COURSE TITLE-

INVENTORY
MANAGEMENT

Course code – 26137

Unit 4. Purchasing Principles

Purchase – Definition, Meaning, Organizing purchase, Ethics in

Buying, Buyer seller relationship, Element of scientific purchasing
including E- Bidding and Auctions, Buying the Right quality and
quantity , Buying From The right Source at right Price.

Purchasing cycle including Standard Conditions of a purchase

order ( PO)

Documents in purchase transactions and introduction of contracts

& Agreements

Scrap & Waste Management – Surplus and Obsolescent stocks ,

Management of scrap.
 PURCHASE -

MEANING –
Purchasing is a function of procuring goods and services from sources external to
the organization. Purchasing in essence is the task of buying goods of right
quality, in the right quantities, at the right time and at the right price.

Purchase means to buy (property, goods, etc.) to get (something) by paying

money for it.

A purchase means to take possession of a given asset, property, item or right by

paying a predetermined amount of money for the transaction to be completed
successfully. In other words, its’ an exchange of money for a particular good or
service. Purchases can be made in cash or credit.

An example of to purchase is to buy food at the grocery store.

The purchase item should be of specifies quality and desired quantity available at
the prescribed time at a competitive price. Purchasing is an operation of market
exploration to procure goods and services at desired quality, quantity at lowest
price and at a desired time.
Purchasing is defined as to buy materials of the right quality in the right quantity
from the right source delivered to the right place at the right time at the right
price.

Purchasing generally refers simply buying goods or services. Purchasing often

includes receiving and payment as well.

Purchasing means procurement of goods and services from some external

agencies. The object of purchase department is to arrange the supply of
materials, spare parts and services or semi-finished goods, required by the
organization to produce the desired product, from some agency or source outside
the organization

Purchase it is process of acquiring goods, services and equipment from another

organization in legal and ethical manner.

DEFINITION:

1. Alford and Beatty, “Purchasing is the procuring of materials, supplies,

machines, tools and services required for equipment, maintenance, and operation
of a manufacturing plant”.

2. According to Westing, Fine and Zenz “Purchasing is a managerial activity that

goes beyond the simple act of buying. It includes research and development for
the proper selection of materials and sources, follow-up to ensure timely delivery;
inspection to ensure both quantity and quality; to control traffic, receiving,
storekeeping and accounting operations related to purchases.
 ORGANISING PURCHASE -
Organizing is used to describe the formal and informal communication system
that bring about interaction and knowledge exchange in order to coordinate
technical, physical, commercial and administrative matters related to purchasing
and supply management.

Organization purchase in furtherance of organizational objectives, such as to

manufacture and deliver of goods and services to members, customers or
community.

Organization buying is the decision-making process by which formal organizations

establish the need for purchased products and services and identify, evaluate and
choose among alternative brands and suppliers Organizational buying is heavily
influenced by derived demand, that is, demand for an end product or for a
product or service sold by the buyer’s customers.

The demand for components by a manufacturer will be dependent on demand

coming from their customers, the retailers and wholesalers, who in turn are
reacting to demand from their customers, the consumers.

In an organization, the purchase decisions are influenced by several individuals

and are not made in isolation by an individual. Organizational buyers are more
concerned about the price and quality of the product along with the service being
provided by the vendor.

Organizations adopt certain methods for buying products such as checking a

sample before the actual purchase. Most organizational purchases involve
purchase of products in large lots. So it is not feasible to individually inspect each
and every item in the lot.
Organizational demand for products or services may be inelastic, derived, joint or
fluctuating in nature.

 Many people are involved in making decision as to –

1. Whether to buy
2. What to buy
3. At what quantity
4. From whom
 BUYER-SELLER RELATIONSHIP

 Buyer – A party which acquires or agrees to acquire ownership benefit or

usage of products or services in exchange for money or any other
consideration under a contract of sale is called a buyer. It is also referred as
purchase or customer.
 Seller – An Individual or entity that exchanges any type of goods or services
in return for payment to an existing or potential consumer.

The basic foundation in this type of relationship is the commitment and trust
between the buyer and the seller.

The buyer is the person or organization that purchases products from seller. A
buyer could be a manufacturer purchasing raw materials a customer buying a
finished product from a retailer.

The relationship between the buyer and seller can be either short term or long
term. Both short term and long term buyer and seller relationships have
advantages and disadvantages. Short term relations can be useful when a degree
of flexibility is required.

For example, short term agreements give the buyer the option to switch seller for
their next purchase.
 Long term buyer and seller relationships generally involve a high level of
commitment and work to maintain. Entering into long term contracts may be
involved so it is important to have accurate forecasts about the future
performance and needs of both businesses.

Buyer-supplier relationships refer to commercial transactions between

organizations for the purchase and supply of goods or services.

The major objective in this is to maintain a long term mutually benefitted

relationship. Buyers prefer this type of relationship mostly where there is less
choice in selection of the sellers.

Buyer and seller relationship may also be more scope for discount after the
relationship is established and there may be more flexibility in the timing of
payments.

It is the duty of sellers to deliver the goods to the buyer. Then the buyers accept
or reject it. If the buyers accept it then he must pay for goods.

Short term arrangements also have their disadvantages. They generally provide
little scope for payment and order flexibility. For example, a new supplier on a
short term agreement will want a definite order and prompt payment.

Buyers and sellers are the two wheels of the industry, be it that of the buyer or
that of the seller. Every buyer and seller must realize that growth of their
respective firms depends on the good will and relationships between the two.
Every buyer must realize that success of his firms depend on how good his
suppliers are and similarly every supplier must realize that his firms prosperity
depend on the prosperity of his buyers company.

