Chapter three

Purchasing
 3.1 Definition of Purchasing
• Purchasing is an important function of materials
management. In any industry purchase means buying of
equipment, materials, tools, parts etc. required for
industry. The importance of the purchase function varies
with nature and size of industry. In small industry, this
function is performed by works manager and in large
manufacturing concern; this function is done by a separate
department.
• The moment a buyer places an order he/she commits a
substantial portion of the finance of the corporation which
affects the working capital and cash flow position. He/she is a
highly responsible person who meets various salesmen and
thus can be considered to have been contributing to the
public relations efforts of the company. Thus, the buyer can
make or mar the company’s image by his excellent or poor
relations with the suppliers.
• No organization can operate without materials,
supplies and equipment’s. The efficiency of any
business activity is contingent up on having
materials, supplies and equipment available in
proper quantity with proper quality at proper
place and time, and at proper price.
• Purchasing is a managerial activity that goes
beyond the simple act of buying and includes
the planning and policy activities covering a wide
range of related and complementary activities
such as research and development; proper
selection of materials and sources from which
those materials may be bought.
3.2 The goals of purchasing :
Ensure uninterrupted flows of raw materials at
the lowest total cost,
Improve quality of the finished goods
produced, and Optimize customer satisfaction.
To buy competitively and wisely.
To keep inventory losses (due to deterioration,
obsolescence and theft) at a Practical minimum
level.
To achieve maximum integration with the other
departments of the firm.
 3.3 Parameters of Purchasing
5 R’s in purchasing
1. Right Quality
• Cost and quality are critical dimensions. The
interaction between the two is very complex. A
right quality is not necessarily best quality. To a
large degree manufactures determine the quality
of goods by the desired quality of a product to
make.
• The considerations are basic materials, grades,
size, design, colors, patterns and durability. The
quality must be described precisely so that vendors
should understand what is exactly needed
2. Right Quantity
• Quantity to be purchased varies with the
production strategy and planning. Right quantity is
the level of quantity which is not too much or too
few. This can be made possible through the
techniques of E.O.Q (Economic Order Quantity),
which save the producer from the danger of stock
outs as well as carrying cost of surplus inventory.
• Other strategical considerations in determining
quantities are combination of items to reduce
transportation costs, anticipation of market
conditions both of raw materials/spares as well as
the minimum quantity of finished goods.
3. Right Source
• The source of supplier is determined normally by
calling quotations and the lowest bidder is selected
provided he has quoted as per the requirement of
producer in terms of quality and period of delivery.
• But such ideal situations do not appear in all cases
and selection of supplier involves a strategic
consideration of various factors.
• It is always prudent to select a manufacturer in case
of patented standard products even if it means a little
extra transportation. Secondly, the past records,
financial capacity, technical ability and other
resources play important role in selection of supplier.
4. Right Price
• The right price is the worth in terms of quality,
time and adequacy of supply of an item
obtained.
• It is no doubt easy and safe to go for standard
products at a higher price but one has to keep in
mind the utility of item in the ultimate worth of
product
5. Right Time
• The ideal time of purchase period would be the
minimum time for which the goods remain
unconsumed. This could be achieved if the
stockiest or manufacturer of raw materials
supplies the day-to-day requirements in regular
installments. This would save the storage. But the
geographical and market conditions do not
permit and it is where the ordering system comes
into existence. The timing policies will depend up
on fluctuating prices as well as problems arising
out of monopolistic trade and sellers’ maturity.
There are two types of Bids.
• Open Bid – It is a type of bid where all potential
suppliers are invited through mass media and
advertising agents to participate in the bidding.
• Closed Bid – In this case selected suppliers are
approached (invited ) to participate in the bid.
Here, the invitation can be made through personal
contact, telephone or formal letter.
3.4 Steps In The Purchasing Cycle

1.Origination of Purchase Requisition.

