Material Management & Control

Construction Materials Management
Definition of MM
Materials management is that process of management which co-ordinates, supervises and executes the tasks associated with the flow of materials to, through and out of an organization in an integrated fashion. Another Definition Materials Management is an integrated process of planning and controlling all necessary efforts to make certain that the quality and quantity of materials and equipment are appropriately specified in a timely manner, are obtained at a reasonable cost and are available when needed. The materials management systems combine and integrate the off-take, vendor evaluation, purchasing, expediting, warehousing, distribution and disposing of materials functions. Definition :It is concerned with planning, organizing and controlling the flow of materials from their initial purchase through internal operations to the service point through distribution. AIM OF MATERIAL MANAGEMENT ( Objective) To get 1. The Right quality 2. Right quantity of supplies 3. At the Right time 4. At the Right place 5. For the Right cost
Scope of MM
Procurement (including Planning & Scheduling) Inspection & QC Stores & Inventory Control Transportation & handling Distribution (logistics)
Objective of material management Primary Right price High turnover Low procurement & storage cost Continuity of supply Consistency in quality Good supplier relations Development of personnel Good information system
S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT
Secondary Forecasting Inter-departmental harmony Product improvement Standardization Make or buy decision New materials & products Favorable reciprocal relationships
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PURPOSE OF MATERIAL MANAGEMENT To gain economy in purchasing To satisfy the demand during period of replenishment To carry reserve stock to avoid stock out To stabilize fluctuations in consumption To provide reasonable level of client services Four basic needs of Material management: 1. To have adequate materials on hand when needed 2. To pay the lowest possible prices, consistent with quality and value requirement for purchases materials 3. To minimize the inventory investment 4. To operate efficiently
Basic principles of material management 1) Effective management & supervision It depends on managerial functions of Planning Organizing Staffing Directing Controlling Reporting Budgeting 2) Sound purchasing methods 3) .Skillful & hard poised negotiations 4) Effective purchase system 5) Should be simple 6) Must not increase other costs 7) Simple inventory control programme
Functions of the MM Dept. Identification and Estimation of materials requirement. Procurement and allied functions Stock or inventory control Storage Disposal of surplus, obsolete, scrap and empties. Control & analysis through a well designed information system. Integrated approach to MM Efforts are made to coordinate effectively the end objective of various departments, divisions and projects so that optimization in procurement and usage takes place.
S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT Page 2
Materials Policy
Importance of a Policy Manual 1. Complex nature of the materials management function requires standard set of rules which should be known to all. 2. Thus policy and procedures are consistently followed leading to efficient achieving of corporate objectives. 3. Periodic review of the manual is necessary in order to keep up with the changing requirements of an organisation. Typical policy aspects w.r.t. the materials management dept.(MMD) MMD only to serve as a point of contact between suppliers and the company. Any department wishing to contact any supplier directly must do so only after clearance from the MMD and also keep it informed of the progress. Source development is the exclusive responsibility of the MMD. MMD can question the quality, quantity and price of the materials asked by the user department. MMD shall be responsible for analysis of requisitions, sending out enquiries, analysis of quotations, placement of purchase orders, expediting and controlling inventory. MMD shall keep user departments informed of delivery schedules, accounts payable, receipts etc. in order to ensure smooth operations. Market price levels, new product developments etc. shall be communicated to the concerned departments by MMD. For effective performance of its function the MMD will be assisted by finance department for supplier bills payment and insuring goods in transit and stores. Marketing, business development and planning department shall keep the MMD informed of future plans. MMD shall assist the top management in capital equipment procurement through source location, analysing various alternatives, documentation, including for imports if any. Organising for Materials Management Various models are available to the materials manager. Centralised Vs De-centralised Organising based on product category. Organising based on Project Location. Organising based on functions purchasing, stores, material receipts, transportation etc. Important aspects for projects. Storage at site where conventional storage aspects are not relevant. Flexibility of the set-up to spot interchangeable materials and equipment between projects to avoid delay and idling of equipment. Ability to forecast costs accurately which will assist in correct costing of the project.
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The case of Sobha Developers Limited, Bangalore

Procurement Department It has a centralized procurement department which is responsible for the procurement of material (indigenous & imported) including civil, finishes, plumbing, electrical items, plant and machinery and services for its residential and contractual projects. The material procured by the procurement division includes items such as steel, ready mixed concrete, granite, cement, blocks, tiles, sanitary fittings, paints, tools and construction equipment. Its dedicated procurement department ensures that the raw material requirements of each project are satisfied in a timely and cost effective manner. The procurement department ensures that raw materials and other goods and services sourced from third party vendors are delivered in a timely manner, payment is made to suppliers in a timely manner, scrap on project sites is effectively disposed and it also develops relationships with vendors. Ordinarily Sobha conducts procurements on the basis of prevailing market prices, in certain cases, like that of copper procurement, it has entered into several forward contracts in order to minimize the impact of market fluctuations in the price. Some of its procurement arrangements are created by means of agreements while others are entered into on the basis of letters issued by/to the agencies from which procurement is being done. The said letters or agreements are intended to ensure the availability of a fixed price for the materials being procured from the respective vendors for a period of one to six months from the date of their issue. Some of the above arrangements require that it deposit advance amounts with the vendors and also require that it ensure guaranteed off-take of certain quantities of materials within a fixed time period. As of June 30, 2006, the procurement department comprised of 41 permanent employees and is headed by a Procurement Director.
Classification of Materials
Why should we classify materials? We deal with hundreds of different types of inventory items. With so many items, complexity of managing the process increases. To manage these inventories effectively grouping is essential. Grouping together of materials of technical affinity is known as classification. Classification can be based on various attributes: By size By names By values By end use By product category
ABC Analysis
Is a basic analytical management tool It enables management to place efforts where the results will be greatest. This technique is popularly known as Always Better Control. This technique tries to analyze the distribution of any characteristic by money value of importance in order to determine its priority.
Principles of ABC analysis: 1. The analysis does not depend upon the unit cost of the items but only on its annual consumption value. 2. It is independent of the importance of the item. 3. The limits of ABC analysis are not uniform but depend upon the size of the undertaking, its inventory as well as the number of items controlled. Applications of this technique
For:
Inventory Control Criticality of items Obsolete stock control Purchase orders Receipt of materials Inspection
Store-keeping Verification of bills Basis of ABC analysis This technique is based on Paretos Law ( an Italian Economist) which states the rule of 80:20.
Based on the principle that: - FEW ARE VITAL - MANY ARE TRIVIAL This aims to direct efforts where results are important. Use of ABC analysis Helps in rationalizing the number of orders and reduce the overall inventory even though overall purchase orders are the same, the average inventory can be reduced substantially. Steps for classifying the items into A,B,C categories. 1. List out all the items in the inventory. 2. Ascertain the unit cost of each of the items. 3. Ascertain the number of units issued in a year. Assumption: Issues and consumption are the same. 4. To obtain the annual consumption value multiply the unit cost of each item with the number of units issued in a year. 5. Sort the list of consumption value of each item in the descending order. 6. Starting at the top of the list compute the cumulative total of the rupee consumption value. 7. Compute for each item the cumulative percentages for the item count and cumulative annual value. 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 resources About 20 % of materials consume 20 % of resources About 70 % of materials consume 10 % of resources
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A ITEMS Small in number, but consume large amount of resources Must have: Tight control Rigid estimate of requirements Strict & closer watch Low safety stocks Managed by top management
ABC analysis does not stress on items those are less costly but may be vital B ITEMs Intermediate Must have: Moderate control Purchase based on rigid requirements Reasonably strict watch & control Moderate safety stocks Managed by middle level management
C ITEMS Larger in number, but consume lesser amount of resources Must have: Ordinary control measures Purchase based on usage estimates High safety stocks
ANNUAL COST [Rs.] 90000 50000 20000 7500 7500 5000 4500 4000 2750 1750 1500 1500 500 500 500 500 500 500 500 500 CUMMULATIVE COST [Rs.] 90000 140000 160000 167500 175000 180000 184500 188500 191250 193000 194500 196000 196500 197000 197500 198000 198500 199000 199500 200000 10 %
ABC
A N A L Y S I S
ITEM %
10 %
ITEM 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
COST %
70 %
20 %
20 %
70 %
WORK SHEET
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ACTION PLAN
Limitations of ABC analysis: Over reliance on this method tends to overlook the VED nature of items in the inventory. Items on the border line of the ABC classification need to be scrutinized for placing them under A/B or B/C. In the face of frequent fluctuation of price of the items accurate data needs to be maintained for working out the cost of each item. H-M-L Classification High, Medium, Low value of items. Focus: Cost per unit of items. Useful for: keeping control over material consumption at the departmental level for deciding the frequency of physical verification controlling purchases.
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V-E-D Classification
VITAL-ESSENTIAL-DESIRABLE Focus: To determine the criticality of an item. Mainly useful for the purchase department. 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 A B C AV BV CV E AE BE CE D AD BD CD CATEGORY 1 CATEGORY 2 CATEGORY 3 ITEM 10 20 70 COST 70% 20% 10%
CATEGORY 1 - NEEDS CLOSE MONITORING & CONTROL CATEGORY 2 - MODERATE CONTROL. CATEGORY 3 - NO NEED FOR CONTROL
VED ANALYSIS Categorisation Plan

FACTOR Stock-out in the event of non-availability (30) Lead Time Procurement (30) Nature of the Items (20) Sources of supply (20) First Degree Below Rs. X (30) 1 to 4 weeks (30) Commercial, standard, off the shelf availability (20) Local (20) Second Degree Between Rs. X & Y (60) 4 to 8 weeks (60) As per suppliers design (40) Outstation (40) Third Degree Above Rs. Y (90) Over 8 weeks (90) Produced to buyers design, proprietary item (60) Imported, Quota, Controlled supply (60)
Typical Categorisation Plan

POINTS Between 100 to 160 Between 161 to 230 Between 231 to 300 CLASSIFICATION DESIRABLE ESSENTIAL VITAL
VED - Action Plan VITAL maintain large stock of inventory. ESSENTIAL An In-between policy DESIRABLE Minimum stock is enough
S-D-E Classification
Scarce-Difficult to Obtain-Easy to Obtain Focus: Availability Useful for the procurement department, vital to the lead time analysis, helps in determining purchasing strategies. SCARCE items in short supply. DIFFICULT items which might be available in the indigenous market but cannot be procured easily, items from distance places, un-reliable suppliers EASY items which are easily available, possibly from the local markets G-O-L-F Classification Government-Ordinary-Local-Foreign Focus: source of material Useful for: Purchase department F-S-N Classification Fast Moving Slow moving Non-moving. Focus: Inventories Useful for: Stores department and inventory control. Enables the adoption of the right type of inventory policy to suit a particular situation. Also useful for controlling obsolescence. Categorisation is based on value, criticality and usage. To determine the number of months lapsed since the last transaction the date of receipt or the last date of issue is taken whichever is later. Fast Moving items: most inventory models are aimed at managing the fast moving goods, which exhibit a regular consumption pattern. Slow Moving items: Many spare parts come under this category, they require different management approach, (see below). Non-moving items: Optimal stock disposal rules rather than inventory provisioning rules are to be determined. Managing Slow moving inventory 1. If spares are required only at a pre-specified time, such as the time of scheduled major maintenance for replacement, then it is desirable not to stock them but to place procurement orders sufficiently well in advance, keeping lead times in view, so that spares arrive just-in-time. 2. If the part gives adequate warning of an impending breakdown, then the best policy is to place an order the moment a warning is received. Adequate warning means when the lead time required is less than the warning time. 3. In situations where adequate warning is not obtainable, some stock should be kept. In general one-for-one ordering policy is useful. This means placing an order for one spare when one is consumed.
S-O-S Classification
Seasonal Off-Seasonal nature of items. Focus: Seasonal nature of items Useful for: Purchase department, stores planning for stocking, finance working capital cash flows. X-Y-Z Classification Based on the value of stocks on hand (i.e. investment in inventory) - Items whose inventory values are high are X items. - Items whose inventory values are low Z items - Items whose inventory values are moderate are Y items. - XYZ is used in conjunction with ABC or FSN analysis XYZ in conjunction with ABC
Class of items A Make efforts to reduce the stocks to Z category B Make efforts to convert to Y category C Steps to be taken to dispose off surplus stocks Control may be further tightened **
-do-
**
**
Stock levels may be reviewed twice a year
** indicates items are within control, no further action is necessary
XYZ in conjunction with FSN analysis