Buyer and seller relationship are at the optimal level when the supplier supplies
the goods of right quality , in the right quantities , at the right price , and at the
right time and buyer understand the problems of the supplier and ensures
supplier’s firm makes profit and growth .
Common factor of Buyer – seller relationship:

1. Attitude toward each – other :

Both buyer and supplier must create an atmosphere that gives the
feeling to the other that he is welcome.

2. Timely Communication :
Timely communication between buyer and seller is vital for
establishing good buyer-seller relationships. Both should be prompt in
acknowledging and replying the letters. A buyer gets numerous
opportunities to communicate with the sellers: delivery schedules, reports
of rejections, changes in workload, revision in schedules etc. Complaints
concerning delivery failures, rejections, shortages, debit note etc should be
made in such a way that negative reactions are avoided. Similarly seller too
gets ample opportunities to communicate with the buyer: order
acceptances, delays in deliveries, enquiries for payments and new items,
collection of rejected materials etc.

3. Business Ethics :
Both Buyer as well as seller must observe business ethics.

4. Mutual Faith and Trust :

Good Business relationships are always built on mutual faith and
trust.

5. Avoidance of legal action :

Purchasing is a contract and it is always desirable to spellout
everything clearly in quotation, purchase order, order acceptance. Even if
everything is clear, there should be still difference of opinion and conflict of
interests.

Types of Buyer – Seller Relationships:

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Transactional or distant / Relationship
This type of relationship occurs when there is large number of suppliers
available.
When the supply market is constant
There is no complexity in the purchase decision
This method is preferred by the sellers when they feel that the buyer’s have low
potentials.
The sellers focus on low price of the product and also aim at timely delivery.

Value-Added or continuing/ Relationship

This type of relationship occurs when there is medium sales and the potential of
the buyer is also medium
This type of relationship aims at fulfilling the needs of the buyers more than
that of the competitors that is, providing them with the maximum value.
The main objective of the seller in this type of relationship is getting the
maximum share of the market.

Collaborative or Partnership Exchange Relationship

 The basic foundation in this type of relationship is the commitment and trust
between the buyer and the supplier.
 The major objective in this is to maintain a long term mutually benefitted
relationship.
 Buyers prefer this type of relationship mostly where there is less choice in
selection of the suppliers.
 Few buyers prefer this when there is much complexity involved in the purchase
decision.
 Sellers prefer this type of relationship when they feel that the potential of the
buying firms are high

Advantages of closer Buyer-Seller Relationships –

1. The development of mutual trust which is the foundation of all strong

relationships between the buyer and the seller. If trust exists between a
buyer and a seller, then they can work together early in the design of a new
product.
2. The opportunity to evaluate which suppliers should be given long-term
contracts. Both Buyer and seller should realize the benefits they can get
from long-term contracts between them. If a supplier gets long-term
contracts from a buyer, then the supplier is motivated to invest in new
plants and equipments to become more efficient and cost effective.
Element of scientific purchasing
including E-Bidding and Auction:
Elements of Scientific Purchasing:

Purchasing is the most important function of materials management.

Scientific purchasing, however, it is not mere procurement of needed
materials at the lowest price but their procurement in a way that minimizes
the overall cost of product.

Scientific purchasing is governed by five well-known parameters called

basic elements of scientific purchasing or also called “5 R‘s of buying”.

i) Right Quality
ii) Right Quantity
iii) Right Price
iv) Right time
v) Right Source

i) Right Quality: Quality of a product is measured in terms of its design,

materials, chemical composition, heat treatment, surface treatment,
manufacturing processes, mechanical and electrical properties,
workmanship, etc. Two distinct but closely inter -related aspects of
quality are: “Quality of design “and “Quality of conformance “.

Quality of design - Quality of design for purchased items refer to the

quality specified by the company’s design department in the form of
specifications.
 Quality of conformance –Quality of conformance refers to the
extent to which the goods and services purchased complies with the
laid down specifications.

ii) Right Quantity: Right quantity is yet another important parameter in

buying. Quantity decisions are influenced by -
“Replenishment methods “and “Buying methods “.
Consumption, market conditions, lead time, source of supply etc too
influence the decisions of right quantity.

iii) Right Price: Right price does not mean the lowest price but the price
which minimizes the overall cost. Right price is not easy to determine
The technique of:

 Negotiation is used when there are limited vendors, and/or

time available to make purchase is short, and items belong to
fixed price category.

 Tender system is followed in public sector organizations to

identify the lowest potential bidder.

 Learning curve is employed to determine the price of the item

with high labour content.

iv) Right Time: Right time and lead time are closely related. Right time
implies that the time at which the goods requested should be
received while lead time refers the time that elapses between the
communication of the need for the item by indentor to purchase till
the item is actually received and is made available for consumption.

Basic elements of lead time are:

  Time required by the indentor to communicate requirement to
purchase.
 Time required by purchase to locate, select, develop qualified
source of supply including agreement and contractual terms.
 Transit time for the purchase order to reach supplier.
 Time required by the supplier to route buyer’s order through
his administrative channels.
 Time required by the supplier to fill buyer’s order
 Transportation time for the goods to reach buyer’s destination.
 Time required by buyer’s receiving department to collect
materials from transporter’s godowns, verify receipted
quantities and prepare necessary documents.
 Time required by the buyer’s inward inspection to verify the
quality of goods.

v) Right Source: Only the right source can give goods of the right
quality, in the right quantities, at the right price and at the right time.
Right source aspect requires decisions as to what items should be
purchased directly from the manufacturers, which item from dealers
and which item from open market. Right source also requires the
analysis of transportation costs along with the basic price to make
selection between a distant supplier and a local supplier.
E-Bidding:

E-bidding is the process of bidding through electronic medium.