2. Verification of Authority and Budget.
3. Request for Quotation or Bids.
4. Evaluation of Bids and Selection of Suppliers.
5. Placing the Purchase Order.
6. Follow–up and expediting.
7. Receiving, Inspecting and Storing
8. Closing the order
• Competitive bidding/open Tender
• Limited Tendering
• Two-stage Tendering
• Request for proposal
• Request for quotation
• Single source procurement
• Negotiation
• Contracting
1. Origination of Purchase Requisition (PR)
• Purchase Requisition is a document generated by the
using department or by the store that authorize
material purchase.
• Here, if the policy of the organization states, “All the
materials have to be made available to using
department through the Store.” then the store
department is the only one which is authorized to fill
the Purchase Requisition. From this we can infer that
the need for purchase originates in the inventory
control section or in the operating (using) department.
This need for purchase is transmitted to the purchasing
department by Purchase Requisition.
• This Purchase Requisition is a serially numbered
internal document by which the need for purchase is
transmitted or communicated. It is prepared by a
minimum of two copies.
Information that a Purchase Requisition contains
include:
• Description of the materials
• Quantity
• Date of requires
• Date of issue
• Estimated unit cost
• Operating account to be charged
• An authorized signature
2. Verification of Authority and Budget
• The responsibility of indenter (who fills the
Purchase Requisition) is to incorporate of details
items with full descriptions.
• However, the responsibility of the buyer (who
receive the Purchase Requisition) is to check
whether the PR is within the budget limit or not
and also checking the accuracy of the
document. In addition, he/she checks the stock
level and see if cheaper material can equally do
the same purpose,
3. Request for Quotation or Bids /Price Quotation/
• This refers to identification and analysis of
possible soured of supply. A Quotation is a
statement (perform) acquired from potential
suppliers. Requests for Quotation is a process of
initiating potential suppliers that are willing to
compete to supply the required material. The
request depends on the type of materials because
some materials need price quotations and other
not.
• Items which are purchased repetitively, from
known suppliers, with small quantity and with low
value doesn’t require price quotation.
4. Evaluation of Bids & Selection of Suppliers
• This is analysis of the potential suppler who fulfill the
criteria of the organization. Suppliers are evaluated
/reviewed by the following factors or selection
criteria.
► In terms of price proposed by the suppliers.
► In terms of discount they offer.
► In terms of the shipping terms.
► In terms of delivery date.
► In terms of reliability of the supplier by analyzing past
performance.
► In terms of reciprocity (this refers to mutual
interchange of favors, privileges in good sense)
► In terms of quality of work & other services
 Supplier Evaluation Methods

1. Weighted-Factor Analysis
Factor Weight

Supplier Score 1.00

1. The weighted-point method:
The weighted-point method provides the quantitative data for
each factor of evaluation. The weights are assigned to each
factor of evaluation according to the need of the organization,
e.g., a company decides the three factors to be considered—
quality, price and timely delivery. It assigns the relative weight
to each of these factors as under:
• Quality ……… 50 points
• Price ……… 30 points
• Timely delivery ……… 20 points
The evaluation of each supplier is made in accordance with the
aforesaid factors and weights and the composite weighted-
points are ascertained for each suppliers—A, B and C— are
rated under this method. First of all the specific rating under
each factor will be made and then the consolidation of all the
factors will be made for the purpose of judgment.
ILLUSTRATION 1: Vender Rating
The following information is available on 3 vendors:
A, B and C. Using the data below, determine the best
source of supply under weighed-point method and
substantiate your solution.
• Vendor A: Delivered ‘56’ lots, ‘3’ were rejected, ‘2’
were not according to the schedule.
• Vendor B: Supplied ‘38’ lots, ‘2’ were rejected, ‘3’
were late.
• Vendor C: Finished ‘42’ lots, ‘4’ were defective, ‘5’
were delayed deliveries.
Give 40 for quality and 30 weightage for service
SOLUTION: Formula:
• Quality performance (weightage 40%) =
Quality accepted × 40%
Total quantity supplied
Delivery performance
• X Adherence to time schedule (weightage 30%) =
= No. of delivery made on the scheduled date × 30 %
Total no. of scheduled deliveries
• Y Adherence to quantity schedule (weightage 30%) =
= No. of correct lot size deliveries × 30 %
Total no. of scheduled deliveries
Total vendor rating = X + Y
Vendor A = 53/ 56 × 40 + 54/ 56 × 30 = 66.78
Vendor B = 36/ 38 x40 + 35 /38 × 30 = 65.52
Vendor C = 38/ 42 X40 + 37/ 42 × 30 = 62.62
• Vendor ‘A’ is selected with the best rating
• HW Exercise: The following information is available
on 2 vendors: X, and Z. Using the data below,
determine the best source of supply under
weighed-point method and substantiate your
solution
• vendor X: -Quality: Shipped 58 lots/2 rejected
-Price : $1.07/unit
-Service: 55 lots received as promised
• vendor Z: -Quality: Shipped 34 lots/4 rejected
-Price : $0.93/unit *
-Service: 29 lots received as promised
Give 40,35 & 25 weights for Quality, price & Service,
respectively,
 Solution
Performance Vender X Vender Z
rating
Percentage of good lots 56/58 X 100% = 96.5% 30/34 X100% =88.23%
(Quality rating) = 96.5% x 40 = 38.6 =88.23% X 40 =35.29