Class of items X F Tighten Control S Deplete stocks to very low level Deplete the stocks further, at a good price (to ** N Dispose off immediately at optimum price Dispose off possible as early as
**
Liberalise Control reduce clerical costs)
Dispose off as early as possible, even at lower price
** indicates items are within control, no further action is necessary. This analysis helps prevent obsolescence
RECAP :
ABC - emphasizes % value of consumption JIT - purchase only when demanded VED - criticality for production FSDN - frequency of use HML unit value of stock XYZ closing value of different items
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Classification for accounting and valuation (Type of Inventory) Raw Materials In-process or WIP Finished Goods Goods in Transit MRO Maintenance, Repair and Operating. Supplies which are consumed during the construction process but do not form part of the product itself. (e.g. oil, lubricants, cutting blades, grinding, polishing wheels).
Source Selection & Vendor Development

What is supply chain management? A supply chain is a stream of processes that begins with the raw materials needed to make a product or service and deliver it to customers. Supply chain management flows can be divided into three main flows The product flow The information flow The finances flow There are five basic components for SCM PLAN SOURCE MAKE DELIVER RETURN/RECTIFICATION Plan This is the strategic portion of the SCM. A strategy for managing all the resources required is developed. This involves developing a set of metrics to monitor the supply chain so that it is efficient, costs less and delivers high quality and value to customers. Source Aim is to choose those suppliers that will deliver the goods and services you need to create your product or service on your terms mainly. It includes developing a set of pricing, delivery and payment processes with suppliers. Creating metrics for monitoring and improving the relationships. Sourcing The objective of sourcing is the identification and selection of the Supplier whose costs, qualities, technologies, timeliness, dependability and service best meet the firm's needs. Strategic Sourcing is a systematic process that directs a materials manager's plan, to manage and develop the supply base in line with a firm's strategic objectives. It is the application of current best practices to achieve the full potential of integrating suppliers into the long-term business process.
The supplier as an asset Organizations should view suppliers as potential assets and think of developing them in the long run. Apart from the goods or services that they supply they are a good source of information about: Market conditions General industrial climate Price trends Importance of source development For: Import substitution Cost reduction Quality improvement Source selection and development should be viewed as a continuous activity by a firm. Sembawang - a Punj Lloyd Company Sembawang is renowned for its global advantage in procurement. With its established relationships with manufacturers, suppliers, and vendors around the world, it is able to select the best materials at the best price to give customers the best value. With unsurpassed networking and intimate market knowledge matched by its track record in construction, its customers are assured of the highest level of service and value. Vendor development at Simplex Simplex believes in partnering with their vendors on the road to growth. Simplex is looking for vendors to partner them in their pursuit of growth and in their search for excellence in quality and services To continue to develop the supply chain through closer working relationships, vendors supplying material and services related to civil engineering are requested to register through the form given below. Stages in source selection of Vendors Searching Selection Development Rating Searching Advertising Trade magazines and journals Trade directories In print and on-line. Trade shows and expositions. Encouraging salesmen and supplier correspondence. On-line registration
Selection Vendor Registration Inspection of vendors facility or site Calling for samples. Ascertaining trade reputation. Giving trial order. Critically evaluating the supply. Performance review before making main stream supplier
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Vendor Registration Status of the firm Status of the management Production facilities General impression Housekeeping Type of plant and machinery with capacity and age Space available for expansion Laboratory for Quality Control Certifications Research & development activity
Other essential facilities Staff and worker details Financial Resources Bank limits Turnover Associate companies Licenses and Quotas obtained Registrations with other companies and government departments List of existing customers along with supply details.
Vendor development Vendor Development can be defined as any activity that a Buying Firm undertakes to improve a Supplier's performance and capabilities to meet the Buying Firms' materials or service needs.
Ways to improve supplier performance Assessing the suppliers' operations. Providing incentives to improve performance. Initiating competition among suppliers. Working directly with suppliers - either through training or other activities.
Best Practices in Vendor development Teaching a supplier the importance of QMS after initial guidance from the supplier development team Analysing with the supplier the underlying causes of long delivery cycle times. Involving suppliers in new product and process development. Providing on-line and off-line training programs to suppliers. Conducting frequent improvement-focused seminars for suppliers. Creating supplier support centres at their location. Loaning-out process engineers and quality managers to share their expertise with suppliers. Setting 'stretch goals' to encourage radical change as well as continuous improvement schemes for suppliers. Sharing the savings from supplier development activities with suppliers. Providing asset based support to dedicated suppliers.
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Collaboration between Customer and Supplier Collaboration requires COMMITMENT on the part of the buying firm to provide financial assistance for suppliers investment needs. to share all development savings with the supplier. to educate the supplier on waste management techniques, improve quality, better delivery, reduce cycle-times, reduce costs etc. to treat supplier as if, they are a department within the buying company.
Collaboration requires COMMUNICATION on the part of the buying firm , to ensure that supplier is well informed of all aspects of the supplier development programs. to provide a very transparent feed-back system available to suppliers on their reaction to all supplier development initiatives of the buying firm Collaboration requires a MEASUREMENT mechanism to ensure that all members of the supplier development programs, are benefited to ensure success of the collaboration efforts, there must be transparency in sharing accurate costs of both the parties. Collaboration requires TRUST building measures between the parties to ensure that mutual beliefs and trust between the two organizations personnel is established.
Vendor Rating Vendor Rating Index QUALITY = No. of lots rejected No. of lots received DELIVERY = Delivery on schedule Total no. of deliveries PRICE = Lowest price bid Price bid by vendor
Vendor rating index (overall) = VRI (quality) x A + VRI (delivery) x B + VRI (price) x C Where A,B,C are the weights given to the three vendor rating indexes by the materials management department.
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OBJECTIVES OF INDUSTRIAL PURCHASING The main objective of industrial purchasing is to contribute to the profitability of the industrial operation. In specific terms, the objectives are as follows: I. to obtain the quality of the material best suited for the function intended, II. to obtain the quantity necessary to keep going the production continuously, andkeep the inventory levels at its minimum level, consistent with economicordering and market conditions, III. to obtain the materials or services at the best price, keeping in mind the quality IV. to communicate freely internally with all departments to assist in the formulationof specifications, new techniques, and new products, and externally with outside sources to gain information that the internal departments can use, such as solving some engineering or technical problem.and delivery requested. AUTHORITY AND RESPONSIBILITY OF PURCHASING
The head of purchasing function is referred to as the custodian of a firms purse, and the first and foremost obligation on his or her part is integrity in spending the firms money. He or she acts as the legally authorized agent and represents all others in the firm in the acquisition of goods and services needed by the firm. A typical job description for this position includes duties and responsibilities: 1) Authority to commit the funds of the firm for the acquisition of goods and services, 2) Responsibility to satisfy needs of the departments when justified, 3) Responsibility for review of specifications, and authority to challenge the specifications, if found incomplete or incorrect, 4) Responsibility to interview all vendor representatives, and to arrange for the bidding or negotiation for goods or services, 5) Authority and responsibility for selection of the source for supplies and no body else has this authority to select a source for any item, 6) Responsibility to obtain the correct quality, the needed quantity, at the best price delivery at the needed time for continuous operation, and the equal responsibility that the goods, equipment, etc., are safe for the employees to handle.
WHY SOURCE SELECTION? Reputed suppliers are intangible assets to any organisation. For they are not only suppliers of materials but are also extremely important sources of information with regard to market conditions, price trends, and the general industrial climate. It is, therefore, natural that many organisations have accepted source selection as a corporate policy. This helps in bringing about a fair competition among the suppliers with supply failures at a minimum level. Source development is also important for import substitution, cost reduction, and quality improvement. Source development needs are dependent on a number of factors, such as make or buy decisions, amount of sub-contracting, breakeven points at manufacturing and plant capacity. It should, however, be remembered that source selection and development are regular activities, and as such, must be a way of life in any progressive purchasing department of an organisation.
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STAGES IN SOURCE SELECTION Regardless of the buyers ability to provide the technical services, interpret quality requirements, determine price trends, and provide expertise in all procurement functions, the fact remains that his or her prime responsibility is to find reliable sources and to secure and maintain their cooperation in all matters. This purchasing decision directly influences both the economic success of the buyers company and the financial stability of the supplier, thus contributing to the economic welfare of many employees and their families. In general, the source selection process consists of four main stages: 1) Searching: At realisation for the need for a material or product is the starting point. The search process begins with the finalisation of specifications in consultation with technical departments. Identifying the sources of supply as exhaustively as possible is the next activity. The buyer may have information on the past performances of the set of suppliers already I contact Salespersons are extremely valuable sources of information about suppliers. In most cases their information relates to their own company, but many professional salespersons will suggest other sources of supply. A valuable source of supplier information is catalogues supplied by the suppliers,which describe the various items they handle. For standard production items,such catalogues are the most effective and efficient sources for potential suppliers. 2)Selection: The process of search thus provides a list of all possible sources. At the selection stage, specific information on the suppliers financial strength, quality, facilities, efficiency, industrial relations, technical excellence and position in industry is sought. Actually, the possible sources need to be identified and selected on the basis of their ability to meet the delivery and quality requirements in the long run at competitive price levels. The selection of suppliers starts with the floating of enquiries by the buyer to the possible sources that are made available through the search process. Certain progressive suppliers often contact buyers with a request to be included in the buyers list of approved suppliers. Both the buyers enquiry and the vendors request to be considered as a regular supplier, normally lead to visits by the vendors sales representative. The buyer gets an opportunity to present his or her needs in greater details and also to assess vendors personnel and capabilities in meeting his or her needs. The buyer follows this by meeting the technical personnel of the vendor, and inspecting the vendors plant to assess the technical capabilities, efficiency, equipment, financial viability, quality control, raw material practices, and general management aspects. 3)Negotiations and Trial Orders: Once the preliminary screening and selection is over, the process of negotiation starts with the vendors prior to placement of trial orders. Correct and cordial relations with the vendors are essential for mutual cooperation. Various aspects, including terms of delivery, price, and quality are finalised during negotiations, and then the purchase orders are released for the initial trial. Normally, the trial orders do not exceed more than 20 to 30 days requirements as the buyer has to be convinced, in the first place, about the vendors capability in meeting his or her needs.
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4) Experience: After the trial orders are executed, it becomes necessary for the buyer to quantify his or her experience in the form of rating the vendors. This activity enables him or her to determine how the total requirements can be apportioned among the vendors. Thus, the basic responsibility of the purchase manager is not only to locate the sources but also to preserve them through continuous rating.
