INFOLINK UNIVERSITY COLLEGE,

WOLAITA SODO CAMPUS

Department of Business Management

Course Title: Material management

By: MERKINEH MAYZA

Lecture Notes
 CHAPTER-1

OVERVIEW OF MATERIALS MANAGEMENT

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 Outlines of the chapter one
Introduction to Definition and origin and
M.M Scope of MM Transition of M.M

Importance of Benefit of
M. Mgt in Objective of MM integrated M.mgt
corporate policy approach

Relation ship b/n

material mgt with
other functional areas

MM: By MM
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 INTRODUCTION

To get the highest value out of our resources, we must

design production processes that make products most
efficiently to be used.
Once the processes exist, we need to manage their
operation so they produce goods most economically.
Managing the operation means planning for and
controlling the resources used in the process: labor,
capital, and material.
Major way in which management plans and controls is
through the flow of materials.
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 Introduction…………..
 The flow of materials controls the performance of the
process (Efficiency)
 If the right materials in the right quantities are not
available at the right time,
- the process cannot produce what it should.
- Labor and machinery will be poorly utilized.
 The profitability, and even the existence, of the company
will be threatened.

 Studies indicate that materials account about 60-80 % of

the total annual expenditure of organizations.
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 Introduction……………
 Besides, materials management has a tremendous
influence on the ultimate cost of a product and
efficiency of an organization, because it is
concerned with the total flow of materials in the
organization.
 Therefore, efficient management of input materials
is of principal importance in a business organization
for maximizing materials productivity, which
ultimately adds to the profitability of the
organization.

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•

1. Definition of Materials Management

Materials management :- is the planning, organizing

and controlling of the flow of materials from the
initial purchase through internal operations to
distribution of finished goods.

Materials management :- is a process of coordinating

all resources through the process of planning,
organizing, staffing, directing/ leading and
controlling to achieve desired objectives with the use
of human beings.
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 Definitions………………….

- Materials management is a body of Knowledge

which helps the manger to improve the
productivity of capital by reducing materials
costs, preventing large amount of capital being
locked up for long periods and improving the
capital turnover ratio.

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 Definition……………….
- Materials management is a total concept having
its definite organization to plan and control all
types of materials, its supply, and its flow from
raw stage to finished stage so as to deliver the
product to customer as per his requirements in
time.
- Materials management is the process of
management which coordinates, supervises, and
execute the task associated with the flow of
materials to, within and out of an organization
in an integrated fashion
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 Materials management can be defined as

It is an organizations concept which is designed to enhance

coordination and control or the various materials activities including
an activity to plan, purchase, store, handle, distribute, use, and
control of materials in order to contribute to organizational success
and profitability

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 2. Scope of Material Managements

• Materials management covers all aspects of materials, costs,

materials supply and utilization.

• It covers the whole or rang of functions involved in converting

raw materials and ancillary supplies in to finished products.
• It is concerned with the planning & programming of materials
and equipments, market research for purchase; pre design and
value analysis,

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 Scope………………….

Materials management covers that aspect of

industrials management which concerned with
the activities involved in the acquisition, storage
and flow of all materials directly and indirectly
employed in the prediction and marketing of
finished goods.

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 Scope
• Thus, the following functions or activities are listed as a
logical boundary of materials management:

1. Materials forecasting, planning, budgeting and

programming
2. Scheduling, purchasing
3. Receiving, and receiving inspection
4. Inventory control, storage and warehousing
5. Materials handling and movement control
6. Dispatch, shipping and disposal (including wastes, scraps
and surplus materials)
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 1. Origin of material Mgt

 Organizations in which materials management play its roles

have rarely been created with a single stroke of the organization
builders.

 They have evolved gradually and in many cases have not yet
matured.

 The scarcity of materials, which was felt during World War I in

USA to a very large extent and it, has become difficult for
production managers to supply the War goods.

 This has created it necessary to organize the Materials Management department for
managing large inventories in stores and to analyze the problems arising to control
and economize inventory cost problems
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MM shortage elimination. 14
 Origin…………….
With the development of principles of scientific
management by F.W. Taylor in 20th century, the
economic use of materials in all the
organizations was critically felt to reduce the
cost of production.

The early years of developments in the field of

materials purchase and supply systematically
begins from 1850.

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1.3 Importance of materials management in corporate policy

 It is necessary to have an integrated approach to materials

management of various functions such as materials
planning, purchasing, receiving stores, inventory control,
scrap and surplus disposal.

 In case some of the functions were to be separately

handled, conflict of interests would occur.

 Purchase department if allowed to operate independently,

may take decisions, which result in sub-optimization such
as discount in buying as important factor without taking
into account of the impact of inventory carrying cost.
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 Also, it enables the inter-related functions to exercise better
control and co-ordination.

 Lack of availability of adequate materials disturbs the

normal operation or production and causing unnecessary
delay of production or work stoppage.

 The stoppage of work in turn causing additional costs such

as; cost of depreciation of fixed assets, salary of permanent
employee, loss of sales, dissatisfaction of customer…etc.

