MATERIAL

MANAGEMENT
4  Purchasing
 Inventory Control
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 INTRODUCTION
 Most manufacturing organizations spend more than 60%
of their money for materials, i.e., materials soak up a
substantial portion of the capital invested in an industrial
concern.
 This emphasizes the need for adequate materials
management and control
 Materials Management may be thought as an
integrated functioning of the different sections of a
company dealing with the supply of materials and other
related activities so as to obtain maximum coordination
and optimum expenditure on materials etc., used in an
industrial concern.
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 FUNCTIONS & OBJECTIVE OF MATERIAL
MANAGEMENT
 The material management functions consist of the
following:
 Materials planning
 Procurement or purchasing of materials
 Receiving and warehousing
 Storage and store administration
 Inventory control
 Standardization, Simplification and Value analysis
 External transportation (i.e., traffic shipping, etc.)
and material handling (i.e., internal transportation)
 Disposal of scrap surplus and obsolete materials
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The main objectives of material management
 To minimize materials cost.
 To procure and provide materials of desired quality
when required at the lowest possible overall cost of the
concern
 To reduce investment tied in inventories for use in other
productive purposes and to develop high inventory
turnover ratios.
 To purchase, receive, transport (i.e., handle) and store
materials efficiently and to reduce the related costs.
 To trace new sources of supply and to develop cordial
relations with them in order to ensure continuous
material supply at reasonable rates.
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 To cut down costs through simplification,
standardization, value analysis, import substitution, etc.
 To report changes in market conditions and other
factors affecting the concern, to the concern.
 To modify paper work procedure in order to minimize
delays in procuring materials.
 To conduct studies in areas such as quality,
consumption and cost of materials so as to minimize
cost of production.
 To train personnel in the field of materials management
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 PURCHASING OR PROCUREMENT FUNCTION
 The purchasing department occupies a vital and unique
position in the organization of an industrial concern because
 purchasing is the key to the success of a modern
manufacturing concern.
 Mass production industries, since they rely upon a continuous
flow of right materials, demand for an efficient purchasing
division.
 The purchasing function is a liaison agency which operates
between the factory organization and the outside vendors on
all matters of procurement.
 Purchasing implies procuring materials, supplies, machinery
and services needed for production and maintenance of the 7

concern.
 OBJECTIVES OF PURCHASING DEPARTMENT

 The objectives of purchasing department are:

 To procure right material
 To procure material in right quantities
 To procure material of right quality
 To procure from right and reliable source and vendor
 To procure material economically, i.e., at right or
reasonable price
 To receive and deliver materials
 At right place, and
 At right time
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 INVENTORY CONTROL

 An inventory is a list of items or goods. There are various

types of inventory depending upon the context or situations.
 For example, inventory in a library means the list of books,
journals, periodicals, furniture, fans, etc.
 A typical firm carries different kinds of inventories such as:
raw materials and purchased parts; partially completed goods
called work-in-process (WIP); finished-goods or merchandise
in retail stores; replacement parts, tools, and supplies; and
goods-in-transit to warehouses or customers (called pipeline
inventory).
 Generally a firm has about 30 percent of its current assets and
as much as 90 percent of its working capital invested in
inventory. 10
 PURPOSE OF INVENTORIES
 To meet anticipated demand
 To smooth production requirements
 To decouple components of the production-distribution
system
 To protect against stock-outs
 To take advantage of order cycles
 To hedge against price increases or to take advantage
of quantity discounts
 To ensure against scarcity of materials and permit
operations
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 TYPES OF INVENTORY CONTROL TECHNIQUES

 Inventory can be controlled by these two techniques:

(a) Qualitative techniques, (b) Quantitative techniques
1. QUALITATIVE TECHNIQUES
 They consist of selective control methods based on Pareto
80-20 principle, which states that there are a critical few
and trivial many.
 All the items of an industry are classified into some
broad groups on certain basis and the attention is paid
to their control accordingly.
 It is not practical to monitor inexpensive items with
the same intensity of care as very expensive items.
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 Some of the popular classifications selective control
techniques are as follows:
 ABC classification
 FSN classification
 VED classification
A. ABC classification
 ABC stands for ‘always better control’.
 The items on hand are classified into A, B, and C types
on the basis of the value in terms of capital or annual
dollar usage (i.e., dollar value per unit multiplied by
annual usage rate), and then allocates control efforts
accordingly.