An ‘‘‘electronic bidding system ‘‘‘is an electronic bidding event according to

defined negotiation rules.

E- bidding can be used if the demand of the product can be specified , if the costs
are reasonable with regard to the procurement / buying volume and if multiple
suppliers exit who show interest in selling the product using an e-bidding.

E-bidding is one of the three stages of E- procurement.

E-Procurement is the procuring / buying of goods/services or constructions work

through electronic medium

ADVANTAGES AND DISADVANTAGES OF E-BIDDING

 ADVANTAGES:
1) Buyers receive competitive prices
2) Buyers can reach suppliers worldwide
3) Bids can be easily compared by the buyer
 4) Time saving in comparison to usual negotiations
5) Cost saving due to less person hours, less paperwork and less travel costs
6) Suppliers gain more knowledge of the market
7) All bidders have access to the same information and the process is clearly
defined
8) Secure Bidding System
9) Suppliers can react directly to bids from competitors

DISADVANTAGES:
1) The preparation becomes a crucial factor for the success of the auction
2) Good infrastructure (e.g. electricity, internet) is necessary
3) Investment costs for a bidding platform and for the training of employees
4) Malpractice of the buyer is possible (e.g. artificially created competition)
Auction

An auction is usually a process Buying and selling of goods and services by offering
them up for bids, taking bids, and then selling the item to the highest bidder or
buying the item from the lowest bidder.

An auction is a sales event wherein potential buyers place competitive bids on
assets or services either in an open or closed format. Auctions are popular
because buyers and sellers believe they will get a good deal buying or selling
assets. Auctions are conducted both live and online.

In a closed auction, for example, the sale of a company, bidders are not aware of
competing bids.

In an open auction, such as a livestock auction, bidders are aware of the other
bids. Examples of auctions include livestock markets where farmers buy and sell
animals, car auctions.

Auction simply means the process of buying and selling goods or services to the
bidders. The main aim for the auctioneers is to sell the product/service for the
highest price. The sole purpose for auction is to just increase the commodity
value in the market so that the general public would be aware about the price
structure of the product/services. Generally the auction takes place for the sale of
antiques, rare products, or old collectible items. 
Example of Auctions
Open Auctions
In an open auction, parties come together at a physical venue or online exchange
to bid on assets. An interested party is aware of the competing bid amounts and
continues to raise their bid until they are either declared the winner of the
auction (i.e., they submitted the last highest bid within the auction time limit) or
until they decide to drop out of the bidding.

Closed Format Auctions

In many business transactions, including the sale of company assets or an entire
company, auctions are conducted in a closed format whereby interested parties
submit sealed bids to the seller. These bid amounts are only known by the seller.
The seller may choose to hold just one round of bidding, or the seller may select
two or more bidders for an additional auction round.

In a situation where in a division of a company or the whole company is up for

sale, price is not the only consideration. If a bidder does not submit the highest
price but can offer the best terms for continuity for employees, the seller may
select that bidder.

Pros of Auctions:

 Seller controls process

 Find rare items
 Buy at a discount
 Seller can maximize bargaining power

Cons of Auctions:
 Competitive process can deter some buyers
 Cost of running an auction is significant
 Competitive bidding process can drive up price
 Auction Process
Before the start of an auction, potential buyers are usually allowed a preview
period to check the items on sale and examine their condition.

The preview period may be announced as being on the evening before the day of
the auction or a few hours before it starts.

Once potential buyers are done viewing all the items and are interested in placing
their bids, they must register with the auctioneer.

The registration process requires the buyer’s details like phone number, address,
and identification such as a passport or driver’s license number. Each registered
bidder is given a bidder card with a number that is used to identify all
participants.

The sound of a bell traditionally marks the beginning of an auction.

The auctioneer gives a brief description of the item for sale and starts the bidding
with a price that he/she considers a reasonable opening price.

Alternatively, the seller may have set a minimum bid price that they will accept,
and the bidding starts there.

The bidders then call out their bids, with each bid being higher than the
subsequent bid.

The bidders lift up their bidder card to announce their bid price so the auctioneer
can identify who is making the bid.

The process ends when there are no more bids, and the buyer making the highest
bid gets the item.

The highest bidder takes ownership of the item immediately after paying their bid
price.
BUYING THE RIGHT QUALITY AND QUANTITY:
RIGHT QUALITY:
ISO 8402 defines quality as ‘ the totality of features and characteristics of a
product or service that bears on its ability to satisfy stated or implied needs’

Quality thus is the sum of related characteristics – performance , safety ,

appearance,durability and ease of maintence – that distinguishes one article from
anotheror goods of one manufacturer from another or grade of one product from
another.

Two distinct but closely inter-related aspects of quality are :

o Quality of design

o Quality of performance

i) Quality of design : refers to the quality specified by the designer on the

behalf of the customer. A Product is designed because there is a
demand for it and the demand in turn varies to the extent goods and
service produced by the firm satisfy the needs of the customers. It also
depends on what price customers are prepared to pay.To have good
quality of design , the manufacturer must be clear about the specific
segment of customers market he is looking for the product and what
price match their valuation.

ii) Quality of conformance : refers to the extent the products and services
produced by the firm complies with the designer’s specifications.The
more closely the product meets the requirements of the design, the higher
is said to be its quality of conformance. Quality of design though is
closely related to quality of conformance yet the achievement of one does
not guarantee the compliance of the other.

Quality means the useful value of a specific thing for a specific purpose to fulfill.

The quality of a material has a direct relationship with its end use. In other words,
an inappropriate quality would mean that the end product is either too good or
too bad for a particular purpose. Producing the goods of best quality, the best
grade of raw material may be the right quality whereas for producing items of
medium quality, the average lowest grade may be the right quality.

