Unit 4

Materials management- objective, planning, budgeting and

control
Unit 4

• A RECOLLECT
• Differentiate between procurement and purchase Procurement:
Procurement involves the process of selecting vendors, establishing
payment terms, strategic vetting, selection, the negotiation of
contracts and actual purchasing of goods. Procurement is concerned
with acquiring all of the goods, services and work that is vital to an
organization.
• Purchase : Purchasing is a subset of procurement. Purchasing
generally refers simply to buying goods or services. Purchasing often
includes receiving and payment as well. Note: Procurement deals
with the sourcing activities, negotiation and strategic selection of
goods an services that are usually of importance to an organization.
Purchasing is the process of how goods and services are ordered.
Purchasing can usually be described as the transactional function of
procurement for goods or services.
Unit 4

What is Materials Management? Definition

• Materials management is a core function of supply chain
management, involving the planning and execution of supply chains
to meet the material requirements of a company or organization.
These requirements include controlling and regulating the flow of
material while simultaneously assessing variables like demand,
price, availability, quality, and delivery schedules.
Unit 4
Right way of Material management may lead to
1. Maximization of production
2. Reduction in the cost of production
3. Maximization of profit

Material management helps in reducing material cost , preventing huge amount

of capital being locked up for a longer period , improving capital turnover ratio
and achieving Higher profitability.

The main objective of Materials Management is assuring a supply of material

with optimized inventory levels and minimum deviation between planned and
actual results.
Unit 4
Fundamental objectives of materials management
The primary focus of materials management is to ensure materials supply and
inventory levels are sufficient for production needs.

The exact responsibilities and processes depend on the company's needs.

There are five objectives that nearly all companies strive to accomplish through
materials management. These objectives, known as the “Five R's of Materials
Management,” include:

1.The right material

2.At the right time
3.In the right amount (Right quantity )
4.At the right price
5.From the right sources
Unit 4
FROM THE INDUSTRY SIDE …..
In the manufacturing industry, materials managers serve a vital role in
purchasing, obtaining and maintaining raw materials to use in production
properties.

They perform many responsibilities, such as quality assurance and operations

control, which help accomplish the major objectives of materials management,
which is a process that can lead a manufacturing enterprise to find success.

The materials manager is responsible for classifying the materials before they
sent for Inspection, entered in to stock ledger and binned .

The broad classification of materials is therefore necessary

 Unit 4
In materials management there are so many items
Some of the broad classification of materials are
• Raw materials
• Work in progress
• Spares machinery & equipment
• Furniture and fixtures
• Chemicals and drugs
• Packing materials
• Finished Goods
• Purchased components
• Consumables
• Inflammables
• Fuel stock
• Scrap materials
 Unit 4
Materials management is a total concept involving an Organization structure
unifying in to single responsibility, the systematic flow and control of materials
from identification of the need through customer delivery

Includes with this concept are materials functions of planning , scheduling,

sourcing, buying, string, manufacturing , moving and distributing.

