixed Order Quantity SystemsFixed Order Quantity Systems

Behavior of Economic Order Quantity(EOQ) Systems

Determining Order Quantities Determining Order Points


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Behavior of EOQ Systems

As demand for the inventoried item occurs, theinventory level drops

When the inventory level drops to a critical point,

the order point, the ordering process is triggered The amount ordered each time an order is

placed is fixed or constant When the ordered quantity is received, the

inventory level increases . . . more


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Behavior of EOQ Systems

An application of this type system is thetwo-bin system

A perpetual inventory accounting systemis usually associated with this type of system


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Determining Order QuantitiesDetermining Order Quantities

Basic EOQ EOQ for Production Lots

EOQ with Quantity Discounts


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Model I: Basic EOQ

Typical assumptions made annual demand (D), carrying cost (C) and

ordering cost (S) can be estimated

average inventory level is the fixed order quantity (Q) divided by 2 which implies no safety stock orders are received all at once

demand occurs at a uniform rate no inventory when an order arrives . . . more


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Model I: Basic EOQ

Assumptions (continued) Stockout, customer responsiveness, and other costs

are inconsequential

acquisition cost is fixed, i.e., no quantity discounts Annual carrying cost = (average inventory level)x (carrying cost) = (Q/2)C

Annual ordering cost = (average number of orders per year) x (ordering cost) = (D/Q)S

. . . more


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C DS /2=EOQ

Model I: Basic EOQ

Total annual stocking cost (TSC) = annualcarrying cost + annual ordering cost =(Q/2)C + (D/Q)S

The order quantity where the TSC is at aminimum (EOQ) can be found usingcalculus (take the first derivative, set itequal to zero and solve for Q)


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Example: Basic EOQ

Zartex Co. produces fertilizer to sell towholesalers. One raw material calcium nitrate

is purchased from a nearby supplier at $22.50per ton. Zartex estimates it will need 5,750,000tons of calcium nitrate next year.The annual carrying cost for this material is 40%of the acquisition cost, and the ordering cost is$595.a) What is the most economical order quantity?b) How many orders will be placed per year?c) How much time will elapse between orders?


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Example: Basic EOQ

Economical Order Quantity (EOQ)

D = 5,750,000 tons/year C = .40(22.50) = $9.00/ton/year S = $595/order

= 27,573.135 tons per order

EOQ = 2DS/C

EOQ = 2(5,750,000)(595)/9.00


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M d l II EOQ f P d ti


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Model II: EOQ for ProductionLots

Used to determine the order size, production lot,if an item is produced at one stage of production,stored in inventory, and then sent to the next

stage or the customer Differs from Model I because orders areassumed to be supplied or produced at auniform rate (p) rate rather than the order beingreceived all at once

. . . more

M d l II EOQ f P d i L


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Model II: EOQ for Production Lot

It is also assumed that the supply rate, p,is greater than the demand rate, d The change in maximum inventory level

requires modification of the TSC equation TSC = (Q/2)[(p-d)/p]C + (D/Q)S The optimization results in

d p pCDS2 =EOQ

E l EOQ f P d ti


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Example: EOQ for ProductionLots

Highland Electric Co. buys coal from Cedar CreekCoal Co. to generate electricity. CCCC can supplycoal at the rate of 3,500 tons per day for $10.50 per ton. HEC uses the coal at a rate of 800 tons per day

and operates 365 days per year.HECs annual carrying cost for coal is 20% of theacquisition cost, and the ordering cost is $5,000.a) What is the economical production lot size?

b) What is HECs maximum inventory level for coal?

E ample: EOQ for Prod ction


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Economical Production Lot Sized = 800 tons/day; D = 365(800) = 292,000 tons/year p = 3,500 tons/day

S = $5,000/order C = .20(10.50) = $2.10/ton/year

= 42,455.5 tons per order

EOQ = (2DS/C)[p/(p-d)]

EOQ = 2(292,000)(5,000)/2.10[3,500/(3,500-800)]

Example: EOQ for Production


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Total Annual Stocking Cost (TSC)

TSC = (Q/2)((p-d)/p)C + (D/Q)S

= (42,455.5/2)((3,500-800)/3,500)(2.10)+ (292,000/42,455.5)(5,000)= 34,388.95 + 34,388.95

= $68,777.90 Note: Total Carrying Cost Note: Total Carrying Costequals Total Ordering Costequals Total Ordering Cost

Example: EOQ for Production


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Maximum Inventory Level

= Q(p-d)/p

= 42,455.5(3,500 800)/3,500= 42,455.5(.771429)= 32,751.4 tons

Note: HEC will use 23% Note: HEC will use 23%of the production lot by theof the production lot by thetime it receives the full lot.time it receives the full lot.

Model III: EOQ with Quantity


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Model III: EOQ with QuantityDiscounts

Under quantity discounts, a supplier offers alower unit price if larger quantities are ordered atone time

This is presented as a price or discount schedule,i.e., a certain unit price over a certain order quantity range

This means this model differs from Model Ibecause the acquisition cost (ac) may vary withthe quantity ordered, i.e., it is not necessarilyconstant

. . . more



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Under this condition, acquisition cost becomesan incremental cost and must be considered inthe determination of the EOQ

The total annual material costs (TMC) = Totalannual stocking costs (TSC) + annualacquisition cost

TSC = (Q/2)C + (D/Q)S + (D)ac . . . more



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To find the EOQ, the following procedure is used:

1. Compute the EOQ using the lowest acquisitioncost.

If the resulting EOQ is feasible (the quantity can bepurchased at the acquisition cost used), this quantityis optimal and you are finished.