The quality of the item is called as grades. Buying quality item can be measured
by physical tests, chemical analysis or by any other methods depending upon the
nature of a product.

‘The quality of a buying product must be built into the product’. For creating
goodwill, right production, standardization, elimination of waste and for better
results, and the buying right quality are very essential.

Thus, the right quality is the suitability of items purchased for a given purpose.
The best quality of materials purchased need not be the right quality.

If the right quality is not achieved

 Stock may have to be rejected or scrapped.

 Production machinery may be damaged.
 Finished products may be defective and have to be scrapped or re-worked.
 Defective products may reach customers, resulting in recalls, returns,
compensation claims, lost goodwill, damaged reputation.
 The firm will incur high costs.

Quality has to be defined specifically in terms of each item bought. Buying

the right quality is important for customer needs and suppliers profits.
RIGHT QUANTITY:

Right quantity implies the most economical quantity that should be purchased at
a time in order to optimize the cost involved. Smaller quantities reduce inventory
carrying charges while bigger quantities give economy in price etc.

Buying Materials should be of right quantity.

The purchaser must buy the materials in the right quantity to ensure that there is
no stoppage of production or no extra stock piling.

The inventory control wing of purchase) department, fixes up the economic order
quantity (EOQ), i.e., the quantity which should be purchased at a time to get the
maximum benefit at minimum total cost.

This requirement is mentioned in the purchase order and it is necessary to see

that the materials are delivered.

Quality should, therefore, be just right, neither more, nor less than what is
required for a given purpose.

One of the principal tasks of the Buyer is to buy the right quantity at the right
time. Determination of quantity is one of the difficult tasks, since

 Some items are regularly consumed

 Some have Fluctuating Requirement
 Suppliers attract with Volume Discounts for larger quantities purchased
 Prices may fluctuate sometimes very sharply
 There can be fluctuation in the lead time too.

Another factor is that prices may fluctuate sometimes very sharply. For example,
certain products are seasonal in nature, like cotton, groundnuts, etc. It would,
therefore, be necessary to buy such materials when the opportunity is best and
not make periodic purchases as in the case of commodities which are available all
trough the year.

If the right quantity is not achieved:

 Insufficient stock may be held to meet demand.

 Stock outs may cause bottlenecks or shutdowns in production; costs of idle
time; late delivery to customers; lost credibility, goodwill and sales.

Buyer has to use his knowledge, experience to determine the quantity after
considering factor such as price structure, discounts, availability of the item and
make or buy considerations.
BUYING FROM THE RIGHT SOURCE AT RIGHT PRICE :
Right source :
Best source is from where buyer gets the material at the lowest price. But this is
not normally there are several other aspects related to this problem. Quality of
the material cannot be ignored. Equally important are quantity and price criteria.

Right source may be defined as the one who can supply goods and services of the
right quality, in the right quantities, at the right time and at the right price.

This is possible provided,

 The source is free from labour problems

 The source is financially strong
 The source keeps itself abreast with changes in technology

A buyer can get many sources but the good sources are difficult to get.
Source selection and source development require time and efforts on the
part of the buyer.

STAGES IN THE SOURCE SELECTION AND SOURCE DEVELOPMENT PROCESS:

Source selection and source development is the systematic process of locating,

investigating, selecting and developing suppliers who can give acceptable
delivery, quantity, quality and services at the acceptable price to the company.

Source selection and source development is necessary for raw materials, tools,
spares or for items produced to commercial standards , or for items required to
buyer’s design ‘ or for imported items.

There are eight stages in the source selection and source development process of
this category of items.
 These stages are:
i) Source requirement stage to identify the need for source
selection and source development.
ii) Source location stage to collect information on potential
sources of supply.
iii) Source investigation stage to identify technical, financial,
managerial and quality assurance capability of the vendors
and thereby generate data to serve basis for preliminary
source selection.
iv) Preliminary source selection stage to narrow down the
choice to those who are most likely to fulfill the
requirements successfully.
v) Techno-commercial discussions stage to discuss the
technical aspects of the item and finalize terms of contract
of the trail order.
vi) Trial order stage to carry out follow up with the supplier
until sample submission, sample validation , defect analysis
and defect prevention including follow-up for pilot lot and
bulk production lot.
vii) Source appraisal stage to review performance of the
vendor, render assistance and decide on future business
with vendor.
viii) Source retention stage to create necessary conditions so
that supplier sticks to the company.

Right source means the source which is reliable in all respect such as quality,
delivery, after sales service, etc. 

Selecting the right source for the purchase of materials is an important

consideration in the purchase procedure. The right source for the procurement of
materials is that supplier who can supply the material of right quality as ordered,
in right quantity as ordered, at a right time at which the materials were required
to be supplied, at an agreed price with the supplier, who is in a position to honour
the commitment without much follow- up, who has necessary financial resources
and adequate man-power to handle the order.

The source of material should be located within a reasonable distance from the
buyer’s organization. This will minimize the delivery delays, higher transportation
charges and improve the personal contact between the buyer and the supplier
and enable better after-sales service etc.

The suppliers are not only supplying the required materials but they also supply
the information such as probable market conditions and the resultant price
trends, general industrial climate and the business environment.

The source from which the material is procured should be dependable and
capable of supplying items of uniform quality. 

The buyers have to decide which item should be directly obtained from the
manufacturer. In emergencies, open market purchases and bazar purchases are
resorted to.

A Right supplier today might become a wrong supplier next year.

RIGHT PRICE :
One of the primary functions of purchasing is to buy goods at the “right “price.
But what is “the right price “? Price is a dynamic factor. Price vary from vendor to
vendor, at one time to another time and at the same time. The right price
assumes greater importance as it has a significant effect on cost of the final
product.