X's price performance 0.93/$1.07 x 100% 86.9% 0.93/0.93 X100% =100%

Price rating = 86.9% x 35 = 30.4 100%X35=35

Service = 55/58 x 100% =94.8% 29/34X100%=85.29%

Service rating 94.8% x 25 = 23.7 85.29%X25=21.32

Total score 92.7 91.612

Accordingly vender X is the one w/c will be selected as a best

supplier
5. Issuing of Purchase Order
• The Purchase Requisition gives the purchasing agent
authority to order the materials described in the
requisitions. The purchasing agent should maintain
or have access to an up-to-date list of vendors, which
includes price, available discounts, estimated
delivery time, and any other relevant information.
From this list, the purchasing agent selects a vender
form whom high quality materials can be obtained
when needed at competitive cost.
• Then the purchasing agent then completes a
Purchase Order which is a buyer’s documents that
formalizes a purchase transaction with the seller. So
a Purchase Order is a serially numbered external
document that is used to make purchases
6. Follow-up and expediting the Order
• Follow-up refers to reminding the supplier to
insure the timely arrival of the Order.
• And expediting is speeding up or accelerating the
receipt of the item before the agreed-up on time.
The later requires good relationship between the
purchasing unit & the supplier.
7. Receiving, Inspecting and Storing
When the items are received, the following receiving
procedures are usually adopted:
• Unloading and checking the consignment
/shipment. Compare the consignment with the
freight whether there is any damage or not.
• Unpacking and checking the material
• Completing the receiving report and distribute this
report.
• Delivery of materials: these materials may be
handled to the using department to the internal
delivery system or to the Store. Finally, whoever is
receiving the material will sing on the receiving
report.
8. Closing the Order
• After making the necessary payment to the vendor,
Closing an order simply entails a consolidation of
all documents and correspondence relevant to the
order in filling them in closed order file which
include a purchase requisition, the open order file
of the purchase order, the acknowledgement, the
receiving report, the inspection report and any
note or correspondence pertaining to the order.
3.5 Make or Buy decision
• Organizations must evaluate the costs before buying
or making the parts.
 The relevant costs of buying are; purchase cost of
the parts, transportation costs and receiving and
inspection costs.
 The cost of making includes; includes;
 Delivered raw material costs
 Direct labor costs
 Incremental managerial costs
 Inventory Carrying costs
 Costs of Capital and
 Opportunity Costs.
Factors that favor the making decisions
• When the cost to make is substantially lower or less than the
cost to buy.
• When the demand for the product is stable & at a higher value,
so that the investment in equipment can be returned.
• When the companies manufacturing experience & equipment
are well suited to the manufacturing of the product.
• When the suppliers are unable to meet specifications in terms of
quality & performance.
• When the company has idle capacity like, idle space, skilled
human resource, equipment to be utilized in manufacturing the
product.
• When transportation costs can be saved by gathering local
materials to make the products rather than having made at a
distant plant.
• When research break through occurs & the company wants to
maintain trade secrets concerning the product, materials in it &
the process involved.
Factors that favor buying than making.
• When the cost to buy is substantially lower or less
than the cost to make the item.
• When the demand for the product is fluctuating,
creating production problem.
• When the quantities of item required is small.
• When other companies hold trade secret or patents
on a required product so that it is not possible to make
it.
• When obsolescence makes machine worthless or
substantially reduce their value.
• When high scrap or spoilage rates are inherent in the
manufacture of the product
• when the company is assured of getting the same
from suppliers.
Illustration on Buying & Making decision
• ABC metal work company produces parts that are shipped
nation wide. It has an opportunity to produce plastic
packing cases which are currently purchase at 0.70 Br. each.
Annual demand for the product depends largely on
economic conditions & this has been estimated at 45,000
units. If the company produces the cases itself, it must re-
innovate on existing area & should purchase a molding
machine which will result in an annual fixed cost of 12,000
Br. Variable costs for labor, material & factory overhead are
estimated at 0.65 Br./case.