The key to successful analysis is to identify the important characteristics of the particular purchase. Usually, three important factors are evaluated. Quality Evaluation is simply reviewing the suppliers record in respect to meeting the required specifications, which is measured as a percentage of acceptable shipments or delivery. It should be the policy for the quality-control section to inform the purchasing department of the facts concerning each shipment/delivery. Price Evaluation in its simplest form is the net price quoted in each instance for conforming goods compared to the prices quoted by competitors. Consistency of success and integrity in price behavior would provide a measure criterion. Service Evaluation includes prompt submission of data, response to inquiries, delivery performance, special services rendered, and other intangibles. Most of the elements in this factor are subjective in nature. The objective of the supply chain network is to minimize the end customers total level of dissatisfaction, composed of price and delivery lead time. PURCHASING PERFORMANCE AND SUPPLIER DEVELOPMENT Facing increasingly competitive challenges, many organizations view supplier performance as an important contributor to their competitive advantage. They work closely with suppliers and expect to improve performance and capabilities by engaging supplier development programs. It has been reported that such programs have been extensively implemented inwestern countries. However, developing the supplier has also provided quitechallenging. A conceptual model for guiding the implementation of supplier development program was proposed by Hahn et al. However, it was not empirically tested. Some perceived critical elements of supplier development were explored by Krause and Ellram, and some antecedents of involvement in supplier development program were also identified by Krause. But these factors were not linked with purchasing performance. In this body of literature, few empirical research studies have been conducted to examine the factors which are critical to the success of the approach.
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INFLUENCING FACTORS OF SUPPLIER DEVELOPMENT: The important elements of supplier development may be identified from the buying firms perspective. The following factors are worth mentioning: 1. Long-term Strategic Gal: Supplier development efforts should focus on developing supplier future capabilities in technology and product development rather than focusing only on current quality and cost. The clarity of long-term strategic goals is the key to the success of supplier development programme. 2. Effective Communication: Open and frequent communication between buying firm personnel and their suppliers is identified as a key approach in motivating suppliers. Early involvement and open channels of communication increase both parties understanding and encourage problem solving between both parties. 3. Partnership Strategy: The majority of buying firms involved in supplier development may perceive their suppliers as partners. Adopting a partnership strategy means that a buying firm pursues a long-term relationship with suppliers and they would like to show their commitment. Without buyers commitment, the suppliers may be unwilling to make changes in their operation to accommodate and desires of that. 4. Top Management Support: It is top management who recognizes the need to initiate a supplier development programme based on the firms competit ive strategy. Purchasing management needs the encouragement and support from top management to expend their resources within a suppliers operation. 5. Supplier Evaluation: Not all selected suppliers qualify for development assistance and a buying firm must carefully identify where to focus its supplier development efforts. Supplier evaluation results can provide valuable information about general areas of weakness where performance improvements are required. 6. Direct Supplier Development: In order to pursue excellence and develop best practices, the suppliers need the encouragement or expertise of their buyers. Direct supplier development activities include providing support personnel, capital, equipment, technology, or direct involvement with suppliers in identifying and eliminating non-value or duplicate costs, processes and time. These assistances from the buyers can accelerate supplier capability improvement greatly. 7. Perception on Suppliers Strategic Objective: Supplier development requires a mutual recognition by the buyer and supplier of the need for continuous performance improvement. Supplier development would not work if the supplier does not have a compatible strategic objective with that of customer.
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PURCHASING
What is Purchasing? :Purchasing is a service function Definition Purchasing implies the act of exchange of goods and services for money. OR Purchasing is the process of buying - learning a need , selecting a supplier , negotiating a price and fixing the terms of delivery and payment. Procurement Vs Purchasing Procurement is a generic term for the total responsibility of acquiring goods or services. It includes all additional functions such as inspection, receipts etc. Procurement is related to acquisition of materials including purchasing Basic Principles of Purchasing Buying the right quality Buying the right quantity Buying at the right price Buying from the right source Buying at the right time and place Basic objectives of Purchasing 1. To maintain continuity of supply to support construction schedules. 2. To ensure minimum investment in stores and materials inventory, consistent with supply and economy. 3. To avoid duplication of purchases and costly delays. 4. To maintain proper quality standards based on suitability criteria. 5. To procure materials at lowest possible cost, consistent with quality and service requirement. 6. To maintain companys competitive position in the market by controlling material costs. LEAD TIME Lead Time is the time that elapses between the realisation of the need for the item and the fulfilment of that need. It is therefore the total time necessary to replenish stock of an item. Elements of lead time External & Internal 1. Time required by the indenting department to purchase [stock, non stock items, indent channel, C class items fast and direct. A & B class items require more time]. 2. Time required by the purchase department to convert a purchase indent into a purchase order. [RFQ, posting, samples, trial order, time limit to respond]. 3. Time required by the seller to process the order and service the same. 4. Transit time for goods. 5. Time required by stores to inward the goods [GRR, quantity verification]. 6. Time required for quality inspection including performance checks. 7. Time required by stores [to update records, place goods in bins for issue, stacking, storage].
Purchase Procedure 1. Purchase Requisition or Indent from user. 2. Verification of current stock levels by the Stores department. 3. Assessing exact procurement required with detailed specifications. 4. Enquiry / RFQ. 5. Evaluation of Bids received, preparation of comparative statement. 6. Negotiations. 7. Placing of the Purchase Order. Material Indent - Definition Document generated by a user department or storeroom-personnel to notify the purchasing department of items it needs to order, their quantity, and the timeframe. It may also contain the authorization to proceed with the purchase. Also called purchase request or requisition. Requisition/ indent key information check list 1. Date & time 2. Material Description 3. Detailed specification, standards or make. 4. Quantity 5. Suggested supplier 6. Purpose 7. Approximate date when required 8. Originating department 9. Authorisation Request for quotations (RFQ) It is a document used in soliciting price and delivery quotations that meet minimum quality specifications for a specific quantity of specific goods and/or services. RFQ are used commonly for (1) standard, off-the-shelf items, (2) items built to known specifications, (3) items required in small quantities. Suppliers respond to a RFQ with firm quotations. Invitation to bid (ITB), request for tenders, and request for proposals or Enquiry Enquiry form disclaimer To ensure that the supplier does not construe the request for quotation as a firm order and commences supplies, usually the phrase: this is not a purchase order, is written / printed prominently across the enquiry form. Negotiations prior to placing of order: To evolve mutually agreeable terms:1. To finalise price through negotiating (usually in the absence of competitive bidding). 2. To finalise mode of transportation and payment upto site. 3. To finalise payment terms including opening letter of credit. 4. To finalise prior delivery and post delivery inspection/ quality control 5. To finalise the material delivery schedule 6. To finalise guarantees and penalties. Other factors penalty/bonus, rejections, insurance, LD clauses, currency fluctuations etc.
Purchase Order - definition A purchase order is a buyer-generated document that authorizes a purchase transaction. It sets forth the descriptions, quantities, prices, discounts, payment terms, date of performance or shipment, other associated terms and conditions, and identifies a specific seller. When accepted by the seller, it becomes a contract binding on both parties. Also called order. Purchase Order key information check list 1. P.O. reference no. 2. Date 3. No. of copies 4. Quotation / Offer for supply ref. 5. Description of material 6. Detailed specification detailed description of characteristics, blue print, drawing, market grades, brand names or trade names, commercial standards, preference characteristics. 7. Quantity required. 8. Delivery schedule. 9. Price and discounts + taxes and duties. 10. Packing Instructions. 11. Shipping instructions. 12. Place of delivery (Location where material required). 13. Detailed terms and conditions - vendor rating. 14. Payment terms. 15. Price variation / escalation or reduction. 16. Exit terms order cancellation
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PURCHASING- II
Types of buying 1. Forward buying buying materials exceeding current requirement of quantity 2. Speculative Buying buying and selling at a higher price. 3. Hedging Buyer protects himself by entering into 2 contracts. 4. Hand to mouth buying stockless purchase, zero stock 5. Tender buying 6. Rate Contract Govt. item rate is fixed. 7. Systems Contracting covers only delivery period, price, invoicing procedure, users can obtain the material directly from Supplier useful for low unit price but high consumption value items. 8. Blanket order an incomplete contract with a vendor to purchase certain items but not an authorisation to ship materials. Suitable for low value items. Purchasing Organization refers to how purchasing is organized in the firm Centralized Purchasing- one purchasing department located at the firms corporate office Decentralized Purchasing- many individual, local purchasing departments making their own purchasing decisions.
Centralised purchase organisation of GOI DGS&D Directorate General of Supplies and Disposals under Dept. Of Commerce, Ministry of Commerce and Industry. Role of DGS&D To conclude the rate contracts to be operated by the consuming departments of the Government for items of common use. For items, whose anticipated annual purchase by Government Organisations is normally more than Rs. 25 lakhs a year. Preference given to indigenously produced stores vis--vis imported stores. As a matter of policy DGS&D concludes rate contracts with manufacturers. Only where manufacturer himself does not market his products, DGS&D entertains sole distributor/ selling agent in lieu. For imported stores, DGS&D may deal with stockists/ suppliers of imported stores provided they have proven relationship with the foreign manufacturer with guarantee of after sale service and supply of spares and having adequate infrastructure for after sale service in India. Undertakes pre-despatch inspection of stores on orders placed by civil indentors on rate contracts. This ensures that stores actually supplied are strictly as per rate contract specifications & are of proper quality. The Quality Assurance Wing of the DGS&D also undertakes inspection of the stores being purchased by Government Departments outside rate contracts on payment of fees, as also inspection for State Governments/ PSUs & other Government Organisations. The paying authority in respect of the rate contracts is the Chief Controller of Accounts (CCA(S)), Department of Commerce (Supply Division). Subject to adequate safeguards, advance payment upto 98% of the value of the stores is given to the suppliers on submission of bills in the Offices of the CCA(S).
Advantages of The Rate Contract Scheme: 1.To Buyers: Facility of bulk rate at lowest competitive price. Saves time and effort in tedious and frequent tendering at multiple user locations. Enables buying as and when required. Just in time availability of supplies reduces inventory carrying cost. Availability of quality goods with full quality assurance back up. . 2.To Suppliers Access to large volume of purchase without going through tendering and follow up at multiple user locations saving in administrative and marketing efforts and overheads. Rate contract lends respectability and image enhancement What is a Rate Contract (RC)? A rate contract is an agreement between the Purchaser and Supplier to supply stores at specified prices during the period covered by the contract. No quantities are mentioned in the contract. Nor any minimum drawal is guaranteed. The rate contract is in the nature of a standing offer from the supplier firm. A legal contract would come into existence with the placement of individual order (Supply Order) and each such supply order will constitute a separate contract. EXISTING RATE CONTRACT HOLDERS QUOTING PRICES LOWER THAN THEIR EXISTING RATE CONTRACT RATES
13.13.1 If lower rates are quoted by the existing rate contract holders themselves for the fresh rate contract, they may be asked if they are prepared to reduce the rates against the existing rate contracts. 13.13.2 In case, the existing rate contract holders do not reduce the prices against the current rate contracts and quotations have been received at lower rates from new firms, who are likely to be brought on rate contracts, the purchase officers will advise the Direct Demanding Officers of the lower trend in prices and ask them to consider whether they can postpone placement of supply order against the existing rate contracts and wait for finalization of fresh rate contracts.
Centralized or Decentralised purchasing