An accepted criteria regarding a right price assumes that –

Price has a reasonable relation to cost

Price is a result of supply and demand conditions
Price is a determined by competition

Therefore, right price is the price that must be paid to the supplier to
obtain the goods of the right quality at the right time.

Price is an important element in every purchase transaction since it affects

the cost of production and ultimately the profits.

Factors Influencing Price:

A number of factors have a bearing on the determination of the right price of an
item. They are-

i) Quantity requirements: Higher price is usually charged when the

quantity required is small. Bigger quantities on the other hand give the
buyer a leverage to negotiate for better price.

ii) Quality requirements: A higher price is usually demanded for the critical
items since buyer have lesser options available compared to other items
where many alternative sources are available.

iii) Delivery Time: Time available to the buyer has a major influence on the
price charged by the supplier. A higher price is generally charged / paid
 when buyer has limited time to wait and to create urge in the supplier to
supply, or he has no time to locate sources who could supply at lower
price.

iv) Buyer-seller relationship: Good buyer-seller relations provide a good

ground for negotiation while strained relations make the supplier quote
higher.

v) Government restrictions: Prices of certain commodity may be fixed by

the government and thereby putting a restriction on both buyer and
seller. Local taxes in different geographical locations may be different.

vi) Geographical location: Geographical location of the supplier too makes

the price to vary from one supplier to another. The difference may be
the result of difference in local taxes, transportation cost, excise and
sales tax.

vii) Extent of competition: Limited competition is associated with higher

price while wider competition enables buying at competitive rates.

It is the primary concern of any manufacturing organization to get an item at the

right price. But right price need not be the lowest price.

Determination of right price is a difficult task. It is the main object of any

organization to procure the material items at the right price. It is that price which
brings the best ultimate value of the money invested in purchasing the materials.

Deciding the right price of a product depends on variety of factors, viz.; quality,
delivery time and ultimate life of the material, demand and supply curve, extent
of competition, government restrictions, after sales services, discount offered,
and terms of purchase etc.
 The purchaser must have a thorough idea about the market prices, especially the
current prices of raw materials, their likely future trends, and environmental
conditions which affect prices. The purchaser should not be forced by the seller to
accept any price quoted by the supplier. There are various ways of determining
the right price.

 A price that the buyer can afford and allows them to recover the cost of
production and make profit assuming the buyer is in business.

The price is an agreement between the buyer and the suppliers the former
considers his utility while the latter takes into account his cost of production.

The price can be kept low by proper planning and not by rush buying.
PURCHASING CYCLE INCLUDING STANDARD
CONDITIONS OF A PURCHASE ORDER (PO) –
Purchasing Cycle :
Purchasing activity plays a vital role in all the firms in general and in the
manufacturing firms in particular. Purchasing is not merely “buying to satisfy the
intendor’s requirements “but “buying goods of right quality, in the right
quantities, at the right time and at the right price.

The purchase order life cycle is the set of key steps involved in processing a
purchase order. It begins with an approved purchase requision, which is then
converted to a new purchase order and sent through the purchase order approval
process.

Major activities of Purchase Cycle:

i) Establishing and communicating need for

procurement
ii) Scrutiny of the purchase indent
iii) Purchase Market research
iv) Order Preparation
v) Follow up with vendor
vi) Receiving & Inspection
vii) Storage & record keeping
viii) Invoicing & Payment

1. Establishing and communicating need for procurement: The need for purchase
originates in one of the firm’s operating department or its inventory control
section. The need is communicated to the purchase department through a
formal document called “Purchase indent “or “Bill of material “.
 Purchase Indent: Purchase indent also called purchase requisition, is a formal
request made to the purchase department to purchase materials or services
specified therein.

PURCHASE ORDER –

The purchase order is also called as ‘PO’

A purchase order is a contract between the buyer and the seller and it gives
specific information like product or services to be delivered, delivery date, and
any other terms and conditions including the price.

Purchase orders contain the details ranging from products that are ordered to
shipping address. Below are details that usually forms part of purchase order:

 Products that are ordered

 Quantities i.e., (kg, meters, numbers etc.,)
 Price at which it is ordered
 Name of the vendor to whom the purchase order is being sent
 Shipment address or delivery location where the goods are required
 Billing address of the company
 Terms and conditions of payment.
 Due date of delivery/consignment
Conditions of Purchase Order –
1. Terms and Acceptance.

This order becomes a contract

(1) When a signed acknowledgement is received by Buyer, or
(2) When shipment according to schedule of all goods covered by this order
shall be made, or
(3) When Buyer gives Seller written approval of the price and delivery
schedule of the goods as stated by Seller if Seller’s written acknowledgement
of this order contains either:

(a) A different price or delivery schedule or a different type of item, or

(b) No price or no delivery schedule for the item or items to which Buyer’s
approval applies.

Except as provided in the preceding sentence, it is a condition of this order

that any provisions printed or otherwise contained in any acknowledgment
hereof, inconsistent with or in addition to the terms and conditions herein
stated, and any alterations in this purchase order, shall have no force or
effect, and that Seller by such acknowledgement thereby agrees that any
such provisions therein or any alterations in this order shall not constitute
any part of this contract or purchase and sale.

2. Inspection, Warranty.

Goods delivered (whether paid for or not) are subject to inspection, testing,
and approval by Buyer before acceptance. Seller expressly warrants that all
articles, materials, and work will conform to the applicable drawings,
specifications, samples, or other descriptions given in all respects, whether
such drawings, specifications, samples or other descriptions are produced
by Buyer or third parties contracting with Buyer, and that the goods
delivered hereunder will be of good quality, material, and workmanship
merchantable and free from defects.
 This warranty shall survive any inspection, delivery, acceptance, or payment
by Buyer of the goods or services.