• Required:
A/ Should the company Make or Buy the cases?
B/ At what volume, it is more profitable to produce in
house rather than purchase from an outside suppliers?
Since the cost of buying is less than cost of making the
company should buy the cases because there is a cost
saving of 9,750 Birr
Therefore, it is more profitable to produce the items in
house rather than purchase at any volume of greater than
240,000 units.
3.6, Organization of Purchasing

• The organization of purchasing is usually identified as

centralized or decentralized purchasing.

i. Centralized Purchasing
• This occurs when the authority and responsibility to
handle the material needs of the organization is given
to one department.
Merits of Centralized purchasing;
• Order in one department for entire purchase
• Reduced cost
• Large quantity order
• Quantity discounts
• Better negotiation/ purchasing power
ii. Decentralized Purchasing
• This occurs when the various departments in the
organization are established to satisfy material needs.
It is usually used when branches are located in
different parts of a country.
Merits Decentralized Purchasing
• It offers fast action since decision is made close to the
using department.
• It helps to satisfy the differing local needs.
• Transportation cost may be lower by buying locally
from suppliers which are near to each of the branches.
• Local good will may be generated when buying from
suppliers located in the same community
 Type of Purchasing
• There are four time based types of purchasing
1. Hand to mouth purchasing
2. Current Requirement purchasing
3. Forward buying
4. Speculative buying
1. Hand –to-mouth buying
• Hand to mouth buying policy is a practice of buying
materials to satisfy immediate operating
requirements smaller than those normally considered
economical.
• It is not a recommended policy for normal operations
of the typical buying firm .
• The policy seems appropriate whenever there are
plenty of supplies and the price of the item in
question is likely to decline larger purchases are tend
postponed until the price level is lower and a saving
occurs.
• Hand-to-mouth buying policy can be more effective
and facilitated through speedy communications, rapid
transportation, and an increasing degree of
decentralization of production facilities.
2. Current –Requirement Buying
• This is a buying practice in excess of a hand –to
mouth quantity.
• This is the most common method of buying to
satisfy short range requirements.
• The method obtains the most economical quantity
by using EOQ models which balances the costs,
quantity discount, inventory cost, obsolescence
cost… in to account.
3. Forward Buying
• This is a buying practice in excess of current
requirement by taking in to account the supply and
demand interaction of the operation. It does not
include purchases with a view to make a profit out of
it.
Advantages:
• It helps to fulfill known needs at a best price, quantity
discount, volume, freight rate etc.
• To achieve the expected profit level, if an organization
has a contractual agreement to supply its products
for a specific period, it should have enough inventory
inorder to get constant profit level for its operation.
• It reduces the risk of stock outs.
4.Speculative Buying
• This is buying an item at a price with the intention
of profiting on the transaction by selling it at a
higher price in a future,
• The distinction between forward buying and
speculative buying lies in the reason for making the
advance purchases.
• Times Covering in Months
– Hand – to- Mouth buying policy (takes 0-1 months)
– Buying to requirements policy (takes 1-2 months)
– Forward buying policy (takes 3-12 months)
– Speculative buying policy (takes more than one year)
• The selection of buying policies depends largely
on:
– The General economic conditions,
– The buying firms probable needs,
– The decision maker’s and his assistant skill in
forecasting, etc.
 Discount in Purchasing
I. Cash Discount
II. Quantity Discounts
III. Trade Discounts: These are reduction from list
price allowed to various classes of buyer and
distributors to compensate them for
performing certain marketing function for the
Original seller of the product
IV. Seasonal Discounts
Special Purchasing Systems
The following are some of the important purchasing
systems:
• FORWARD BUYING
• TENDER BUYING
• BLANKET ORDER SYSTEM
• ZERO STOCK