Advantages of Centralised purchasing 1. Ensures better control under one person or department, Results in record keeping etc. 2. Develops specialised knowledge, skills and efficiency for economical purchasing 3. Since other departments are relieved of purchase responsibility their performance is better. Disadvantages of Centralised purchasing 1. Somewhat slow due to the spread of sites and geographical distances between sites. 2. Since local purchases are few, attending to problems relating to materials takes longer than decentralised purchasing.
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Centralized vs. Decentralized Advantages- Centralization Leveraging purchase volume Avoid duplication of effort Specialization Lower transportation costs No competition within units Govt.buying 1. Purchase by tender 2. Purchase by repeat order 3. Purchase by negotiation
Common supply base
Advantages- Decentralization Better knowledge of user requirements Local sourcing Less bureaucracy
1.Open Tender This is the usual method of purchase. Involves issue of an invitation to tender by the buyer. This invitation requests the seller to offer to sell the stores described in the tender schedule on terms and conditions stipulated in invitation to the tender. The seller submits his offer including price. With the issue of the acceptance of tender or offer, the contract is concluded. Tender enquiry Of two types: I. Advertised Tender II. Limited Tender Advertised Tender In government purchasing usually when the: Quantity is large Value of procurement is high Delivery schedule allows sufficient lead time for procurement. Source availability is limited and more sources are to be generated Advantage is that it leads to generation of competitive bids resulting in economic procurement. Main disadvantage long lead time due to the process involved and sometimes formation of cartels. Limited Tender Limited tender enquiries are issued: in cases of urgency or where all likely sources of supply are known. Normally such an enquiry is limited to firms which are registered with the buyer department/organisation. When the number of registered firms for a particular product are large the enquiry may be issued to few select at a time such that by rotation all the registered firms get a fairchance to bid.
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STORES MANAGEMENT
Importance Stores is considered the least important and least glamorous function of an organisation. Challenge to the stores manager plays a pivotal role in ensuring smooth project construction besides assisting purchase activities by providing timely information. STORES FUNCTIONS To receive goods raw materials, components, tools & equipments and other items and account for them. To provide adequate and proper storage and preservation of the goods in store. To meet the demands of the consuming departments. To minimize obsolescence, surplus and scrap. To highlight stock accumulation, discrepancies, abnormal consumption and effect control measures. To ensure good housekeeping. Design factors for good stores management Location ideally should be as near to the point of consumption as possible so as to reduce handling and to have timely despatch. Layout should ensure easy movement of materials. Ensure easy retrieval, ergonomically. Sufficient space (for men and material handling equipment) shelves, racks, pallets. Proper preservation rain, light, heat, cold storage, air conditioning. Lighting adequate lighting is essential Safety - training safety consciousness, safety appliances, Personal Protective Equipment (PPE) good house keeping keep stores equipment in good order, forklifts, cranes, trolleys, conveyors. fire fighting equipment toilets Specific Functions of a Store. A. Receipt B. Stocking C. Issues A) .RECEIPT SYSTEM Receipts into the organisation or store come from many sources: a. From outside suppliers b. From rejected stores c. From surplus stores d. From scrap generated e. From empties f. From stock transfer from other project sites The Receipt system of a store starts much before the actual receipt of materials at the store. This requires proper planning in advance.
The Purchase order indicating quantity and delivery date is the starting point. Records should me maintained in a chronological order to show expected daily receipts. So that the handling and storage can be planned in advance. This helps in planning labour contracts for uploading, stocking etc. and when to take delivery demurrage. Suppliers send despatch note or advise note to the stores in advance i.e. Date of despatch, carrier details, description, value etc. Document of transport department LR/RR or consignment note Packaging slip detailing contents in the package. Insurance Actual physical receipts (delivery challan a. verification for quantity, shortages, damages, claims preference. b. take open delivery with transporters get shortage or excess or damage endorsed. Provisional Goods Inward (PGI) physically received, pending inspection note/report. Final goods inward note (FGI) INTERNAL RECEIPTS transfer note/ return to stores, stock transfer (no sale), Debit/Credit note, Internal DC (delivery challan) . Where to integrate the quality inspection dept? B) .STOCKING Sorting and storing issues when volumes are high, provide separate areas for:1) Stores awaiting inspection. 2) Stores which are QC inspected, passed and accepted for use. 3) Storage of rejected materials. ( FG not applicable to construction activity directly) C) .ISSUES For consumption by internal departments as per order or indent. To works on returnable basis. To outside suppliers for processing or conversion. For stock transfer to other divisions or project sites. Standardisation A standard is defined as a model or general agreement of a rule established by authority, consensus, or custom created and used by various levels of interest. Aim of standardisation should be to have uniform standards for similar items. Standardisation leads to simplification or variety reduction. Standardisation should be of the most economical sizes, grades, shapes, colours, types of parts and so on. ISI mark (Bureau of Indian standards) over 7,000 standards
Benefits of standardisation Standardisation enables the materials manager to achieve overall economy, ensures inter changeability of parts, implies better availability, better price and better delivery. It means rationalizing purchase efforts, less stock (due to less variety) and hence less obsolete items.
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Less inspection effort( e.g. - no routine checking of ISI marked items) helps reducing inventory items. Codification and Standardisation We deal with thousands and sometimes even lakhs of different items in inventory. The problem is of how to ensure unique product identification? a. suppler gives it a different name, different departments may give it different names, trade names may be many. Hence codification is necessary for easy identification of materials. a. It should be simple to implement b. It should be capable of being understood by all. c. It should be compact, concise, consistent and flexible. How Can it be Done? a. representing each item by a number (numerical code) b. the digits may represent a group, sub group, type, dimension etc. c. In big organisations these codes may vary from 8 to 13 digits ( Railways, Defence etc) d. Major groups raw materials, spare parts, sub contracted items, hardware items, paints and furnishing materials, electricals, HVAC, tools, oils & lubricants, stationary etc. e. sub groups How Can it be Done? Codification can be as per nature of items e.g. Ferrous, non ferrous or as per end use or as per source of purchasing There can be other methods of codification like: Alphabetical system single or double combination i.e. Alpha numeric colour code ( either exclusive or in conjunction) Advantages of codification Unnecessary writing of lengthy description is avoided Helps in reduction in number of items, becomes a starting point of simplification and standardisation Helps in avoiding duplication of items Helps in easy recognition of an item in stores Illiterate employees who handle loading, unloading stacking and issues by using a code find it easy and it ensures that the right type of material is issued to the users. Popular Models KODAK SYSTEM:
Is a 10 digit numerical code logic based on sources of supply (procurement consideration). Materials are divided into 100 basic classifications Each class is divided into 10 subclasses E.g. 20 - cutting tools, 200 drills, reamers etc.
1. 2. 3. 4. 5.
BRISCH SYSTEM: Based on the name of a consulting engineer. Is a 7 digit system 3 phases, based on logical major groupings.
Assemblies, sub assemblies, components.
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STORES ACCOUNTING
Any inventory item has both physical and financial characteristics. Whereas the physical characteristics (flow of goods) are factual and measurable, financialcharacteristics (flow of costs) are mainly subjective in nature. The financialcharacteristics associated with the flow of costs are usually emphasized in stores accounting and valuation. WHY STORES ACCOUNTING? Stores accounting plays a very important role for the estimation of the cost of a product for pricing decisions. Material costing is very important in terms of the valuation of the cost of materials consumed by say, the production department during a given period of time as well as in terms of the estimation of the value of materials held in stock. In this context, two important aspects, viz., costing of the materials receipt and of materials issue, are considered in stores accounting. 1 Costing of the Receipt of Materials The factors that are to be included in building up the cost of the materials received are material price, freight charges, insurance, and taxes. Price usually refers to the price quoted and accepted in the purchase orders. Prices may often be stated in various ways, such as net prices, prices with discount terms, free on board (FOB) and cost insurance and freight (CIF). For costing purposes the actual cost incurred needs to be calculated by taking price quoted by supplier as the basis, subtracting the discounts and adding any other expenses not covered. 2 Costing of the Issues of Materials to Production There are several methods that are in use for costing the issues of materials to the production and other departments of an organization. First in first out (FIFO), last in first out (LIFO), average cost, standard cost, base stock method, market price at the time of issue, latest purchase price, and replacement or current cost methods are a few of the methods used for this purpose. Material Costing : Is important for: 1) Valuation of the cost of materials consumed, and 2) Estimating the value of materials held in stock. - at various stages FLOW OF COSTS (or) Pricing material issues 1) Actual cost method. 2) FIFO First-In-First-Out 3) LIFO Last-In-First-Out 4) HIFO Highest-In-First-Out 5) Simple Average Cost Method 6) Weighted average Cost Method 7) Periodic Average Cost Method 8) Standard Cost Method 9) Replacement Cost Method (market price method) 10) NIFO Next-In-First-Out method 11) Base Stock Method
FIFO Method Assumption: Oldest stock is depleted first. At the time of issue the rate pertaining to that will be applied. Since actual prices are used there cannot be any profit or loss in the pricing arrangement. The value of stock on hand is the money that has been paid for that amount of stock at latest price levels and hence can be straight away used in the balance sheet, truly reflecting value. Example 1 The periodic inventory record shown in Table 13.1 is available on an item. A physical count of the items on 1 April reveals an ending inventory of 300 units. What is the value of the ending inventory? What is the cost of goods sold for the period?
Advantages: Easy to understand and simple to price the issues. A good store keeping practice in which the material leaves the store in a chronological order based on its age. Involves less clerical costs.
Method of valuation is accepted under standard accounting practice Inventory valuation is nearest to recent market prices. Limitations Process becomes unwieldy when too many changes in price occur. Problem in accounting for returns to stores. 2 LIFO Method In the LIFO method, it is assumed that the most current cost of goods should be charged to the cost of goods sold, and hence, in LIFO, the cost of units remaining in inventory represents the oldest costs available, while the units issued are valued at the latest costs available. The underlying purpose of LIFO is to match current revenues against current costs, so the method charges current revenues with amounts approximating replacement costs. Assumption: Most recent receipts are issued first. Advantages: a. In a period of rising prices, latest (higher) prices are charged to issues, thereby leading to lower reported profits and hence savings in tax. b. When there are wide fluctuations in price levels, LIFO tends to minimise unrealised gains or losses in inventory. - Limitations same as that of FIFO.
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3 Average Cost Method In an attempt to provide a better estimate of the ending inventory and cost of goods sold, the average cost method is proposed. This method does not attempt to indicate which unit goes out first or last. Instead, it determines the average cost for each itemduring a time period. The following three types of average method are in use: i)Simple average, ii)Weighted average, and iii) Moving average. While all three types are suitable for with a periodic inventory system, the moving average is best suited to the perpetual inventory system. The simple average is determined by dividing the sum of production or purchase unit costs by the number of production runs or orders. The simple average does not consider the size of the lot or the number of units and assigns equal weight to the unit production or purchase cost of each lot. The weighted average corrects the distortion of the simple average by considering quantity as well as unit cost. The weighted average divides the cost of goods available during the period. The moving average computes an average unit cost after each purchase or addition to stock, making it better suited for computerized inventory operations. Since the simple average and the weighted average cannot be calculated until the period is over, they are not well suited to perpetual inventory systems. All of the averages are suitable for periodic inventory systems, since costs are not allocated till the end of the period. With the average cost method, the costs of all like items available during the period are averaged to obtain the ending inventory value. The unit cost cannot be equated to any tangible figure, and it does not reveal price changes as clearly as may be desired. Example 5 The periodic inventory record shown in Table 5 is available for an item. A physical count of the item on April reveals an ending inventory of 300 units. Calculate the values of the ending inventory and the cost of goods sold using the (a) simple average, (b) weighted average, and (c) moving average methods.
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3.Specific Cost Method Of all the inventory flow assumptions, the specific cost method provides the most realistic valuation of ending inventory and cost of goods sold. The procedure consists of tagging or numbering each item as it is placed into inventory so its exact cost is readily discernable. Since an item is both valued and expensed at its specific cost, the cost flow and the physical flow are identical with this method. The cost of maintaining records under this method can mount very quickly, so it is most appropriate for goods of significant value, which is few in number. The specific cost method has the added flexibility of being suitable for either perpetual or periodic inventory items used in custom-made products. If the number of custom orders being processed is large, its implementation can be extremely expensive and difficult. Thus, its use is more commonly confined to small operations. A number of methods are included in this category. They are as follows: i)Market Value, ii)Standard Cost, iii) Closing Stock A brief description of each of this method is given below. i) Market Value: This method is also known as replacement rate costing. Herethe materials that are issued are costed at the market rate prevailing at the time of issue. Hence, when prices increase, the stock on hand is continuously underestimated, because receipts are costed at actual rates and issued at higher rates. Conversely, when the prices are falling, the stock on hand is grossly overestimated. This may in turn lead to writing off huge amounts to make it realistic. Besides, this system requires continuous monitoring of market rates for all materials and hence, is very unwieldy and unreliable. ii) Standard Cost: Here, a standard rate is determined based on detailed analysis of market prices and trends. This standard rate is kept fixed for a definite period of six months or so. During this period costing is done on the basis of this standard rate, irrespective of the actual rates. At the end of the period, a review is done and fresh standards are set for a further period of six months. Efficient use of materials is truly reflected by adopting this method, as the accounting is divorced from fluctuations in rates. Moreover, it is not necessary to obtain fresh rates at every point of time. This means greater clerical efficiency and quicker estimation of costs. However, in this method also, at the time of rising prices the stock on hand is underestimated, and at the time of falling prices, the stock on hand is overestimated. iii) Closing Stock Costing: Generally the guideline used here is that either the market price or stock at cost is to be used, whichever is less. The main factors, which determine the cost of closing stock, are price levels, obsolescence, and deterioration. Reasons for discrepancies in stock Discrepancy = difference between physical stock and stock shown in records. Items placed in wrong location. Pilferage and theft by insiders/outsiders. Stock returns not recorded properly. Arithmetical errors in calculating the balances in bin card. Clerical errors in stores ledger. Shortage due to spoilage, evaporation, wastage in material handling and storing, Increase/decrease in weight. Issue and receipt of stock without proper recording. Actual quantity supplied differs from the quantity mentioned in the Delivery Challan.
Steps to avoid discrepancies Restrict entry to stores to authorized personnel only. Materail requisition to be signed by authorized persons only, and issue material only then. Proper maintenance of store records Bin Card, Stock Card, Stores Ledger etc. Regular checks by independent staff to detect and correct mistakes. Record all movements of stock. Physical verification and counting at the time of receipts and issues. Use of FIFO method for stock issue to avoid deterioration and obsolescence. STOCK VERIFICATION It is the process of physically counting, measuring or weighing the entire range of items in the stores and recording the results in a systematic manner. Stock Verification is usually carried out by the materials audit department, reporting to either the materials manager or the internal audit. One person is usually given the exclusive responsibility with adequate facilities and authority. The main objectives of stock verification are as follows: a. To reconcile the stock records and documents for their accuracy and usefulness,Systems b. To identify areas which require more disciplined document control, c. To back up the balance sheet stock figures, and d. To minimize pilferage and fraudulent practices. The physical verification of stock may be carried out either as a periodic or continuous basis. These two methods are briefly discussed below. Periodic Verification and Continuous Verification
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Inventory
Definition: A stock of items held to meet future demand. Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business.
Introduction Constitute significant part of current assets On an average approximately 60% of current assets in Public Limited Companies in India A considerable amount of fund is required Effective and efficient management is imperative to avoid unnecessary investment Improper inventory management affects long term profitability and may fail ultimately 10 to 20% of inventory can be reduced without any adverse effect on production and sales by using simple inventory planning and control techniques
Functions of inventory: To meet anticipated customer demand To decouple suppliers production distribution To take advantage of quantity discounts To hedge against inflation & price increases To protect against delivery variations To avoid production disruptions through use of Work-In-Process (WIP)
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Negative aspects of inventory: Large inventories hide operational problems Financial cost in carrying excess inventories Risk of damage to goods held in inventory Risk of product obsolescence Types of Inventory: Raw material Purchased but not processed Example Iron ore steel mill ,Flour bakery Work-in-process Undergone some change but not completed A function of cycle time for a product Example Radiator auto manufacturer .Draft contract attorney Maintenance/repair/operating (MRO) Necessary to keep machinery and processes productive Example Lubricating oil machine shop .Soap and shampoo hotel Finished goods Completed product awaiting shipment Example Candy bar confectioner ,Policy insurance company Supplies Office and plant cleaning materials not directly enter production but are necessary for production process and do not involve significant investment.
Objective of Inventory Management To maintain a optimum size of inventory for efficient and smooth production and sales operations To maintain a minimum investment in inventories to maximize the profitability Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality
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An effective inventory management should Ensure a continuous supply of raw materials to facilitate uninterrupted production Maintain sufficient stocks of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operation, and efficient customer service Minimize the carrying cost and time Control investment in inventories and keep it at an optimum level Opposing Views of Inventory l Why We Want to Hold Inventories l Why We Not Want to Hold Inventories Why We Want to Hold Inventories ? l Improve customer service l Reduce certain costs such as l ordering costs l stockout costs l acquisition costs l start-up quality costs l Contribute to the efficient and effective operation of the production system l Finished Goods l Essential in produce-to-stock positioning strategies l Necessary in level aggregate capacity plans l Products can be displayed to customers l Work-in-Process l Necessary in process-focused production l May reduce material-handling & production costs l Raw Material l Suppliers may produce/ship materials in batches l Quantity discounts and freight/handling $$ savings Why We Do Not Want to Hold Inventories ? l Certain costs increase such as l carrying costs l cost of customer responsiveness l cost of coordinating production l cost of diluted return on investment l reduced-capacity costs l large-lot quality cost l cost of production problems
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Nature of Inventory 1. Two Fundamental Inventory Decisions 2. Terminology of Inventories 3. Independent Demand Inventory Systems 4. Dependent Demand Inventory Systems 5. Inventory Costs Two Fundamental Inventory Decisions l How much to order of each material when orders are placed with either outside suppliers or production departments within organizations l When to place the orders Independent Demand Inventory Systems l Demand for an item carried in inventory is independent of the demand for any other item in inventory l Finished goods inventory is an example l Demands are estimated from forecasts and/or customer orders Dependent Demand Inventory Systems l Items whose demand depends on the demands for other items l For example, the demand for raw materials and components can be calculated from the demand for finished goods l The systems used to manage these inventories are different from those used to manage independent demand items l
Inventory Costs l Costs associated with ordering too much (represented by carrying costs) l Costs associated with ordering too little (represented by ordering costs) l These costs are opposing costs, i.e., as one increases the other decreases l The sum of the two costs is the total stocking cost (TSC) l When plotted against order quantity, the TSC decreases to a minimum cost and then increases
l l
This cost behavior is the basis for answering the first fundamental question: how much to order It is known as the economic order quantity (EOQ)
An optimum inventory level involves three types of costs