If the resulting EOQ is not feasible, go to Step 2

2. Identify the next higher acquisition cost.



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3. Compute the EOQ using the acquisition cost fromStep 2. If the resulting EOQ is feasible, go to Step 4. Otherwise, go to Step 2.

4. Compute the TMC for the feasible EOQ (justfound in Step 3) and its corresponding acquisitioncost.

5. Compute the TMC for each of the lower acquisition costs using the minimum allowed order quantity for each cost.

6. The quantity with the lowest TMC is optimal.

Example: EOQ with Quantity


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Example: EOQ with QuantityDiscounts

A-1 Auto Parts has a regional tire warehouse inAtlanta. One popular tire, the XRX75, hasestimated demand of 25,000 next year. It costs A-1 $100 to place an order for the tires, and the

annual carrying cost is 30% of the acquisition cost.The supplier quotes these prices for the tire:Q ac1 499 $21.60500 999 20.951,000 + 20.90



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Economical Order Quantity

This quantity is not feasible, so try ac = $20.95

This quantity is feasible, so there is no reason to tryac = $21.60

i iEOQ = 2DS/C

3EOQ = 2(25,000)100/(.3(20.90) = 893.00

2EOQ = 2(25,000)100/(.3(20.95) = 891.93



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Compare Total Annual Material Costs (TMCs)TMC = (Q/2)C + (D/Q)S + (D)ac

Compute TMC for Q = 891.93 and ac = $20.95TMC2 = (891.93/2)(.3)(20.95) +(25,000/891.93)100

+ (25,000)20.95

= 2,802.89 + 2,802.91 + 523,750= $529,355.80

more



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Compute TMC for Q = 1,000 and ac = $20.90TMC3 = (1,000/2)(.3)(20.90) + (25,000/1,000)100

+ (25,000)20.90= 3,135.00 + 2,500.00 + 522,500= $528,135.00 (lower than TMC 2)

The EOQ is 1,000 tiresat an acquisition cost of $20.90.


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Basis for Setting the Order Point

In the fixed order quantity system, theordering process is triggered when theinventory level drops to a critical point, the

order point This starts the lead time for the item. Lead time is the time to complete all

activities associated with placing, fillingand receiving the order.

. . . more


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Basis for Setting the Order Point

During the lead time, customers continueto draw down the inventory

It is during this period that the inventory is

vulnerable to stockout (run out of inventory) Customer service level is the probability

that a stockout will not occur during thelead time

. . . more


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Lead TimeConsumption

EOQ (Economic Order Quantity)


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EOQ (Economic Order Quantity)Model

EOQ = 2 (P D)/(C V)P= Cost of Placing one order D = Annual Demand for the ProductC = Annual Inventory Carrying Cost expressed as a %

of the products cost or valueV = Average Cost or Value of one unit of inventory


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Classifying Inventory

ABC Analysis

ABC Analysis categorizes products based on importance.Importance may be based on: cash flows, lead time,

stockouts, stockout costs, sales volume or profitability.Once the ranking factor is chosen, break points are chosen

for classes A, B, C and so on.

ABC Analysis


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y1. Always, Better, Control2. ABC Analysis applies Paretos law whichseparates the trivial many from the

vital few.

3. A majority of sales originate from asmall portion of sales representatives.4. The 80-20 rule is a version of Paretos

law; that is 80 percent of the orders

come from 20 percent of the customers.

A A S S


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VED ANALYSIS

(Vital, Essential & Desirable) Based on critical nature of the component

or material with respect to production(encompassing proper working of themachine, price and availability)

Applicable for Spare Parts (unpredictabledemand pattern)


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Purchasing System and Vendor

ManagementFor Beginners

FLOWCHART OF THE E- PROCUREMENT


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FLOWCHART OF THE E- PROCUREMENTSYSTEM

Material User

Purchasing

Department /BuyerSupplier

Extract&merges MR datafrom in-house system intoB2B

Buyerreviews MR

Assigns Suppliers to requisition onB2B system for bidding and specificsclosing date and other conditions

Collects and reviews bids submitted

by suppliers through internet basedB2B system or fax

Selects a supplier based on qualitycost and delivery performancethen issues a Purchase Order

Purchase Order (electronic orhard copy)

Prepares MaterialsRequisition inputsinformation into in-housecomputer system

MaterialsRequisition isprinted out

Purchase Order(electronic or hard

copy)

The Corporate Purchasing Process For


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The Corporate Purchasing Process For Contracts

Corporate PurchasingGoal of Purchasing Synergy

Develop Corporate Contracts

Better Conditions 100% OperatingCompanies

Bonuses / Incentives

Average of 0.5% tocover the cost of

Corporate Purchasing

Remainder is returnedto OperatingCompanies


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Source of Information on


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Source of Information onSuppliers

Trade Directories Trade Journals Telephone Directories

Suppliers Catalogues Trade Exhibition and fairs Salesmen

Company Personnel Purchase departments of other companies

l l


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Supplier Evaluation

Quality Delivery Times Flexibility Pricing Internal Facilities

Internal Systems

Method of Supplier Evaluation


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Method of Supplier Evaluation(Weighted Point Method)

Quality:No. of Lots accepted/No. of lots received 50

Delivery Rating:

No. of Lots delivered on time/No. of lots delivered 30

Pricing:

Least offer received/Suppliers offer 20

Documents

Materials Managment (EIILM)