3. Nonconforming Goods

Buyer may charge to Seller all expense of inspecting, unpacking,

examining, repacking, storing, and reshipping any goods rejected as
aforesaid. The remedies herein above afforded to Buyer shall not be
exclusive, but Buyer may hold Seller liable for any and all damages,
including but not limited to compensatory, consequential and incidental
damages, arising from any breach or default herein above set forth.

4. Price

Prices recorded in this order are not subject to increase. No additional

amounts shall be chargeable to Buyer because of taxes or excises, presently of
hereafter levied on Seller. If Seller’s quoted prices for the goods covered by this
order are reduced at time of shipment, Seller agrees that the price to Buyer for
such goods will be reduced accordingly, and that Buyer will be billed at such
reduced prices.

If price includes taxes or excises, and if such taxes or excises or any part
thereof are hereafter refunded to Seller, Seller shall immediately pay Buyer the
amount of such refunded, Seller certifies that the prices herein are not higher
than prices being charged to other organizations purchasing identical goods in
similar quantities at this particular time and do not discriminate against
purchaser.

5. Payment. Terms of payments are as previously arranged, or if specified in

this order, then as so specified

6. Delivery time of Essence. Buyer’s schedules are based upon the agreement
that the goods will be delivered to Buyer by the dates specified on the face of
the purchase order. Time is therefore of the essence and if goods are not
delivered within the time specified hereon, Buyer may reject such goods and
cancel order.

7. Packing. Each package shall be numbered and labeled with Buyer’s order
number, item number, contents, and weight, shall contain an itemized packing
slip and shall be properly prepaid for shipment so as to secure lowest
transportation and insurance rates and to meet carrier’s requirements, unless
otherwise specified.

8.Trademark- if the goods specified within this order are peculiar to Buyer’s
design or if the goods bear Buyer’s Trademark or identifying mark they shall not
bear Trademark or other designation of the Maker or Seller and similar goods
shall not be sold or otherwise disposed of to anyone other than Buyer without
written consent of Buyer

9. Indemnification by Seller. Seller will indemnify, hold harmless, and defend

Buyer from all liability for loss, damage, or injury to person or property in any
manner arising out of or incident to the performance of the contract.

10. Taxes
Seller accepts liability for payment of all payroll and Social Security taxes and
all other federal, state, or local taxes now or hereinafter imposed by any
government authority.

11. Conflicting Terms. If terms on this order do not appear on or agree with
Seller’s invoice as rendered, Seller agrees that Buyer may change invoice to
conform to this order and make payment accordingly.

12. Modification. Buyer shall have the right to make, from time to time, and
without notice to any sureties or assignees, changes as to packing, testing,
destination, specifications, designs, and delivery schedule. Seller shall
immediately notify Buyer of any increases or decreases in costs caused by such
changes and an equitable adjustment of prices or other terms thereof shalt be
agreed upon in a written amendment to this order.
13. Cancellation. Buyer reserves the right at any time and from time to time
without cause, to cancel all or any part of the undelivered portion of this order
by notice to Seller. In the event of such cancellation, Buyer shall not be liable to
Seller for loss or anticipatory profits, nor any other incidental or consequential
damages.

14. Miscellaneous. This contract contains the entire agreement of the parties,

and failure of either party to enforce any of its rights hereunder shall not
constitute a waiver of such rights or of any other rights hereunder.
 DOCUMENTS IN PURCHASE TRANSACTIONS AND
INTRODUCTION OF CONTRACT AND AGREEMENT :

DOCUMENTS IN PURCHASE TRANSACTIONS -

Purchase Transaction Documents means the Purchase Agreement, each bill
of sale, each assignment agreement, each assumption agreement, each transition
services agreement, and all other agreements, instruments and documents
entered into or delivered in connection with the Purchase Transaction, as each
may be amended, restated, modified or supplemented and in effect from time to
time.

 Purchase Agreement - A purchase agreement is a legally binding contract

between a buyer and seller

 Each Bill of Sale - A document that signifies that a person or organization

has sold goods to another person or customer is called bill of sale.

 Each Assignment Document - An Assignment, or an assignment of contract,

is a document that allows one party to transfer the rights and benefits of a
contract to another party.

 Each Assumption Agreement - An assignment and assumption agreement is

used after a contract is signed, in order to transfer one of the contracting
party's rights and obligations to a third party who was not originally a party to
the contract.

 Each Transition Service Agreement - A transitional service agreement (TSA)

is a type of agreement that is made between the buyer and seller of a
company. In this arrangement, the seller agrees to provide certain services
to the buyer at a predetermined price.
INTRODUCTION TO CONTRACT AND AGREEMENT

Contract:

Contract is an agreement between two or more parties that creates

obligation and enforceable by law.

A contact is created any time things of value are exchanged. A contact

could be defined as an agreement which intends to create a legal obligation
between the parties.

The essence of contract is that there should be an agreement between

parties. A contract may be oral or written.

A contract is an accepted proposal (agreement) that is fully understood by the

law and is legally defined or enforceable by the law.

A contract is typically involves the exchange of goods, services, money or a

promise any of those.

A contact is often in the form of a written agreement between parties. A

typical form of written contracts contains information such as:

 The name of the parties to the contact.

 When and where the contact was made
 What service product or good is provided
 What is being exchanged e.g. Money for the service, product or good
that is provided.
 An acknowledgement that the parties agree to the terms in the contact.
 The signature of the parties agreeing to the contact.
 The Indian Contact Act was enacted in 1872 and came into force on 1st
September 1872. The word ‘Contract’ has been derived from the Latin word
‘Contractus’ which means to work on contract.

Section 2 (h) of the Indian contract act 1872 defines the term ‘Contract’ as
an “Agreement enforceable by law “.