Ordering costs: Quotation or tendering Requisitioning Order placing Transportation Stock-out cost Loss of sale Failure to meet delivery commitments Carrying costs: Warehousing or storage Handling Clerical and staff Insurance Interest Deterioration,shrinkage, evaporation and obsolescence Taxes Cost of capital Receiving, inspecting and storing Quality control Clerical and staff
Dangers of Over investment Unnecessary tie-up of firms fund and loss of profit involves opportunity cost Excessive carrying cost Risk of liquidity- difficult to convert into cash Physical deterioration of inventories while in storage due to mishandling and improper storage facilities
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Dangers of under-investment Production hold-ups loss of labor hours Failure to meet delivery commitments Customers may shift to competitors which will amount to a permanent loss to the firm May affect the goodwill and image of the firm
Functions of Inventory Management

Track inventory
How much to order When to order
Classification of inventory ABC Classification HML Classification XYZ Classification VED Classification
FSN Classification SDF Classification GOLF Classification SOS Classification
ABC Classification In most of the cases 10 to 20 % of the inventory account for 70 to 80% of the annual activity. A typical manufacturing operation shows that the top 15% of the line items, in terms of annual rupees usage, represent 80% of total annual rupees usage. Next 15% of items reflect 15% of annual rupees Next 70% accounts only for 5% usage XYZ Classification On the basis of value of inventory stored Whereas ABC was on the basis of value of consumption to value. X High Value Y Medium value Z Least value Aimed to identify items which are extensively stocked. HML Classification On the basis of unit value of item There is 1000 unit of Q @ Rs. 10 and 10,000 units of W @ Rs. 5. Aimed to control the purchase of raw materials. H High, M- Medium, L - Low VED Classification Mainly for spare parts because their consumption pattern is different from raw materials. Raw materials on market demand Spare parts on performance of plant and machinery. V Vital, E Essential, D Desirable FSN Classification According to the consumption pattern To combat obsolete items F Fast moving
S Slow moving N Non Moving SDF & GOLF Classification Based on source of procurement S Scarce, D- Difficult, E- Easy. GOLF G Government, O Ordinary, L Local, F Foreign. SOS Classification Raw materials especially for agriculture units S Seasonal OS Off seasonal Deciding on the inventory model Assume an analyst applies an inventory model that does not allow for spoilage to a grocery chains ordering policy for lettuce and formulates the strategy of ordering lettuce in large amounts every 14 days. A little thought will show that this is obliviously foolish. This strategy implies that lettuce will be spoiled. However it is not a failure of inventory, it is a failure to apply the correct model. Different approaches Certainty approach Uncertain variables and risk are addressed separately Uncertainty approach Uncertain variables and risk are addressed simultaneously Deterministic approach Probabilistic approach Independent Demand Models Fixed order-quantity models Economic order quantity (EOQ) Production order quantity (POQ) Quantity discount Probabilistic models Fixed order-period models
EOQ Model
EOQ assumptions: Known and constant demand Known and constant lead time Instantaneous receipt of material No quantity discounts Only order (setup) cost and holding cost No stockouts
Behavior of EOQ Systems l As demand for the inventoried item occurs, the inventory level drops l When the inventory level drops to a critical point, the order point, the ordering process is triggered
l The amount ordered each time an order is placed is fixed or constant l When the ordered quantity is received, the inventory level increases l An application of this type system is the two-bin system l A perpetual inventory accounting system is usually associated with this type of system l Determining Order Quantities l Basic EOQ l EOQ for Production Lots l EOQ with Quantity Discounts Model I: Basic EOQ l Typical assumptions made l annual demand (D), carrying cost (C) and ordering cost (S) can be estimated l average inventory level is the fixed order quantity (Q) divided by 2 which implies l no safety stock l orders are received all at once l demand occurs at a uniform rate l no inventory when an order arrives l Stockout, customer responsiveness, and other costs are inconsequential l 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 Total annual stocking cost (TSC) = annual carrying cost + annual ordering cost = (Q/2)C + (D/Q)S The order quantity where the TSC is at a minimum (EOQ) can be found using calculus (take the first derivative, set it equal to zero and solve for Q)
l l l l
EOQ = 2DS/C
Example: Basic EOQ
Zartex Co. produces fertilizer to sell to wholesalers. One raw material calcium nitrate is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons 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?
Economical Order Quantity (EOQ) D = 5,750,000 tons/year C = .40(22.50) = $9.00/ton/year