( This definition is accepted by International federation of purchasing and

materials management )
Unit 4

• Materials Management Objectives- continued

• The functions of production and materials management are distinct from each
other. Which activities do production and materials management components
perform?
• Production involves converting materials (whether they are physical, human
resources, or financial) into products or services.
• By contrast,the primary goal of materials management is to ensure a steady supply of
material, with the lowest possible divergence between the planned and actual
outcomes.
• Materials management can include everything from demand forecasting to
scheduling, job cost accounting, and quality control, all of which are integral parts of
the production planning and execution process.
Unit 4
• Objectives of Materials Management:
• Materials management objectives are categorized into:
• 1. Primary objective
• Making available (supply) of materials in specified quantity and quality at
economic cost and maintaining the continuity of supply. Minimization of
investments in materials and inventory costs, and assuring high inventory
turnover.”
• 2. Secondary objectives
• Purchasing the items from a reliable source at economic price.
• Reduction of costs by using various cost reduction techniques such as
variety reduction, standardization and simplification, value analysis,
inventory control, purchase research etc.
• Co-ordination of the functions such as planning, scheduling, storage and
maintenance of materials.
Unit 4
• Functions of Materials Management :
• 1. Materials Planning : It involves forecasting demand and quantity of materials
required, preparing materials budget, forecasting the levels of inventories and
scheduling the orders.
• 2. Purchasing : It involves choosing right sources of material supply, placing of
purchase orders, follow-up, keeping good relations with suppliers, payments to
suppliers and evaluating suppliers.
• 3. Procurement : Procurement of materials, transportation, quality control and
inspection of purchased materials and components.
• 4. Stores Management : It includes conservation of materials in stores, efficient
handling, maintaining stores records, proper location and stocking, scrap, surplus
and obsolete materials disposal.
• 5. Inventory Control : Efficient inventory control is a must to ensure timely
availability of material at minimum cost.
• . Preparin Standardization, Simplification and Specifications of materials.
• 7. Value analysis of costly materials
• 8. Ensuring smooth flow of materials in and out of the organization.
• 9. Packaging, warehouse planning, accounting, finished goods
Types of materials management
Unit 4
What are the Types of Material Management?
1. Material Requirements Planning
2. Purchasing
3. Inventory Control
4. supply management
5. quality control
Materials requirement planning
Unit 4
Material requirements planning (MRP) is a system for
calculating the materials and components needed to
manufacture a product. It consists of three primary steps:

