Training on

Purchase management and inventory control

Facilitator: M/s ICWAI, Bengaluru Conducted on: 20 21 March, 2009. An overview

In modern industrial world competition has been very stiff and many industries turn sick now and then. Some industries face huge while even those which were flourishing slowly deteriorate in their earnings. An analysis of such happenings would indicate that ineffective control is the root cause. Controls are therefore absolutely necessary for survival of industries. A control is the process of ensuring performance of various levels of organization, in line with the plans courses of action for the plan period. It involves: Preparation of action plan for the period. Communication of the plan to various levels. Monitoring actual V/s Projections. Among the various controls exercised in industries, inventory control occupies one of the prime places since material constitute one of the important factors of productions in an organization. Materials refer to commodities supplied to an undertaking for consumption in manufacture or in rendering service or conversion into products. Cost of such materials enters into product cost or cost of services. Often the term stores is used synonymously with materials, though stores has wider meaning covering not only raw materials for consumption or utilization but also other sundry items like sundry supplies, maintenance stores, fabricated parts, components, tools & other equipments, further there are finished and semi finished products. To cover all such items of stores the commonly used term is INVENTORY, which includes raw materials, components, WIP & semi finished stocks. In any organization materials are procured, stored till they are actually required & finally issued. In order to prevent deterioration, waste, theft etc. proper physical control on such materials is necessary to avoid extra expenditures on purchases(in excess of needs), Stock outs(Affecting production), improper use(Internal or other wise). Any system of inventory control starting from the point of request for purchase of materials up to point of consumption. Thus inventory control is divided into Purchase control, Storage control & Issue control.
Purchase control:

Effective purchase department/Organization. Qualifications of purchaser. Purchase routine. Purchase requisition. Specification & quality of materials. Time of purchase & quantity to be purchased. Stock levels of material holding determining purchase.

Storage control:

Role of store keeper. Location & organization of stores department. Classification and codification of materials. Perpetual inventory system. ABC/VED methods of control.
Issue control:

o Bill of materials(Specification Cum quantity) o Materials requisition/return note. o Pricing of issues. Thus to sum up, inventory which comprises stocks of stores, components, WIP, finished goods is subjected to controls with a view to achieve maximum efficiency in production and sales with least investment in inventory. The techniques applied for inventory controls are ABC/VED Analysis. Setting levels. Establishment of system of budgets. Perpetual inventory system. EOQ etc. Provisioning and purchase procedure. Review of SM/NM items. Rato analysis. Inventory TO( material consumed to average inventory). SM/NM to total inventory Total inventory to cost of production.
(SCM) SCM): Supply chain management (SCM):

Definition: the physical, financial & information network for the logistic movement of material funds & related information in an organization.
Characteristic SCM: Characteristic of SCM: er

Any number of companies may form part of SCM. It includes all activities & processes that required supplying the final product to customer. Customer can be supplies to other customer creating customer customer relationship.
Process of SCM:

Plan: Includes planning of requirements i.e. raw materials, spare parts, consumables etc. Sources: Includes collection of system requirements i.e. raw materials, consumables, spares etc., Produce: Production of end products. Deliver: Deliver to the customer. Return: Rejection or in other words source of improvements.

Decision areas under SCM:

Location decision: Planning of layouts in an organization has a vital role in a company, it is directly proportional to the cost. SCM involves layout planning i.e. warehouse, machine hall, control room etc. Product decision: Decision on type of product to be manufacturing i.e. modification in design, improvements, changing the process etc. Inventory decision: Decision on purchasing, classifying, maintaining(stock levels) of inventories. Transportation or distribution decision: Decision on supply of product and optimistic means of supply i.e. transportation is also very important while exporting the product.
SCM Systems:

Supply chain planning software Supply chain execution software Application service provider Entrepreneurs resource planning

Advantage of SCM:

Business integration/development Cost saving Quality control

Work capital management (WCM):