A contract is a type of agreement where there is an exchange of legally

enforceable promises between parties. To create a legally-binding contract,
there must be 6 essential elements:

1. There must be an offer where one party is willing to enter into an

agreement with another party.
2. There must be an acceptance where one party signifies their willingness to
enter into a contract with the party making the offer. An offer can be
accepted by words or actions.
3. There must be consideration given by each party. Consideration is a right,
interest, profit or benefit experienced by one party with some detriment,
forbearance, loss or responsibility experienced by another party. An
example of consideration between parties is one party paying money and
the other party providing a service.
4. Parties to a contract must intend for the agreement to become
binding when it is accepted by the other party.
5. Generally, only parties who are privy to (named in) a contract can sue or be
sued on the contract. Third party rights are usually not recognized except in
specific circumstances.
6. There must be certainty of terms between the parties to the contract. Each
party must know what the terms of the contract are.

A contract is often in the form of a written agreement between parties.

Contracts can also be in the form of an oral agreement but oral agreements
can be much harder to prove when a dispute arises.

“ A Contract “ according to section 2 ( 4 ) of the Indian contract Act ,

1872 , “ is an agreement enforceable by law” and
“ agreement “ according to the Act ( Section 2-e) is “ every promise
and every set of promises forming consideration for each other. “

A contract is an agreement which requires involvement of at least

two parties:

An agreement is made of a proposal and the proposal needs

acceptance. The person making the proposal is called promisor and
the person to whom promise is made is called promisee.
The agreement must be capable of being enforced by law.

 Contract is an agreement enforceable by law.

 Agreement is every promise and every set of promises forming
consideration for each other.
 Consideration is the price for the exchange of promise and it
may be either money or property, or a promise to give money
or property, or forbearance of a legal right.
 Discharge (or terminated) of the contract: A contract is said to
be discharged or terminated when the obligations created by
the contract come to an end.

Contracts are basic to every sale – purchase transaction. A contract is

the result of an offer by one party and acceptance of the offer by the
other party subject to such agreements being enforceable by law.
Introduction To Agreement –

An agreement is a promise or arrangement between two or more parties to

do, or not do, something. It’s usually informal and sometimes unwritten
(but not always). 

An agreement is made when two parties agree to something. 

An agreement is made when two people reach an understanding about a

particular issue, including their obligation duties and rights.

While agreement is sometimes used to mean contract legally binding oral

or written.

 Definition –

According to Contract Act 1872,

“Every promise and every set of promises forming the consideration for
each other is an agreement”

Agreements are fully understood.

All contracts are agreements but all agreements are not contract.
Contract = Agreement = Enforceable by law

Agreements can be Social agreements or legal agreements.

2. If A invites B to a dinner and B accept the invitation, it is social

agreement.
3. If A gives 1 Milk bag to B for a consideration of rs.27, then it is a legal
agreement.
  In other words, an agreement is an accepted promise, accepted by all
parties involved in the agreement or affected by it.

Difference between Contract and agreement –

Contract Agreement

A promise or a number of promises that

A contract is an agreement that is
are not contradicting and are accepted by
enforceable by law.
the parties involved is an agreement.

An agreement must be socially acceptable.

A contract is only legally enforceable. It may or may not be enforceable by the
law.

A contract has to create some legal An agreement doesn’t create any legal

obligation. obligations.

An agreement may or may not be a

All contracts are also agreements.
contract.
SCRAP AND WASTE MANAGEMENT –

Surplus and obsolescent stocks :

A firm’s investment in inventories to a large extent is influenced by

presence of surplus and obsolescent stocks.

Surplus stocks –
o These are materials which have no immediate use or at least in the
foreseeable future. They have accumulated due to faulty planning,
forecasting and purchasing. Sometimes, they may have accumulated
since they are standard bought in quantities only and not in loose
form where they would be more expensive. In short, surplus stocks
are the items which are in excess of their requirement. 

o Surplus means such items which are more than the required quantity
and cannot be consumed during a specific time for certain reasons.
These are the materials which can be consumed at some future time
or that which is no longer required for the job, for which it was
purchased.

o Surplus materials arise from many reasons:

 When manufacturing operations are suddenly curtailed on

account of design improvement etc.
 When the project has been completed.
 These stores may be in excess of the normal manufacturing
and repairing requirements to the job concerned.
  Excess purchase of stores due to wrong judgment at the
procurement stage.

Genesis of surplus Material:

“A surplus item is one whose stock is likely to last longer than the normal
period of consumption “

a) Over buying results due to errors in estimation of the quality or because

of non-realization of anticipated sales.
b) Reduction in production programme of a product generally renders its
raw materials and components surplus.
c) Product simplification is yet another reason which leads to surplus
stocks. Where items are common to more than one product,
discontinuation of one or more products reduces the demand of
common items which makes their stocks surplus.
d) Lack of control on quantity of incoming materials may cause dumping of
material by the suppliers.
e) Forward buying on account of fear of non-availability /transporter’s
strike etc. may result in accumulation of stock.

Obsolescent stock / Obsolete Stock -

They are those items which are not damaged and have economic worth but are
not suitable for the company's specific operations.

For example, the spare parts of machines that have been phased out. Changes in
product design, technological advancements, rationalistic, food and drugs whose
effectiveness has lapsed over time, wrong codification etc. are some of the
reasons why obsolescence occurs.

As the name implies, they are non-moving items of the inventory

One of the most common reasons for obsolescence of high technology / new
technology / automation / design change / product change / diversification.