1. Taking inventory of the materials and components on hand

2. Identifying which additional ones are needed

3. Scheduling their production or purchase.

MATERIAL REQUIREMENT PLANNING
• This important step in material management directly affects profits as
the lower the amount of material used, the lower the cost of
production and the more profit is delivered. Reducing material
overspend has caused some industries to consider ‘Just in Time (JIT)’
strategies that require very small levels of inventory. However, this still
requires careful planning to maintain without impacting production
schedules.
Before the start of manufacturing process or a service facility, it is necessary to have
required materials in hand.
If the material is not available in time, entire efforts of starting the manufacturing
will go waste.
Therefore, materials management department should make prior estimation of
materials requirement and proper planning is done, so that right material is
available at right time.
M.R.P can be defined as a computational technique that converts the
master schedule for end products into detailed schedule for raw materials and
components required for the end product. The detailed schedule identifies the
quantities of each raw materials and components. M.R.P. also as to when each of
these items must be ordered and delivered so as to meet the target of master
schedule of the final product.
The objectives of materials requirements planning are
i) To avoid inventory stock outs so that production runs smoothly, according to
plans.
ii) To reduce investment in raw materials and work in process inventories.
iii) Reduction in production and delivery lead times, as it identifies materials and
components quantities, timings, availability and procurement and production
actions required to meet delivery deadlines by coordinating these actions delay
in production can be delayed.
iv) Realistic delivery promises which can enhance customer satisfaction.
Materials requirement planning is the scientific way of determining the requirement
of raw materials, components, spares and other items required for meeting production needs
within the economic investment policies of a productive system.
In manufacturing concerns, the demand for raw materials, components, subassemblies etc.
is dependent on the production plan for the final product.
Therefore, once we know the production requirements of the final product,
it is possible to determine as to
how many parts or components will be needed in each future time period.
The production requirements for the final product are determined by the sales forecasts.
 Different options available depend upon the policy which we adopt. In MRP These may be:
• Lot-for-lot:
In this policy, lot size for a batch is chosen to satisfy the net requirements for a single
period.
• Economic Ordering Quantity (EOQ):
In this Policy, EOQ is calculated based on expected requirements.
• Period Order Quantity:
In this policy, the lot size is equal to the actual requirements in a predetermined
fixed number of periods.
• Part-period Total Cost Balancing:
In this policy, holding costs and set-up costs are balanced as closely as possible for each lot
size decision.
 Pre-requisites for launching M.R.P:
For launching M.R.P. in any organization following pre-requisites are
necessary:
i) All inventory items are identified.
ii) Inventory reports containing data on the inventory status of every item is
prepared.
iii) A bill of materials and product manufacturing details are available.
iv) Master schedule of the manufacturing of different products indicating number
of end products to be manufactured.
Lead times for all inventory items are known or at least estimated considering
market positions.
• MRP technique was identified by Orlicky in the early 1960’s and had been
known for many years, but they could not be fully exploited without the data
processing power of the modern computers.
• Its early application, in the 1960’s, was a bill of material explosion technique
(desegregation of the end product) for determining the time-phased requirement
of the components and subassemblies (for the quantity of end product given in
the MPS) and a method of releasing manufacturing and purchase order to the
shop and vendors/suppliers.
• Orlicky called the technique ‘time-phased material
requirements planning’.
 Techniques of materials planning
1) Bill of materials explosion:
Materials planning is done on the basis of sales forecast. Requirement of various materials are
arrived at from sales forecast using bill of material through explosion charts. Bill of materials
indicates materials required for a given component.
It also indicates bought out item and shop made items. Explosion chart is then made by
combining all the bills of materials, so as to give the exact materials requirement. Thus materials
requirement is determined with the help of explosion charts.
Delivery schedules of materials are then prepared considering the production scheduling and
inventory level in the stock and organisation policies for maximum and minimum inventory level.
2) Past consumption analysis
The materials which are consumed continuously and for which no bill of materials are made,
like maintenance items, lubricants, fuel etc., past consumption data is analysed and then future
projections are made.
Unit 4
MRP OUTPUTS
The MRP system
takes the master
schedule for end items
and determines the
gross quantities of
components required
from the product
structure records. Gross
requirements are
obtained by “exploding”
the end item product
structure record into its
lower level
requirements.
Unit 4
Steps in material requirement planning
• STEP 1 : Determine the Gross Requirement.
• STEP 2 : Determine the Net Requirements.
• Net Requirements = Gross requirements – Available Inventory.
• STEP 3 : Develop the Master Schedule.
• STEP 4 : Explode the Bill of Materials.
• STEP 5 : Screen for ABC items.
• STEP 6 : Determine net requirements for an item.
• STEP 7 : Adjust requirements by Scrap or Shrinkage factor.
• STEP 8 : Schedule planned orders.
• STEP 9 : Explode the next level.
• STEP 10 : Aggregate Demands and Determine Order Quantity.
• STEP 11 : Write and place the planned orders.