EOQ = 2DS/C
EOQ = 2(5,750,000)(595)/9.00
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S = $595/order = l 27,573.135 tons per order
Total Annual Stocking Cost (TSC) TSC = (Q/2)C + (D/Q)S = (27,573.135/2)(9.00) + (5,750,000/27,573.135)(595) = 124,079.11 + 124,079.11 = $248,158.22 Number of Orders Per Year = D/Q = 5,750,000/27,573.135 = 208.5 orders/year Time Between Orders = Q/D = 1/208.5 = .004796 years/order = .004796(365 days/year) = 1.75 days/order
Model II: EOQ for Production Lots

l l l l l l 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 are assumed to be supplied or produced at a uniform rate (p) rate rather than the order being received all at once 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 2 DS p EOQ = C pd
Example: EOQ for Production Lots Highland Electric Co. buys coal from Cedar Creek Coal Co. to generate electricity. CCCC can supply coal 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 the acquisition 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? l Economical Production Lot Size d = 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
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EOQ = (2DS/C)[p/(p-d)]
EOQ = 2(292,000)(5,000)/2.10[3,500/(3,500-800)]
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 Maximum Inventory Level = Q(p-d)/p = 42,455.5(3,500 800)/3,500 = 42,455.5(.771429) = 32,751.4 tons
Model III: EOQ with Quantity Discounts l Under quantity discounts, a supplier offers a lower unit price if larger quantities are ordered at one time l This is presented as a price or discount schedule, i.e., a certain unit price over a certain order quantity range l This means this model differs from Model I because the acquisition cost (ac) may vary with the quantity ordered, i.e., it is not necessarily constant l Under this condition, acquisition cost becomes an incremental cost and must be considered in the determination of the EOQ l The total annual material costs (TMC) = Total annual stocking costs (TSC) + annual acquisition cost TSC = (Q/2)C + (D/Q)S + (D)ac To find the EOQ, the following procedure is used: 1. Compute the EOQ using the lowest acquisition cost. l If the resulting EOQ is feasible (the quantity can be purchased at the acquisition cost used), this quantity is optimal and you are finished. l If the resulting EOQ is not feasible, go to Step 2 2. Identify the next higher acquisition cost. 3. Compute the EOQ using the acquisition cost from Step 2. l If the resulting EOQ is feasible, go to Step 4. l Otherwise, go to Step 2. 4. Compute the TMC for the feasible EOQ (just found in Step 3) and its corresponding acquisition cost. 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 Discounts A-1 Auto Parts has a regional tire warehouse in Atlanta. One popular tire, the XRX75, has estimated 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 ac 1 499 $21.60
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500 999 1,000 +
20.95 20.90
Compare Total Annual Material Costs (TMCs) TMC = (Q/2)C + (D/Q)S + (D)ac Compute TMC for Q = 891.93 and ac = $20.95 TMC2 = (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
Compute TMC for Q = 1,000 and ac = $20.90
TMC3 = (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 TMC2) The EOQ is 1,000 tires at an acquisition cost of $20.90.
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POQ Model Answers how much to order and when to order Allows partial receipt of material Other EOQ assumptions apply Suited for production environment Material produced, used immediately Provides production lot size Lower holding cost than EOQ model
Quantity Discount Model Answers how much to order & when to order Allows quantity discounts Reduced price when item is purchased in larger quantities Other EOQ assumptions apply Trade-off is between lower price & increased holding cost
Probabilistic Model Answer how much & when to order Allow demand to vary Follows normal distribution Other EOQ assumptions apply Consider service level & safety stock Service level = 1 - Probability of stockout Higher service level means more safety stock
Fixed Period Model Answers how much to order Orders placed at fixed intervals Inventory brought up to target amount Amount ordered varies No continuous inventory count Possibility of stockout between intervals Useful when vendors visit routinely Example: Paul Mitchell representative calls on salon every two weeks
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INVENTORY MANAGEMENT
PERT Applications to Material Management Numericals Inventory Importance and Classification Various costs Safety stock ,Reorder level and lead time service level Economic Order Quantity Advantages and limitations Numericals PERT APPLIED TO MATERIALS MANAGEMENT Purchasing ,Planning and Research can be aided by use of PERT and CPM techniques. Both are control techniques designed to make planning more effective. These are principally scheduling and cost controlling devices. These techniques can be used in other areas of purchasing research where complex relationship are involved. Primary advantages of these techniques Providing a means for careful planning by specifying all the variables involved Providing a clear understanding of the inert relationship involved in projects Assuring a constant review to see that projects are progressing in schedule Making it possible to predict the completion time of projects with reasonable accuracy. Application of PERT in Materials Management Pert represents planning of materials ensuring that the various stages of work are brought forward in a logical sequence with minimum cost and least delay. Pert is extremely useful for precise planning and buying To plan in advance and allocate responsibilities to the different Each executive knows what precisely his responsibilities are and what he has to do in such situations without having to wait instructions.. By anticipating the trouble spots likely to appear, application of PERT results in improved utilization of resources and hence aids better managerial decisions. PERT is particularly useful for extremely complex products ,where the end product are made in relatively small quantities and is extremely complicated. Cost concept of PERT PERT tells us to achieve the committed objectives in best possible manner and also in the least possible cost and time. To effect this control, the management must know that What is required to be done Scheduled time required The estimated cost The following functions are to be carried out To make a budget of expenditure for given time schedule To arrive at optimum cost To draw expenditure plan against time To review the progress in terms of expenditure incurred and time spent.
The cost incurred in the performance of an activity is divided into 3 subheads Direct cost The cost incurred in compressing the activity completion time. Each of the activity in network can be performed in a shorter time than early expected time by providing additional resources. So the direct cost has the tendency to increase with decrease in time. Indirect cost All overheads such as interest on capital, rent for various equipments, cost of supervising cost of storing materials etc. comes under indirect cost. Total cost It is the sum of direct and Indirect cost. INVENTORY MANAGEMENT The pressure for operating capital has made business an increasingly aware of inventory as a form of earning investment. Why are we always out of stock? Why do we have inventories? The basic problem of inventory policy is to strike a balance between operating savings and costs of capital investment associated with larger stocks. Defn of inventory Inventory is defined as any idle resource of an enterprise. It is commonly used to indicate materials-raw, in progress, finished etc stocked in order to meet an expected demand. Inventory is made of all those items ready for sale or of items which keeps the project running. Every business man must have faced the problem of either being out of stock or a large amount of money tied up in the form of inventories. Inventory is an evil which cannot be eliminated. On the other hand large level of inventories hamper the growth of companies. Inventory control is to determine the optimum level of inventory which is essential to carry out the various operations of the organization efficiently and effectively. What is inventory Inventory constitute one of the most important elements of any system dealing with the supply ,manufacture and distribution of goods and services. The important purpose of inventory are Existence of time lags between manufacturing and transport operations The need to schedule various stages of the system independently. The need to meet the fluctuation in demand and production rates. The need to maintain the control over the quality of the finished product The need to exercise the influence over the changes of material prices particularly basic raw materials. So inventory is an idle resource which is usable and have value. The idle resources may be men ,money ,materials and plant acquisition. The scientific inventory management helps the purchase department to determine when to buy and how much to buy. The problem before the management is to balance the following opposing costs ie cost to have inventory and costs not to have inventory..
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Why Inventories are essential Inventories are thought as a sign of wealth, even excess inventories in relation to the magnitude of production and distribution function are considered advantageous. On the other hand the wise business man place more emphasis on having working capital in the form of cash and securities. In recent years a greater emphasis has been placed on having the means of purchasing materials than having the material themselves. Excessive inventories have been the death of many a business and very high inventory levels have tipped the scale in our economy. The finished product after packaging are first stored and sent to the market as the need arises. Also the raw materials needed for the finished product cannot be directly fed to the production department from the market. These have to be stored first after procurement and when the need arises it is utilized. This process of storing is called Inventory. Factors influencing inventory Materials account for over 50% of the production costs One thirds of the companies total investment is in the form of work in progress, finished goods and stores inventory The stores inventory usually represents the largest share and this is the area in which the purchase department can contribute significantly in company profit by efficient management of quantity and timing of purchases. There is one right quantity to buy for any given transaction but since there are many different kind of transaction the ,the determination of correct quantity is complicated. The issue is important because if too small quantity is purchased the unit cost will usually higher and shortages are likely to increase. On the other hand if too large quantity is purchased the excess inventory will raise costs Necessity of Inventory control. It is either physically impossible or economically unsound to have goods arrive in a given system precisely when demands for them rises. In general customers cannot be allowed to wait for longer periods of time . The price of some raw materials used by manufactures may exhibit considerable seasonal fluctuations. Sales and profits can be increased ,if one has an inventory of goods to display to customer. Inventory control- Defined as planning ,ordering and scheduling of materials used in the manufacturing process. There are four major reasons for the maintenance of sound inventory control procedures. 1.Unit cost Quantity purchases permit lower unit cost 2.Operating costs Quantity purchases permit efficient use of manpower ,machines and facilities. 3. Customer service Provide efficient scheduling of internal options 4.Efficient use of Investment capital The balancing of unit cost, operating cost with cost of capital. Inventory control determines the level of composition of inventories of materials and products which will protect most efficiently the production ,sales and financial requirements of the business.
Inventory control can be justified if It provides the means for effective co-ordination of the production department with other department of the business. Advantages Ensures availability of materials by providing adequate protection against uncertainties of supply and consumption of materials. Reduces chances of going out of stock. Leads to reduction in inventory levels Advantages of price discounts by bulk positioning. Even out the workloads on the shops in the face of fluctuation demands. Evils of excess inventory Essential though they are ,Inventories also mean lock of capital More store space ,equipment and personal ,insurances taxes etc for excess inventory Invites risks of deterioration Chances in the price of inventory materials sometimes go unfavourable. Control aspects of inventory There are 3 general methods of control to choose from Elimination of certain inventories. Semi automatic routines Periodic review. Elimination of inventories Elimination of inventory may found strange It is more feasible to eliminate the inventory entirely if little absence information is available on exact specifications and quantities Example is of a steel plate of absence of actual specifications Semi- automatic routines This is applicable for standard items with fairly stable prices and steady usage. This system is usually established by considering the minimum balance desirable ,the reorder point etc. The order point is located somewhere above the minimum. When the available balance reaches the order point ,a clerk will note this fact and place an order. Periodic review Periodic review is required for want of a better item. Required because Price fluctuations Delivery or manufacturing cycles too long There is considerable risk of obsolescence. (state of no longer wanted even though it is in good condition)
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Classification of inventory Raw materials and production inventories -Parts and components which enter into the product direct during the production process In process inventories Semi finished parts ,work in progress and finally finished products formed at various stages of production M.R.O Inventories Maintenance, repairs and operating supplies which are consumed during the production process and generally do not form of the product itself. Example POL Finished goods inventories Complete finished products ready for sale.
Inventory cost
The classical inventory analysis identifies four major cost components1.Purchase cost This refers to the nominal cost of inventory. It is the purchase price for the items that are brought from outside sources ,and the production cost if the items are produced within the organisation. This may be constant per unit or it may vary as the quantity purchased increased or decreases If the unit cost is constant it does not affect the inventory control decisions, because whether all the requirements are bought just once ,or whether they are obtained in installments ,the total amount of money involved is same. However we do consider the quantity discounts when they occur, because they affect these decisions. 2.Ordering cost Ordering cost is incurred whenever the inventory is replenished. It includes costs associated with the processing of purchase order, transportation, inspection for quality etc. It is also known as procurement cost. The parallel of ordering cost when units are produced within the organization is the setup cost. 3. Carrying cost Also known as the holding cost or the storage cost ,carrying cost represents the cost that is associated with the storing an item. It is proportional to the amount of inventory and the time over which it is held. The elements of carrying cost includes the opportunity cost of the capital invested in the stock ,the costs directly associated with the storing goods like store men salary ,store transport etc, deteriorating costs and fire and general insurance etc. 4. Stock out cost Stock out means shortages. A shortage can evoke different reactions from customers. It would result in a backorder or a lost sales. In the case of backorder the sales are not lost they are only delayed. When the new shipment arrives ,a customer who was denied earlier would be immediately supply the goods. But it would involve costs like expediting costs and also packaging and shipment costs. On the other hand ,when the sales are lost forever, it is difficult to asses the cost involved in terms of the profit on sales lost ,profit lost on whatever the customer would have brought in all future periods in case he decides not to turn to the organization for anything in future.
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EOQ model Here it is discussed to find what should be the quantity Q ordered each time to keep down both the inventory carrying cost and the ordering cost in this consumption and procurement cycle. Consider the procurement of the entire annual requirement of an item under the procurement and consumption cycle. For keeping the inventory and the inventory carrying costs low it will be better to procure the item in as small consignment as possible. But this would mean large number of orders and so more ordering costs. The requirements are thus conflicting and there is a particular quantity at which the sum of both the ordering and inventory carrying costs is minimum and this very quantity is called EOQ. Assumptions in EOQ formula The demand for the term is certain, continuous and constant. The lead time ie the time between placing an order and its delivery is known and fixed. Within the range of the quantities to be ordered ,the unit holding cost and the ordering cost are constant and thus independent of the quantity ordered. The purchase price of the item is constant that is to say no discount is available on the purchase of large lots. The inventory is replenished immediately as the stock level reaches exactly equal to zero. Consequently there are no stock surplus or shortages. Limitation of EOQ The cost analysis on the basis of which the formula is developed are merely notional rather than actual in some cases. In practice unit cost of purchase of an item varies ,lead times are uncertain and also requirements or demands of inventory items are not perfectly predictable in advance. Rate of consumption varies greatly in many cases. So as such the application of formula often becomes difficult. Lead time- The procurement and consumption cycle has got 2 elements in it. 1. Lead time 2. Safety stock. From the time the requisition for an item is raised ,it may take several weeks or months before the supplies are received ,inspected and taken into stock. This time is called the lead time and involves the time for the completion of all or some of the following activities. Raising of a purchase requisition Inquiries ,Quotations, scrutiny and approval. Placement of an order Suppliers time to make the goods ready Transportation or clearing Receipt of goods at the company Receiving inspection Taking into stock.
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Obviously ,in order to receive supply before the stock reaches zero level, it is necessary to order the materials much in advance ie when the stock available is sufficient to last during the lead time. Safety stock (reserve stock) It is well known that neither the consumption rate of the material is constant throughout the year nor is the lead time. In either case a stock out would be experienced resulting into hampering of production to guard mainly against these uncertainties in consumption rate and lead time, an extra stock is maintained all along and this is called buffer stock or safety stock. This stock also comes in use when Any excess in project rejections Rejection at the time of receipt due to damages Before deciding how much the safety stock should be ,analysis of the following aspect is essential. Is the variation in consumption more predominant in the lead time If the variation in lead time is more predominant ,is it restricted to a particular period or spread all over the year. In most cases it is found that the variation in consumptions can be predicted fairly in advance accurately by good production and maintenance planning and does not provide much of a problem. Re order point The order or reorder point should be set at such a level that the stock on hand plus on orders should last till fresh supplies are received. This will require to ascertain the usage rate of the particular item. If the rate of consumption greatly varies and there is an upward surge in the construction pattern suddenly, this will lead ultimately to the stock out condition.
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Inventory (Valuation, Reconciliation & Records)