Obsolesce arises following reason:

1. Faulty planning leads to over stocking of inventory.

2. Non-implementation of project/job.
3. Changes in demand due to change in fashions and supply conditions and
change in business policy.
4. Purchasing wrong items results in non-utilization of stores.
5. Bad communication within the organization as well as with suppliers.
6. The sudden emergence of new technology or a design change.
7. Excess purchasing, whether due to wrong forecast of requirement or to
take advantage of quantity discount.

Genesis of obsolete materials:

“An obsolete item is one which has been superseded by another item
due to change in design, modification or substitution “
 a) Product simplification is yet another cause for large scale
obsolescence. The management an item may decide to delete a
particular product because of its poor sale, its lower contribution or
both.
b) Sales return – Goods may be received back because the customer
has either payment problem or fails to retire the documents or
wrong supplies. If the goods have been produced for specific
requirement, the components for the same become obsolete when
taken into stock.
c) Financial degradation of materials in stock – Certain material
such as rubber parts when stocked beyond their service life become
non-usable and therefore obsolete.
d) Wrong purchases – Items procured because of error in description
or wrong code numbers may be found to be non-usable at the time
of assembly resulting into obsolete stock.
e) Changes in manufacturing process may render raw materials,
tooling etc. utilized in the old manufacturing process obsolete.
f) Excess buying procurement of non-stock items in excess of their
actual requirement leads to obsolete stock.

Management Of Scrap

Meaning of Scrap –
Scrap consists of residue or unutilized portion of raw materials which
cannot be used for manufacturer of other components, materials and
component rendered defective during manufacturer, non – returnable
empties, broken or worn out tools which are beyond retrievable,
irreparable parts of the machinery and the like.

Essential of Scrap Disposal –

Scrap theoretically is supposed to be a thing of no use but usually a big

money potential is there in their proper disposal.

Essentials of scrap disposal are –

1. Collection of Scrap – Scrap is money and hence should be treated like
money. All types of scrap should be collected and properly stored at one
place. The Scrap yard should be supervised by senior officials.
a. Scrap from production machines should be collected and
removed to the scrap yard daily, preferably few times in a day.
b. Separate bins may be installed on the shops to deposit used
cotton waste and waste paper which can be periodically
removed to scrap yard.
c. Used aprons, gum boots and hand – gloves, etc should be
returned to issue counter for replacement.

2. Segregation of scrap: Segregation involves sorting of scrap by type,

grade, size and weight to obtain maximum result.
General rules are –
a. Ferrous and non-ferrous scrap must be segregated and stored
separately.
b. Steel scrap should further be classified into three groups – first
group consisting of drilling, turnings, borings etc, second group
consisting of end pieces and third group consisting of defective
components.
 c. Scrap yard should be marked and different variety of scrap
such as paper scrap, steel scrap, wooden scrap, rubber scrap,
other scarp etc should be deposited in their assigned locations
thereby enabling segregation up to certain limit.

3. Storage of scrap –
Different types of scrap should be stored so as to suit their
respective nature – steel scrap may be stored in the open yard , brass or
copper scrap in the scrap room and tools scrap in drums or wooden
cases.

4. Periodical analysis of amount of scrap :

The total amount of scrap of each category should be analyzed
to see whether it is too low or too high and reasons for the same should
be invested. Scrap should be broadly divided into two categories –
i) Regular Scrap
ii) Irregular Scrap

Scrap –

Scrap means waste that either has no economic value or only the value of its basic
material content recoverable through recycling.

Scrap Yard – It is a place where receiving or handling scrap is done.

 Reason For generation of scrap –

1. Change in design , method or product
2. Mistake in procurement
3. Wrong planning decision
 4. Waste full process in production
5. Inevitable waste during the adjustment of the equipment
6. Overall obsence of efficiency.

Management of Scrap –

Manufactures do not intend or plan to make scrap, but depending on the industry
and the product, scrap is produced. But depending on the type of scrap, it may be
recycled back into the production process or sold as a revenue generating product
or simply non – recyclable and enterprise has to pay for an outside contractor to
dispose of the product.

ETHICS IN BUYING:
The word ‘ethics’ refers to norms for conduct that distinguish between acceptable
and unacceptable behavior. 

'Ethics' in purchasing/ Buying and supply management can relate to a wide range
of issues from supplier business procedures and practices to corruption.

The common areas relate to ethics and ethical behavior in companies include fair-
trade, ethical trading, ethical sourcing, social accountability, social auditing,
corporate social responsibility, corporate citizenship, codes of conduct and
reputation assurance.

Firms have reputations, just like individuals. Buyers can have significant influence
on corporate reputations.

Buyers have great authority in granting contracts. Sometimes suppliers attempt to

secure this business with unethical practices. Unfortunately, temptation is always
present when large amounts of money are involved.

Word “Ethics “means character or conduct is that branch of philosophy

which deals with rightness or wrongness, goodness or badness of human
conduct.

Ethics is the systematic study of moral action provides the basis for deciding
whether a particular course of action of an individual is morally correct or
incorrect, good or bad.

Ethics therefore defined as little finest complications of do’s and don’ts

resulting from conflict of mind as to what a person is tempted to do and
what he ought to do. Buying activity offers umpteen opportunities to a
buyer to test his moral turpitude and only the one who has set a very high
standard of morality is able to overcome the temptation to perform
unethical acts.

Typical unethical acts:

1. Misrepresentation of facts – A buyer can have short term benefits by
misrepresenting the facts to the vendor .He may give him wrong idea of
his actual requirement or show him a fictitious figure to get some price
discount, or reduction in price or adjustment in other terms of contract.

2. Personal Requirements: Some buyers buy their personal requirements

from their suppliers and try to get these free of cost or at much lower
price. For e.g. A buyer may ask his vendor who is a gear manufacturer to
make a new gear for his vehicle and expect him not to charge. The
supplier tolerates this in anticipation of getting more business from the
company.