PURCHASING
 Purchase Management:
Purchasing is the activity responsible for getting the right material to the right place at right
time, in the right quantity at the right price.
For an organisation, purchasing is that function which is responsible for that phase of the
material cycle, from the time an item is requisitioned until it is delivered to the user. This includes
the selection of vendors, deciding the price and negotiating for quality and delivery. It also
coordinates for transportation, receiving, inspection and inventory control.
Objectives of purchasing:
A. From a top managerial perspective:
The management expects the purchase department to achieve the five rights in the acquisition
of materials. Five rights are:
i) Right quality ii) Right Supplier
iii) Right Quantity iv) Right time
v) Right price.
A sixth factor implied in these items includes the desired services necessary for optimal supply
and utilisation of materials.
 B. From an operating or functional perspective
1) Uninterrupted flow of materials and services.
2) To buy competitively.
3) To buy wisely, which involves a continuous search for better combination of
quality, service and price relative to the buyer’s needs.
4) To keep inventory investment at a practical minimum.
5) To keep inventory losses at a practical minimum.
6) To develop effective and reliable sources of supply.
7) To develop and maintain good relationships with the suppliers.
8) To achieve maximum integration with other departments of the firm.
9) To handle the purchasing function in a professional and cost-effective
manner.
Functions of purchasing department:
• To purchase materials on properly authorised requisitions
• To place orders of the requisitioned goods with right suppliers.
• To obtain right type and quality of goods at cheapest price.
• To purchase right quantities in right time.
• To see that deliveries of all goods are received within time.
• To check and see that the goods received are in accordance with the
orders placed in respect of quality, quantity and specifications.
• To advice the management regarding possible economic to be
maintained by manufacturing an item instead of purchasing or vice-versa.
• To study the market conditions and enter into a rate contract
with the large suppliers to ensure availability of materials all the time.
• To study various sources of supply and decide upon the most convenient
as well as alternate supplies.
• To maintain the list of available and reliable suppliers.
• To prepare specifications to obtain quotations and compare
these quotations and placing orders.
• To purchase directly all small items, which do not require quotations.
• To ensure suppliers’ payments are made promptly
so that better relations are maintained with the suppliers.
• To consider first the interest of the enterprise.
• To assist purchasing agents, cooperate and guide them
and raise the purchasing standards
• Duties of purchase manager:
• To maintain the standard of quality of product by selecting right quality of materials during purchases.
• To organise and direct the purchasing department for efficient working.
• To represent his concern with other concerns during purchasing contacts.
• He should maintain the reputation of the concern, through integrity and fair dealings with others while negotiating.
• To make a final check on all the requisitions received from different shops in the interest of economy, as regards
quality, quantity and specifications.
• To help in the preparation of purchasing budget.
• To spend money on purchase very carefully and wisely.
• To suggest if the materials can be economically produce in the concern instead of purchasing and vice-versa.
• Negotiation
• Is an integral part of purchasing process
• Most organisations prefer negotiations as a policy, where full advantage of
competition could not be explored
• Negotiation is essentially a discussed on a business transaction leading to
finalisation of purchase and sale contract of goods and services
• Major objectives of negotiation are
• To obtain a fair and renewable price for specified quality.
• To meet the supplier to perform the contract on time.
• After sales service, availability of spares, guarantee, warranty buy back clauses
and supply of free spare with capital equipment.
• To exert some control over the manner in which the contract is performed.
• To persuade the supplier to give maximum cooperation.
• To develop a sound and comparative relations with the competent suppliers.
Negotiation process:
The negotiation process consist of three major phases preparations,
establishment of objective and face to face discussions which result in agreement
on all items and conditions of a contract.
1.Preparations:
 Know the item or service
 Know sellers and buyers bargaining strength
 Adequacy of cost of price analysis.
 Disposition of damaged goods
2.Establishing objectives:
Objectives are established for items to be discussed including:
 All technical aspects of the purchase
 Types of material and substitutes.
 Modes of transportation
 Terms and condition
 Payment terms
 Liability for claims and damages
 General terms and conditions
 Incentive arrangement
 Packaging
3.Face to face discussion:
 Fact finding.
 Reassess strengths and weaknesses during the recess.
 When negotiations reconvene, negotiator defines each issue, state the
facts and attempts to convince other party and narrow down the
differences.
 Hard bargaining, as last resort. It is used as take-it or leave it tactics. Its
use is limited to one-time or adversarial situations where long-term
collaborative relationship is not an objective.
INVENTORY CONTROL
Inventory control
Inventory control is a systematic location, storage and recording of
goods in such a way that desired degree of service can be made to the
operating shops at minimum ultimate cost. Inventory control has following
functions:
i) To run the stores effectively
ii) To ensure timely availability of material and avoid build up of stock.
iii) Stock control systems be developed and followed.
iv) To maintain specified raw materials.
v) To protect the inventories.
vi) To develop policies, plans and standards essential to achieve inventory
control objectives.
Unit 5