MCM311 Construction Materials Management Prof. Rajiv Gupta
FIFO Method of Valuation of Inventories

FIFO First In First Out Oldest stock is depleted first The value of stocks on hand is the money that has been paid for that amount, this reflects the true value of inventory Becomes unwieldy when too many changes in price levels occur Encounters problem in costing of returns to store
MCM311- Prof.Rajiv Gupta 2
FIFO
FIFO Date Qty. 01-Feb 14-Feb 1000 2000 Receipts Rate 1 1.1 Value 1000 2200 Qty. 0 0 Issues Rate 0 0 Value 0 0 Stock on Hand Qty. 1000 1000 2000 20-Feb 0 0 0 500 1 500 500 2000 28-Feb 0 0 0 1500 1 1.1 500 1100 1000 1.1 1100
3
Rate 1 1 1.1 1 1.1
Value 1000
3200
2700
MCM311- Prof.Rajiv Gupta
LIFO Method of Valuation of Inventories

Latest prices are charged to the issues, thereby leading to lower reported profits During wide fluctuations in price levels, LIFO tends to minimise unrealised gains or losses in inventory Applied in a period of rising price.
LIFO
LIFO Date Qty. Receipts Rate Value Qty. Issues Rate Value Stock on Hand Qty. Rate Value
01-Feb 14-Feb
1000 2000
1 1.1
1000 2200
0 0
0 0
0 0
1000 1000
2000
1 1
1.1 1 1.1 1
1000
3200
20-Feb
0 500 1.1 1.1 550 1650
1000 1500 1000
2650 1000
5
28-Feb
1500
Average Cost Method

The issues are split into equal batches from each shipment at stock It is a realistic method reflecting the price levels and stabilizing the cost figures As more purchases are made, new average is computed and this average is applied to the subsequent issues
Average Cost
Average cost Date
Qty. Receipts Rate Value Qty. Issues Rate Value Qty. Stock on Hand Rate Value
01-Feb 14-Feb
20-Feb 28-Feb
1000 2000
0 0
1 1.1
0 0
1000 2200
0
0 0
0 0
0 0
1000
3000
1
1.067 1.067 1.067
1000
3200 2667
500 0
1.067
533
2500 1000
1500
1.067
1600
1067
7
Market Value Method

Also called replacement rate costing Materials that are issued are costed at the market rate prevailing at the time of issue. This method requires continuous monitoring of the market rates for all materials, hence it is unwieldy.
Standard Cost Method

In this method a standard rate is determined based on detailed analysis of market price and trends. This method of accounting evens out fluctuations in rates. The standard rate is kept fixed for a considerable time i.e. 6 months or more. This method has limited application in management control.
Closing Stock Valuation
As per accounting principles for the purpose of valuation of stock for balance sheet purpose the market price or stock at cost is used, which ever is less.
10
RECONCILIATION & RECORDS
11
Aspects of material control

Accounting and procedural aspect concerned with laying down detailed procedures for requisitioning, ordering, receiving, stocking, issuing and paying for materials. Operational aspect deals with maintaining adequate supplies of all types of materials for smooth conduct of the construction operations and dealing with obsolescence, wastage, spoilage, scrap, empties
Objectives of material control for reconciliation
Strict quality control materials should be tested at the time of receipts and responsibility fixed for testing. Minimum handling cost and time materials should be stored at such a place and in such a manner that i) they can be located with ease ii) made available to user departments with least effort iii) time consumed in tracing the materials and making them reach the user department should be least.
13
Contd.
Control on payments for materials ensure that no payment is made for materials not ordered though received, or for materials not received or for materials of defective quality. Authorized issues ensure that no issues from stores take place without proper authorizations. Store keeper to be held accountable for all issues. Control on misappropriations ensure that no misappropriation of materials takes place. Once leakages develop in the system they tend to become recurring in character.
14
Contd.
Minimize wastages at the time of receipt, issues, usage. Fix norms at each stage. Higher wastages should be investigated. Control on leakages and pilferages especially for those materials prone to pilferage. Minimize spoilage and obsolescence fix norm for each item. Detect slow and non-moving items
Material accounting and reporting
Complete records of all purchases, issues, returns, transfers and losses of materials to be maintained. An efficient system of internal audit of material records should be maintained. All materials should be periodically verified. Payments of all suppliers bills should be made only after comparing the suppliers bill with the copy of purchase order and the receiving and inspection report. Method of valuation of stocks should be followed on consistent basis.
Material accounting and reporting..contd.
Control accounts and subsidiary ledgers should be maintained for obtaining summarized information. Special reports should be prepared regarding spoilage, return to suppliers, obsolete items, defectives and abnormal losses.
17
Pre-requisites for a good inventory system
Up-to-date records all issues and receipts should be immediately recorded in the bin cards and stores ledger. Balance in hand should be recorded after each transaction. Continuous stock-taking Detailed advance programme should be prepared for weekly or monthly stock taking well in advance. The duties of stock taking staff as regards counting, weighing, measuring, reconciling, listing and preparation of stock verification sheets etc. should be determined.
Contd.
Separate recorded and unrecorded stocks stores items which have been received but have not yet been recorded in bin cards and stores ledger because their documents have not yet been received or they have not yet been inspected, should be separated from recorded items.
19
Contd.
Use inventory tags to avoid confusion between the portion of inventory which has been verified and that to be verified Reconcile bin cards and stores ledger receipts, issues and quantity in hand should be same in bin cards and stores ledger. The two records should be tallied. Discrepancy, if any, should be located. It can arise due to some arithmetical error in balancing or wrong posting or non-posting either in bin card or in store ledger. Such errors should be rectified by passing a rectifying entry and initialed.
20
Contd.
Regularly reconcile book figures with physical stocks In case of any difference an enquiry should be made, the difference should be ascertained and records be rectified. Stock verification sheets should be prepared to record verification of stocks in chronological order. They convey how much verification work has been done by whom and by what time. These facilitate future stock-taking programmes.
Stock Discrepancies
Discrepancy may be observed between quantity of stock as shown in stock ledger and bin cards and that verified by physical counting of stocks. The causes can be categorized as: i) Avoidable causes ii) Unavoidable causes
22
Avoidable causes or abnormal losses
These are causes which can be avoided through reasonable skill and care in material handling and recording. These are: Improper storage Carelessness in counting, weighing and measuringresulting in under or over issues. Losses due to evaporation, moisture, shrinkage etc. beyond the expected level. Loss due to carelessness and breaking bulk, cutting etc. Clerical errors resulting in wrong recording Theft and pilferage.
23
Unavoidable or normal losses Losses which are inherent in the nature of materials or material handling . Normal losses due to evaporation, moisture, shrinkage etc. Normal pilferage. Normal storage losses. Normal losses in breaking bulk or cutting Normal obsolescence. Normal defectives and scraps. Losses due to accidents inherent in the nature of business activity.
Treatment of stock discrepancies Normal material losses must be charged to output. This must be done in two ways. a) By suitably inflating the rate of issue of material so that normal loss is distributed over normal output. b) The normal loss of materials may be debited to construction overheads and credited in stores ledger so as to bring stores ledger balance in agreement with the actual physical balance in stores.
Checks for Receipt Function
a) Check valid documentation for material & carrier entry. b) Monitor arrival of material at Warehouse. c) Verify PO, identify material and tally the order and acknowledge the delivery, d) Report to buyer all deliveries without valid Purchase Order in SAP. e) Verify Third Party Inspection documents or Arrange for Incoming Inspection & Confirm QM acceptance. f) Usage decision, Prepare GRN and Post to Inventory. g) Lodging claim on supplier for shortages, discrepancies, wrong or substandard supplies. Intimate buyer and commercial.
h) Intimate Insurance group for claims of transit damage or losses or pilferage if any. Arrange for insurance survey, lodge preliminary claim on insurance.
Checks for Material Storage.