Work capital management is concerned with decision involving current assets and current liabilities. Current assets are acquired with an intension of sale or conversion into finished goods for sale and include cash and bank balances, raw materials. WIP, finished goods and account receivables. Supportive assets are primarily intended to feed fixed assets and to carry funds required for carrying out the day to day operations. The term work capital normally denotes investment in current concern assets and also used with different connotations like Gross working capital which deals with total investment in current assets, Net working capital which concerns current assets less current liabilities.
Types of work capital:

Depending on nature of funds blocked, working capital can be categorized as Permanent working capital: It represents that minimum amount of investment in current assets that is deemed necessary for carrying out operations for a period. It is an investment in the nature of long term, like that of fixed assets. Fluctuating working capital: It represents additional assets required at different times during the operating year to cover any change or variably from the normal operations. A change may be affected by seasonal or cyclical factors. For example a firm keeps a large stock of inventories and carries larger receivables during peak selling periods like festival seasons. Seasonal fluctuating working capital: Additional inventory or other current assets are held due to the seasonal nature of the industry. Seasonal industries like wooden goods or sugar carry an additional stock of inventory.

Special fluctuating working capital: Extra funds needed to meet contingencies during inflationary situations, recession or strike or to take advantage of bulk discount are the examples.
Importance of work capital:

Work capital to iterate is needed to carryout manufacturing, administrative and distribution functions. An adequate level of working capital is essential for the profitable operations of every enterprise. The need of working capital arises as cash expenditures and cash receipts are non-synchronous, that is these do not occur at the same time are a sizeable part of the total assets and normally account for approximately 50-60% total assets.
Working capital components and management: 1. Cash management: Cash is most liquid asset is necessary to honor obligations

and commitments. Cash balance here includes cash in banks. With a geographical dispersal of business enterprises cash management has acquired added significance as cash balances in regional offices are to be optimized. An increasing sophistication in cash management has resulted in reduction in cash balance held by an enterprise due to various reasons like o Rising interest rate on securities o Innovations in the area of cash management o Economies of scale in cash management with the growth of corporate size. Techniques of cash management: Concentration banking: While an objective of speeding up the collection of cheques from customers. Strategic collection centers are established in different regions. Lock box system: An arrangement sometimes is made with the local post office where in the customers are requested to deposit the cheques. Centralized banking system: In a multi division company bank balances are centrally controlled and the balances in regional offices are transferred to the central office.
2. Inventory management:

ABC and VED analysis of inventories: In ABC analysis materials are categorized into three groups namely A, B and C. Small number of items say 1% having heavy investment (80%) is categorized as A, area of concentration in item A category is to avoid heavy stocking but at the same time keeping in mind the possibility of stock out. Another 10% of items having 15% of the value are categorized as B, area of concentration for items in B category are reviewed less frequently. Large number of items says 89% involving low investment say 5% are categorized as C, these items may not subjected to rigorous control. In VED analysis materials are categorized as Vital, Essential and Desirable. Vital items very important items for production/maintenance and required less frequently. Essential items are less important than the vital items for production/maintenance and possibility of requirement little bit higher than vital items. Firm controls on vital and essential items are required and are viewed frequently and stored so that inventories should not be damage/ Spoil in any case. Vital and essential items are always kept stock in safe level so that production may not be stop due to lack

of these items. Desirable materials are not so important like vital & essential items in view of production and maintenance and it doesnt require firm control. Economic order quantity(EOQ): Various cost involved with the inventories are:, 1. Material cost, 2. Ordering cost: i.e. cost of placing an order like typing the order, inspection of goods receipt. 3. Carrying cost: Various costs are incurred for having an inventory stock i.e. Storage costs, Insurance, obsolescence and spoilage, damage or theft. 4. Costs of funds tied up in the inventory. 5. Cost of running out of stock and loosing an order.
Total cost Inv. Carr. cost