 Thus, effective management of material is crucial for the

performance of any organization.
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 Benefits of integrated materials management approach

1. Reliable and accurate performance for required result

 In all aspect of management supervision and control,
the base for good performance is timely information
and up-to-date records.
2.Strict devotion to plan and schedule
 Careful planning ensures effective uses of men,
machinery, materials and money.

3.Timely and optimum materials procurement.

 Procurement policy must ensure that materials of right
quality, in the right quantity, available in the right price
within a given conditionMM:ofBy delivery.
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4. Optimum inventory turnover

 This indicates as well as determines the speed at which

materials comes in and goes out from stock. There should be
a high turnover rate of inventory, which equates the rapid
movement of materials and low stoking costs.
5.Good vendor vendee relationship
 Closely related to improved materials acquisition and
delivery performance is the necessity to maintain good
supplier relationship.

6. Optimum materials logistics and product distribution

 According to customer needs, transporting required
materials in the required qualities and in a good condition
in order to satisfy the market
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needs and company objectives
MM: By MM 19
 Integrated………
7.Control over all material cost
 Materials management is expected to coordinate all activities
keeping in view low purchasing cost, making way for optimum
use of facilities and equipments with high usage rate and
minimum of wastes. This will directly contribute towards
corporate profit and increase productivity of materials.
8.Coordination, elimination/minimization of duplication of
functions
 These objectives are easier to achieve under an integrated
system of materials management.
9.Conflict resolution
 This is made easier under overall supervision of an executive
authority.
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 Objective of M.M
The fundamental objectives of the Materials
Management function are acquisition of
materials and services, often called the famous 5
Rs of Materials Management:
 of the right quality ,
 in the right quantity ,
 at the right time,
 from the right source and
 at the right time.
 The basic objectives of materials management
are given below:
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 Objective……………..
1. Maintaining continuity of productive
operations by ensuring a uniform flow of
materials.

2. Reducing materials costs by systematic use of

scientific techniques.

3. Releasing working capital for productive

purpose by efficient control of inventories.

4. Increasing the competitiveness of end products

by ensuring right quality at the right price
especially in foreign market.
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 Objective…………
5. Saving foreign exchange through economic use of
foreign purchases and import substitution.

6. Establishing good buyer –seller-relation.

7. Ensuring low departmental cost and high efficiency.

In this way it is clear that materials mgt covers all aspects

of materials, including flow of materials cost, quality,
supply, conservation and utilization.
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 Objective……
 The primary task of modern materials management with an
integrated view in purchasing materials of;
Right Quality,
Right Quantity,
at the Right Price
from Right Source,
at the Right Time,
using Right made of Transport.

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 Relationship between materials management and other
functional units
 Generally the materials management unit is related to other functional
units in a number of ways.
 In order to use the synergic effect all organizational units have to work
together.
1.Materials Management and Finance
 The finance section is responsible for maintaining cash flow and providing
advice in preparing operating budgets.

 It also supplies the finance to buy the materials & control how well the
money is used.

 To have smooth relationship between finance and materials management.

the later should spend only reasonable costs for ordering, handling &
inventory.
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 2.Materials Management & Manufacturing
 In this case the material management. section supplies all the
necessary materials to manufacturing section.

 So there is a need to have smooth relationship between them.

 The materials management section should supply the right

quantity materials/part with the right of quality at the right
time and at a reasonable price.
 The materials management section fails to accomplish its task
the overall production of the organization will be collapsed.

 So, this section should develop its plan based on the plans of
the manufacturing section plan.
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 3. Marketing and Materials Mgt.
 The marketing section is the key section for the overall
operation of the organization.

 In- order to meet customer needs /wants we should have

close cooperation between them.

The basis for marketing section work is the sales forecast.

 In sum, the services of the materials management section
are essential for all functional units of the organization.

 So it is a dynamic activity that ensures the small flow of

supplies through the entire organizational activities.
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11/20/2024 MM: By Legese L 29
 Chapter-Two
Forecasting

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 CHAPTER II - FORECASTING

2.1.Why Forecasting?

2.2.Features of Good Forecasting

2.3.Steps in Forecasting Process

2.4.Types of Forecasting

2.4.1. Qualitative Methods

2.4.2. Quantitative Methods

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 INTRODUCTION
The success of an organization depends on how well the
organization sees the future environment which is full of
risks and uncertainties.

In order to make prediction about the future, we must

use the past and present data.
These data helps in minimizing risk and/or uncertainties
about the future.
Forecasting is a prelude to planning.
Before making plans, an estimate must be made
of what conditions will exist over some future
period.
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 How estimates are made, and with what accuracy, is another
matter, but little can be done without some form of
estimation.

 Every day managers make decisions without knowing what

will happen in the future.

 They order inventory without knowing what sales will be,

purchase new equipments despite uncertainty about
demands for product, and make investments without
knowing what profit will be.

 Managers are always trying to make better estimate of what

will happen in the future in the face of uncertainty.

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Making good estimates is the main purpose of forecasting.
33
 Meaning of forecasting
 Forecasting is the art(personal feelings) and science
(experiments) of predicting future events.

 It involves estimation of the occurrence, timing, and

magnitude of uncertain future events or levels of
activities.