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 Thus, the items with high value and low volume are kept in A-
type, items with low value and high volume are kept in C-
type, and the items with moderate value and moderate
volumes belong to the B-type.
 Typically, three classes of items are called: A (very
important), B (moderately important), and C (least
important).
 With three classes of items, A items generally account for
about 15 to 20 percent of the number of items in inventory
but about 70 to 80 percent of the dollar usage.
 At the other end of the scale, C items might account for about
60 to 70 percent of the number of items but only about
5to15 percent of the dollar usage of an inventory.
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 Example
A computer hardware company has organized its 10 items on an
annual dollar-volume basis. Details like item numbers, their annual
demand, unit cost, annual dollar volume, and percentage of the
total represented by each item are shown in the following Table.
Item no. % of no. Annual Unit cost Annual $ % of annual Combined class
(1) item stock volume ($) (4) volume dollar %
(2) (units) (3) =3*4 (5) volume
1 20% 1000 90.00 90,000 38.8% 72% A
2 500 154.00 77,000 33.2% A
3 30% 1550 17.00 26,350 11.3% 23% B
4 350 42.86 15,001 6.4% B
5 1000 12.50 12,500 5.4% B
6 50% 600 14.17 8,502 3.7% 5% C
7 2000 0.60 1,200 0.5 % C
8 100 8.50 850 0.4 % C
9 1200 0.42 504 0.2 % C
16

10 250 0.60 150 0.1 % C

8550 $232,057 100%
 B. FSN Classification
 In this method, the items are classified according to the
rate of consumption.
 Thus, the materials can be fast (F), slow (S) and non-
moving types (N).
 Let the different items in our home be: rice, pulses,
salt, sugar, tea, vegetables, fruits, medicine,
cosmetics, shaving blades, wound plasters, and dry-

fruits. 17
 According to FSN, they can be classified as
 F = Rice, pulse, salt, sugar, tea are consumed almost
daily at relatively faster rate and they need more
attention to avoid stock-out situation in the house
especially if some unexpected guests happen to drop
in from somewhere.
 S = Fruit, dry fruits are consumed at a moderate speed
and need moderate attention.
 N = Medicine, shaving blades, wound plasters;
cosmetics are consumed at a very negligible rate and
need less attention. They can be bought once and can
be consumed leisurely when need arises. 18
 C. VED Classification
 The materials are classified according to its criticality in the
production system.
 Thus, materials can be vital (V), essential (E) and
desirable (D) types.
 Maximum attention is paid to the procurement and control
of vital items and less to the desirable ones.
 It is so because the lack of vital items can bring the
production of the plant down and the plant will run into
losses.
 For example, based on VED classification, the 1000 items of a
steel plant can be classified as
 V = 200—Much attention is given to the vital items.
 E = 300—Moderate attention is given to these items.
 D = 500—Less attention is given to these items. 19
 2. QUANTITATIVE TECHNIQUES /MODELS
A. ECONOMIC ORDER QUANTITY (EOQ)
 Inventory models deal with idle resources like men,
machines, money and materials.
 These models are concerned with two decisions:
 How much to order (purchase or produce) and
 When to order so as to minimize the total cost.
 For the first decision how much to order, two basic
costs are considered namely,
 Inventory carrying costs and
 The ordering or acquisition costs.

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 As the quantity ordered is increased, the inventory
carrying cost increases while the ordering cost
decreases. The ‘order quantity’ means the quantity
produced or procured during one production cycle.
 Economic order quantity is calculated by balancing the
two costs.
 Economic Order Quantity (EOQ) is that size of order
which minimizes total costs of carrying and cost of
ordering.

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 Economic order quantity can be determined by two methods:
1. Tabulation method.
2. Algebraic method.
1. Determination of EOQ by Tabulation (Trial & Error) Method
 This method involves the following steps:
1) Select the number of possible lot sizes to purchase.
2) Determine average inventory carrying cost for the lot
purchased.
3) Determine the total ordering cost for the orders placed.
4) Determine the total cost for each lot size chosen, which is the
summation of inventory carrying cost and ordering cost.
5) Select the ordering quantity, which minimizes the total cost.
 The data calculated in a tabular column can plot showing the nature
of total cost, inventory cost and ordering cost curve against the
quantity ordered. 21
 Example
The XYZ Ltd. carries a wide assortment of items for its customers.
One of its popular items has annual demand of 8000 units. Ordering
cost per order is found to be Rs. 12.5. The carrying cost of average
inventory is 20% per year and the cost per unit is Rs. 1.00. Determine
the optimal economic quantity and make your recommendations.