Inventory
It is a stock of physical goods held at a specific location and in a specific
time .
Each specific item in the inventory at a location is termed as SKU – Stock
keeping unit.
If you carry multiple locations , each point is called as stock point.
Unit 4

• 3. Inventory Control
• An inventory can include a range of goods being held including
partially finished items, goods ready for sale and those used in
production. Many industries try to time purchasing so that materials
enter stores just ahead of production, although there is also a need
to gauge supplier levels so items can be stocked before they become
unavailable.
• Inventories are required to control the flow of raw
materials, purchased goods and finished parts and
components.
Unit 5

Challenge in Inventory
One of the basic challenge in Inventory management is to find out the
order quantity , so that it is most economical from overall point of view .
Here it lies in minimizing the two conflicting costs , one is ordering cost
and inventory carrying cost.
Unit 5

Costs associated with Inventory-

Material cost ( cost of material itself)
Ordering or procurement cost ( processing , ordering, procurement,
paper work, staff salaries, transportation etc )
Inventory carrying costs ( Bank funding, interest, insurance, rent of the
place, cost of obsolescencence, cost of pilferage , damage spoilage)
Stock out cost
Unit 5

Economic order quantity refers to the quantity ordered to be purchased

at the lowest cost .
EOQ is the point at which cost of procurement and cost of carrying are
equal .At this point the total cost is minimum.
Unit 5
Costs associated with Inventory decisions
1.Material cost ( Cost of material itself )& Opportunity cost ( If I had
invested this amount of purchases materials , in some where else what
will be my return ?)
2.Ordering or procurement cost – consists of
Rent for space used by purchase department
Salaries payable to purchasing staff
Paper work and stationery or computer consumables cost
Cost of inviting tenders
Cost of placing the purchase order
Postage, reg post , e mail and other related cost
Travelling expenses
Depreciation of furniture and cupboards in the purchase department
Legal cost
Entertainment expenses of vendor
Unit 5
3 Inventory carrying costs – these costs are associated with carrying
inventory to maintain a particular level of inventory always
Financing cost 4 to 6%
Insurance charges 1 to 2 %
Property taxes 1 to 2 %
Stores expenses 3 to 4 % – like salaries payable to stores staff, rent, cost
of storage facilities like racks , bins ,lighting , cooling, any small/
medium and large equipment's inside for moving parts
Handling expenses –3 to 4 %cost of Moving the inventory
Cost of spoilage , damage , deuteriation, pilferage 2 to 4 %
Cost of obsolescence 3 to 5 %
4 Stock out costs
Unit 5 – EOQ Representation.
Unit 5

AP – Inventory procurement cost

IC- Inventory carrying cost
BT – Total per unit cost
N- the point at which the total procurement cost is equal to total
inventory cost .
OQ – is the economic order quantity or economic lot size . If more than
OQ is purchased it will raise the total cost which is uneconomical
Some times bulk buying reduces the frequency of ordering and therefore
the ordering cost.
But too much of bulk buying is also not good for the company
UNIT 4

• EOQ ? and its Significance.

• EOQ, or Economic Order Quantity,
• It is defined as “the optimal quantity of orders that minimizes total
variable costs required to order and hold inventory”. While deciding how to
manage inventory, two questions are to be answered.
• (1) How much should we order? And
• (2) How often should we order ?
• EOQ is a formula that determines the quantity at which the combination
of procurement costs and inventory carrying costs are the least. In
purchasing this is known as the order quantity, while in manufacturing it is
called the production lot size.
The EOQ provides a model for calculating the appropriate reorder quantity to
ensure the instantaneous replenishment of inventory without any shortages. EOQ
is a valuable tool for managers to make decisions about how much inventory to
keep on hand, how many items to order each time, and how often to reorder to
keep the costs minimum
Unit 5 – EOQ Formula

Square root of 2DCo/Pci

Annual consumption = D;
Cost per order Co;
Price per unit =P;
Cost of carrying inventory in percentage is Ci
Unit 5

Total cost at optimal order quantity at Q= EOQ formula

Total cost Tc(eoq)= (D/Q) x Co + (Q/2 ) x P x

Ci
Unit 5
PROBLEM 2
From the following data , obtain the EOQ and ordering cost, carrying cost
and total inventory managing cost
Total annual consumption 12000 units
Unit purchase price Rs1
Ordering cost Rs75 per order
Cost of carrying inventory – 20 % per annum
END OF UNIT 4- PART 1