Costs

EOQ Quantity

Ordering cost

Economic ordering quantity = (2xAxC/I) Here A Annual consumption of materials C Ordering cost or cost per order I Inventory carrying cost. Just in time inventory: Just in time is a Japanese method of integrated philosophy by team approach, is not only applicable to the various components of inventories but also in most of the day to day activities. In just in time system, the advance stage of production draws the right amount of inventory from the preceding stage to sustain the activity. In this process, the production activity is planned upon the actual demand, rather than the predetermined schedule, since the cycle time for production of various models is given only to the final assembly point of mixed production line. This process is repeated at each stage, right down to raw materials or up to sub contracted items. The production stages are interlinked in the form of a tree and each production order generates pull throughout the system. This system enables the market place to pull the necessary items from the plant as against the conventional system of pushing the product to the market. Hence this system is likely to be operated by most companies in future, as competition develops. This is similar to conventional job shop or makes to order procedures, with the customers specifying their requirements. At the operational level of inventory management, this is known as Zero inventory concept or ZIN system.

Advantage of JIT: The system eliminates the waste arising from areas like over production, waiting time in assembly process, transportation bottlenecks, excess inventories, increased process timings, low labor utilization, generation of scrap and network. Quality Cost reduction about 25% to 60%. Raw material reduction about 35% to 70%. 40% to 80% decrease in space requirements. Up to 25% reduction in indirect and direct labor cost. 10% reduction in process lead time. Up to 80% reduction in finished goods inventories. JIT integrates the thinking of worker, listening supervisor, supportive manager and dynamic leadership. Redesigning and set up time reduction. Consumerism is the main philosophy of JIT so that it satisfies all the needs of customer. KABAN control: This is a Japanese word for a small card or tag, which is attached to a standard bin of inventory. The production Kanban authorizes the preceding stage to produce the required quantity of components or subassemblies that are listed. The conveyance Kanban is attached to the container when it is transported from one stage to the next operation stage. Use of two Kanbans will expose the production bottlenecks and encourage finding out solutions.
Negotiation skills:

Negotiation must be object oriented and flexible. It has to cover wider areas like specification, quantity, delivery schedule, funding strategy, currency fluctuation, INCO terms, free along side, commissioning, political stability in supplier countries, company structure, R&D budget, annual report analysis, corporate governance etc. Inventory turnover ratios = Annual sales/year end inventory As per norms inventory turn over ratio is 81 Three crucial variables of negotiation: 1. Power: Power of awarding more contracts Huge potentials. Power to go to other supplies The power of legitimacy The power of commitment of the entire team The power of expenditure The power of rewarding and punishing 2. Time: Do not reveal our dead lines Patience The other side may have a dead line Do not precipitate the matter till it is guaranteed to be in your advantage 3. Information: The true interests of other side The true needs of other side The true priorities of the other side

Vendor rating:

Objective: Purchasing aims at having two suppliers for most of the items. Hence identifying potential and reliable vendors as well as maintaining up to date records on their performance is vital for purchasing operations. The consequences of choosing the wrong type of suppliers are serious both financially and operationally. In deciding the market share between suppliers, it is necessary to assess the performance of the suppliers. It is also necessary to educate the supplier with a view to improve his performance. It is desirable to compare one vendors performance with others in order to improve overall reliability. Just as the buyer tries to rate the supplier, the seller also rates the buyer with regard to his authority, technical knowledge, professionalism and commitment to promises. Purchase department has sole responsibility for the choice of the supplier and placing orders. Hence it is necessary to access the vendors performance on an objective basis, based on price, delivery, quality & service aspects. Stages of evaluation: There are four stages of evaluation of suppliers. In survey stage, all possible sources are explored for their capabilities, based on preliminary information. The enquiry stage consists of detailed analysis of the vendors performance with other consumers. In the negotiation and selection stage, only those vendors, who pass the enquiry stage, are called in for negotiation on all aspects and the list of approved vendors is drawn up. These three stages are considered as a part of source development and source registration process. Vendor rating refers to the experience stage when the supplier has started sending the material after trial orders. For this process the parameters are quality, price, delivery, schedule and service. In this process quality controls department assistance is needed to get information on rejection at incoming a materials stage, in process conversion stage and the out going final stage. All the above stages of evaluation should be carried out objectively using scientific methods without personal biases and prejudices.

Date:

Sathyanarayana Sharma HR AE (M), 07 - 2758

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