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2. Determination of EOQ by Analytical Method
 In order to derive an economic lot size formula following
assumptions are made:
1. Demand is known and uniform.
2. Let D denotes the total number of units purchase/produced
and Q denotes the lot size in each production run.
3. Shortages are not permitted, i.e., as soon as the level of the
inventory reaches zero, the inventory is replenished.
4. Production or supply of commodity is instantaneous.
5. Lead-time is zero.
6. Set-up cost per production run or procurement cost is C3.
7. Inventory carrying cost is C1 = CI, where C is the unit cost
and I is called inventory carrying cost expressed as a
percentage of the value of the average inventory. 24
 This fundamental situation can be shown on an inventory-
time diagram, with Q on the vertical axis and the time on the
horizontal axis. The total time period (one year) is divided
into n parts.

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 The most economic point in terms of total inventory
cost exists where,
 Inventory carrying cost = Annual ordering cost (set-
up cost)
 Average inventory = 1/2 (maximum level +
minimum level)
= (Q + 0)/2 = Q/2
 Total inventory carrying cost = Average inventory ×
Inventory carrying cost / unit i.e.,
 Total inventory carrying cost = Q/2 × C1 = QC1/2
… (1) 26
 Total annual ordering costs = Number of orders per year ×
Ordering cost per order i.e.,
 Total annual ordering costs = (D/Q) × C3 = (D/Q) C3 … (2)
 Now, summing up the total inventory cost and the total
ordering cost, we get the total inventory cost C (Q). i.e.,
 Total cost of production run = Total inventory carrying cost
+ Total annual ordering costs
C(Q) = QC1/2 + (D/Q)C3 (cost equation) … (3)

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 But, the total cost is minimizing, when the inventory carrying
costs becomes equal to the total annual ordering costs.
Therefore,
QC1/2 = (D/Q) C3
Or QC1 = (2D/Q) C3
Or Q2 = 2C3D/C1
Or 𝑄=√(2𝐶3𝐷/𝐶1)
i.e., optimal quantity (EOQ), Q0 =√(2𝐶3𝐷/𝐶1) ... (4)
Optimum number of orders, (N0) = D/Q0 ... (5)
Optimum order interval, (t0) = 365/N0 in days = 1/N0 in years or
(t0) = Q0/D ... (6)
Average yearly cost (TC) √2𝐶 3𝐷𝐶1 … (7) 28
 Example:
An oil engine manufacturer purchases lubricants at the rate of birr
42 per piece from a vendor. The requirements of these lubricants
are 1800 per year.
What should be the ordering quantity per order, if the cost per
placement of an order is birr 16 and inventory carrying charges per
year is 20%.
SOLUTION:
Given data are:
Number of lubricants to be purchased, D = 1800 per year
Procurement cost, C3 = birr16 per order
Inventory carrying cost, CI = C1 = 42 birr× Re. 0.20 = 8.40 birr per
year
Optimal quantity (EOQ), Q0 =√(2𝐶3𝐷/𝐶1) 29

Q 0 =√((2∗16∗1800)/8.4) = 82.5 =83 lubricants

 Example 2
A manufacturing company purchase 9000 parts of a
machine for its annual requirements ordering for month
usage at a time, each part costs Rs. 20. The ordering cost
per order is Rs. 15 and carrying charges are 15% of the
average inventory per year. You have been assigned to
suggest a more economical purchase policy for the
company. What advice you offer and how much would it
save the company per year?

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 SOLUTION:
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs = Rs. 20
Procurement cost, C3 = Rs. 15 per order
Inventory carrying cost, CI = C1 = 15% of average inventory per
year
= Rs. 20 × 0.15 = Rs. 3 per each part
per year
Then, optimal quantity (EOQ), Q0 =√(2𝐶3𝐷/𝐶1)
Q0 =√((2∗15∗9000)/3) = 300 units
And optimum order interval, (t0) = Q0/D in years = 300 / 9000 =
1/30 years
= (1 /30) *365 days = 122 Days

Minimum average cost = √2𝐶3𝐷𝐶1 = √(2∗3∗15∗9000) = 900

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If the company follows the policy of ordering every month,
the annual ordering cost is =12×15 =180 birr
Lot size of inventory each month = 9000/12 = 750
Average inventory at any time = Q/2 = 750/2 = 375
Therefore, storage cost at any time = 375 × C1 = 375 × 3 =
1125 birr
Total annual cost = 1125 + 180 =1305 birr
Hence, the company should purchase 300 parts at time
interval of 1/30 year instead of ordering 750 parts each
month. The net saving of the company will be = 1305 –
900 = 405 birr per year
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?
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