a) Review the warehouse functions including facilities planning, layout and material handling equipment. b) Ensure insurance cover for all material in stock at warehouses, in transit and on sites.
c) Follow statutory guidelines and licensing requirements for specialty material such as HSD, LDO, Explosives, corrosive chemicals etc.
d) Ensure Store hygiene through routine activities such as sweeping, cleaning, dusting.
27
Checks Inventory Accounting & Control
a) Review the construction program, stock availability and consumption pattern. b) Ensure proper documentation in SAP for material receipt, Issue and return receipts of usable, used and scrap material. c) Draw up annual stock verification and audit program and arrange for material audit including spot checks. d) Implement Inventory control & Analysis methods ABC, XYZ and VED, Max/Min Inventory. e) Review non-moving, slow moving and life expiring stock and initiate action, for return to vendor or disposal in consultation with user group. f) Investigate binning errors, audit discrepancies and advice corrective action.
Material Issue.
a)Ensure compliance of Standard Operating procedure. b) Ensure proper authority and statutory approvals (custom/excise) for material movement to other warehouses or to outside agencies. c) In case of Block-to-Block transfer (including issue on loan) ensure necessary Govt.approvals and Essentiality certificate is in place. d) Ensure compliance of Sales Tax, Entry tax, Octroi and other statutory regulations in force time to time. e) Regulate gate passes and vehicle authorizations at outbound gate. f) Post all Stock Transfer Orders and Sale Orders for material issued. g) Report and reconcile any discrepancy in material receipt/issue during transit.
The estimated requirement of material in Depots is based on Anticipated Annual Consumption (AAC). Any irregular issues i.e. materials shown as issued but not physically lifted, could lead to computation of incorrect AAC and thus, estimation of excess quantity. In 4,274 cases, material worth Rs.20.67 crore was fictitiously shown as issued but not actually removed from the depots. Based on these inflated issues, the requirement estimated for the next year also got inflated. 383 items were found in excess of the requirement assessed with reference to Anticipated Annual Consumption (AAC).
Some typical results due to effective control (basis: an audit report)
30
The material received in the Receipt Section should be got inspected promptly. A test check of 819 receipt challans in 33 depots revealed that in 322 cases, the inspection was not completed even after a period of 3 months of receipt. In 47 cases, the inspection was kept pending deliberately to avoid inflation of inventory. Audit Review of rejected material cases in 32 depots disclosed that out of 2826 pending rejection cases, 758 cases valued at Rs.2.79 crore were more than 3 years old. In 1231 cases, the entire consignment were rejected by the consignee due to non-conformity of the material to the specification. This indicates poor quality of inspection by Inspecting Agencies.
31
The efficiency of Inventory Control is judged by Turn Over Ratio (TOR) which is expressed in percentage of value of closing balance at end of financial year to the value of issues during the year. The TOR was manipulated by delaying accounting of receipts and showing materials as issued without lifting these in the same year. A review of 29 depots disclosed that in respect of 12598 cases, material worth Rs.43.50 crore was shown as issued but material was not lifted in the same years. This tantamounted to manipulation of TOR.
33
34
LEGAL ASPECTS OF PURCHASING

MCM311- CONSTRUCTION MATERIALS MANAGEMENT PROF. RAJIV GUPTA
DOCTRINE OF CAVEAT EMPTOR

This is a Latin term
2
Its literal meaning is Buyer Beware
Simply put, its means that the buyer should carry out
all checks and be aware of the sellers capability to supply the goods and of the inherent nature of the goods to meet the buyers requirement. Earlier, all buying-selling transactions were under this principle. Since the buyer bore the risk of being sold poor quality goods. In the current scenario of increasing consumer rights this is now changing but even now the business should be cautious. MCM311: Prof. Rajiv Gupta
RELEVANT ACTS
3
Legal Acts governing commercial and other

-
transactions :The Indian Contract Act The Sale of Goods Act The Transfer of Property Act The Negotiable Instruments Act
MCM311: Prof. Rajiv Gupta
LAW OF CONTRACT
4
It differs from other acts

It does not lay down rights and duties of the parties
to the contract which the law will enforce Rather ,it consists of a number of limiting principles subject to which the parties may create rights and duties for themselves which the law will uphold. In a sense the parties make the law themselves So long as they do not infringe any legal prohibition, they can make rules they like in respect of the subject matter of their agreements
DEFINITION OF A CONTRACT
5
An agreement enforceable by law

A legally binding agreement between two or more
persons by which rights are acquired by one or more to act or forbearance on the part of other or others. Agreement = Offer + Acceptance Contract = Agreement + Enforceability by law All contracts are agreements but all agreements are not contracts An agreement can be in writing, or oral or even by reference from the conduct and circumstances of the case
ESSENTIAL ELEMENTS OF A VALID CONTRACT

6
A contract in order to be enforceable by Law, must have the
following essential elements 1. Offer & Acceptance 2. Legal Relationship 3. Lawful Consideration 4. Capacity of parties competency 5. Free and Genuine consent 6. Lawful object 7. Agreement not declared void 8. Certainty and possibility of performance 9. Legal formalities
Offer & Acceptance

7
There must be a lawful proposal or offer by one party
and a lawful acceptance of that proposal by the other party thus resulting in an agreement. The terms of offer and acceptance must be definite The acceptance of the offer must be according to the mode prescribed and must be communicated to the proposer.
Legal Relationship
8
The agreement must create legal relationship
between the parties. If there is no intention to create legal relationship, there can be no contract between the parties.
Lawful Consideration
9
The agreement to be enforceable by law, must be
supported by a consideration. The term consideration means something in return Only enforceable when both the parties give something and get something in return.
Capacity of parties - Competency

10
The parties to the agreement must be capable of
entering into a valid contract. Every person is competent to enter into a contract if he is of sound mind, age of majority, and not disqualified from contracting by any law. Flaws may arise due to being a minor, lunacy, idiocy, drunkenness and status.
Free & Genuine Consent

11
There must be free and genuine consent of the
parties to the agreement. They must agree upon the same thing in the same sense, i.e. they must be of the same mind on all the material terms of the contract.
Lawful Object
12
The object of the agreement should be lawful.

It is lawful unless forbidden by law, or Is of such a nature that if permitted, would defeat
any provisions of law.
Agreement not declared void

13
The agreement, though it might possess all the
essential elements discussed above, must not have been expressly declared void by any law in force in the country.
Certainty and Possibility of Performance

14
The terms of the agreement must be certain and not
vague or ambiguous. The terms of the agreement must enable performance
Legal Formalities
15
The agreement may be oral or in writing.

Where it is in writing it must comply with the
necessary legal formalities as to writing, registration and attestation. Otherwise it cannot be enforced.
16
Passing of title
Concept of agent and principle Damage to goods Disputes- inspection, acceptance, rejection, returns Warranty Breach of Contract Avoiding litigation Some important legal terms and conditions E&OE,
E & OE
17
Errors and Omissions Entertained

It is a disclaimer for legal liability due to errors of
information supplied in contractually related document. It implies that the buyer should verify the details of the invoice before releasing payment and if any error has crept in it will be rectified by the supplier. This term appears on the sellers invoice/ bills/cash memo etc.
PROFORMA INVOICE
18
Difference between Invoice and Pro-forma Invoice
WARRANTY - concept
19
Under the doctrine of caveat emptor, the buyer could
not recover from the seller for defects on the goods that rendered them unfit for ordinary purposes. The only exception was if the seller actively concealed latent defects or otherwise made material misrepresentations amounting to fraud. The buyer had no warranty of the quality of goods. In many jurisdictions now, the law requires that goods must be of "merchantable quality". This is covered by a product warranty.
Warranty - meaning
20
In commercial and consumer transactions, a
warranty is a collateral assurance or guarantee that certain facets of an article or service sold is as factually stated or legally implied by the seller. It often provides for a specific remedy such as repair or replacement in the event the article or service fails to meet the warranty. A breach of warranty occurs when the promise is broken, i.e., a product is defective or not as should be expected by a reasonable buyer.
TRANSPORTATION & HANDLING

MCM311- CONSTRUCTION MATERIALS MANAGEMENT
MATERIALS FLOW
22
Flow of materials occurs to the project site

Flow of materials occurs within the project site
Guiding principles: Keep lead times in mind Optimise costs Minimise handling Reduce lead and lift Different types of materials require different plans; for structure, for finishing materials, for equipment etc.
CRITICAL PARAMETERS
23
Movement of goods choice of carrier

- Dependent on: - Costs involved - Time taken (urgency) - Documentation - Associated risks and packing required
TO THE PROJECT SITE

24
Route selection - seek to minimise distance in

sourcing bulk materials Prefer reliable carriers Reduce carrier risks by transit insurance Check documentation Claims preparation Tracking shipments
WITHIN THE PROJECT SITE

25
Manual handling
Material handling equipment
Passing of title
26
Legal disputes arise about when the legal title to the

goods passes from the seller to the buyer? The FOB point usually determines this. FOB-Free on Board Even the freight charges are determined by the FOB point. If nothing is mentioned then it is generally assumed that it is at the point of shipment
FOB
27
The risk and title passes to the buyer, including the
transportation and insurance payment, once delivered on board the ship by the seller (only for sea and inland water way). Since stores are delivered free on board the vessel at the port of shipment prices include all charges from the contractors works to the delivery point, viz on board the ship, at the port of shipment. Also FOR (Free on Rail), FOT (Free on Truck)
TRANSPORTATION DOCUMENTATION
28
Seller (supplier) initiates shipment by using a
forwarding note while handing over the goods to the carrier. Based on this the carrier issues a consignment note which may also be called as Lorry Receipt (LR), Railway Receipt (RR) or Bill of Lading (BL) The consignment note can be conditional or unconditional. Said to Contain and condition of packing is mentioned (usually in code), this is critical during settlement of claims.
CONSIGNMENT NOTE
Is a document, issued by a goods transport agency
29
against the receipt of goods for the purpose of transport of goods by road or in a goods carriage. It should be serially numbered and contain details of: Name of the consignor and consignee Registration number of the goods carriage in which the goods are transported Details of the goods transported Details of the place of origin and destination (door delivery or otherwise) Person liable to pay service tax, whether consignor, consignee or goods transport agency.
CONSIGNMENT NOTE
30
This is a document of title and should also mention
the place of delivery of goods. Mere issuing of cash receipt or acknowledging receipt of goods is not the same as a consignment note. Freight prepaid or to pay basis
Ex-Works
31
The title and risk passes on to the buyer, including
the transportation, handling and insurance cost from the sellers point. Can be used for any mode of transport. Waybill or airway bill
DEMURRAGE
32
Demurrage is the fine or penalty levied by the
carrier for: i) Holding up the carrier ( i.e. not releasing it within a reasonable time due to any reason whatsoever usually delay in unloading) this is on an hourly basis, and ii) For delay in taking delivery of materials from the transporters warehouse or store within a reasonable time, usually a few days; beyond which a charge is levied on a per day basis for taking late delivery
INCOTERMS
33
Inco terms are worldwide accepted commercial
terms that define the respective roles of the buyer as well as of the seller in arrangement of the transportation and other responsibilities and it also clarifies when the ownership of the merchandise takes place. These are used in a sales contract or other methods of transacting a deal. Inco Terms 2000 are developed by the International Chamber of Commerce (ICC)
Few Important Inco Terms

34
FOB Free on Board

CIF Cost, insurance, freight: the title and risk
passes on to the buyer if delivered on board the ship by the seller who paid the transportation and insurance cost to the destination port. Please refer to handout for complete list of INCO Terms
ULTIMATELY, DO REMEMBER
35
That litigation is both costly and of uncertain
outcome and should therefore be avoided except as a last resort. That a purchasing executive must understand basic legal concepts well enough to detect potential problems before they become a realty.
36
THANK YOU FOR YOUR ATTENTION

Material Management &amp; Control

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Construction Materials Management

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

The case of Sobha Developers Limited, Bangalore

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

VED ANALYSIS Categorisation Plan

Typical Categorisation Plan

Stock levels may be reviewed twice a year

** indicates items are within control, no further action is necessary

XYZ in conjunction with FSN analysis

Liberalise Control reduce clerical costs)

Dispose off as early as possible, even at lower price

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

Source Selection & Vendor Development

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

Centralized or Decentralised purchasing

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

Common supply base

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

Assemblies, sub assemblies, components.

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

An optimum inventory level involves three types of costs

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

Functions of Inventory Management

How much to order When to order

FSN Classification SDF Classification GOLF Classification SOS Classification

Economical Order Quantity (EOQ) D = 5,750,000 tons/year C = .40(22.50) = $9.00/ton/year

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S = $595/order = l 27,573.135 tons per order

Model II: EOQ for Production Lots

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

500 999 1,000 +

Compute TMC for Q = 1,000 and ac = $20.90

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

S.R.P** NICMAR 3RD TERM- MATERIAL MANAGEMENT

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