 Forecasting may involves taking historical data and

projecting them into the future with some sort of
mathematical model. It may be a subjective or intuitive
prediction.
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 it may involves the combination of both mathematical data
and manager’s perception.
 Successful forecasting requires blending art and science.
 Experience, judgment, and technical expertise will all play a
role in a successful forecasting.
 The purpose of forecasting activities is to make use of the best
available present information to guide future activities towards
systems goal.
 Process of predicting a future event.
 Underlying basis of all business decisions: Production, Inventory
Personnel Facilities

 It is a statement about the future, Used to help

managers to Plan the system, to Plan the use of the
system
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 2.1. Why Forecasting
× forecasting is inevitable in developing plans to
satisfy future demand.

× Most firms cannot wait until orders are actually

received before they start to plan what to produce.
× Customers usually demand delivery in reasonable
time, and manufacturers must anticipate future
demand for products or services and plan to
provide the capacity and resources to meet that
demand.
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× Firms that make standard products need to have saleable goods
immediately available or at least to have materials and
subassemblies available to shorten the delivery time.

× Firms that make-to-order cannot begin making a product before

a customer places an order but must have the resources of labor
and equipment available to meet demand.

× Many factors influence the demand for a firm’s products and

services.

× General business and economic conditions, competitive factors,

market trends such as changing demand, the firm’s own plans
for advertising, promotion, pricing,
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and product changes 37
Forecasting Time Horizons Forecast Uses
• Plan the system
• Process of predicting a future – Long-range plans related to:
event • Types of products and
• Short-range forecast services to offer
• Facility and equipment
– Job scheduling, worker levels
assignments • Facility location
• Medium-range forecast • Plan the use of the system
– Sales & production planning, – short- and medium-range plans
related to:
budgeting
• Long-range forecast • Inventory management
– New product planning, • Workforce levels
facility location • Purchasing
• Budgeting

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Principles of Forecasting(Common Features)
2.2 Features of a Good Forecast

• Assumes causal system

past ==> future
• Timely
• Forecasts rarely perfect • Reliable
because of randomness
• Accurate
• Forecasts more accurate for • meaningful
groups vs. individuals
• Written
• Forecast accuracy • Easy to understand
decreases as time
horizon increases

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 Advantages of Good Forecast

It assures improved materials management system

in a given organization.

It may also served as starting point Better use of capital and

for budgeting finance may be created.

Enhances improved employee Assures improved customer

relation service

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2.3 Steps in the Forecasting Process
“The forecast”

Step 6 Monitor the forecast

Step 5 Make the forecast

Step 4 Gather and analyze data

Step 3 Select a forecasting technique

Step 2 Establish a time horizon

Step 1 Determine purpose of forecast

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 Types of forecasting methods

Qualitative methods Quantitative methods

Rely on subjective opinions from Rely on data and analytical

one or more experts. techniques.

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Qualitative forecasting methods
Sales person : deriving future demand by asking the person closest
to the customer.
Market Research: trying to identify customer habits; new product
ideas.
Panel Consensus: deriving future estimations from the synergy of a
panel of experts in the area.
Historical Analogy: identifying another similar market.
Delphi Method: similar to the panel consensus but with concealed
identities.

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 Summary of qualitative forecasting
techniques
Type Characteristics Strengths Weaknesses
Executive A group of managers Good for strategic or One person's opinion
opinion meet & come up with new-product can dominate the
a forecast forecasting forecast

Market Uses surveys & Good determinant of It can be difficult to

research interviews to identify customer preferences develop a good
customer preferences questionnaire

Delphi Seeks to develop a Excellent for Time consuming to

method consensus among a forecasting long-term develop
group of experts product demand,
technological
changes, and

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Quantitative forecasting methods
In opposite to qualitative approach, quantitative models are
objective in their very nature and they employ numerical
information. This model includes time series model and causal
models.

Time Series: models that predict future demand based on past

history trends
Causal Relationship: models that use statistical techniques to
establish relationships between various items and demand

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 Time Series Forecasts
A time series has four components

Trend Cyclical

Seasonal Random

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 Time Series Forecasts Variations
Irregu
Trend - long-term lar
movement in data variati
Seasonality - short-term on
Trend
regular variations in data
Irregular variations -
caused by unusual
circumstances
Random variations - Cycles
caused by chance

CYCLE- wave like 90

variations lasting more 89
than one year 88
Seasonal variations

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How should we pick our forecasting model?

1. Data availability
2. Time horizon for the forecast
3. Required accuracy
4. Required Resources

Time Series: Moving average

• The moving average model uses the last t periods in order to predict
demand in period t+1.
• There can be two types of moving average models: simple moving average
and weighted moving average
• The moving average model assumption is that the most accurate
prediction of future demand is a simple (linear) combination of past
demand.
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a) Naïve forecasting :-Assumes demand in next period is
the same as demand in most recent period
Example:- If October sales were 48, then November sales
will be 48
Advantage
- cost effective & efficient
Disadvantage
- less accurate

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 b. Simple Moving Average Method
• The simple moving average model assumes an
average is a good estimator of future behavior.
• MA is a series of arithmetic means
• Used if little or no trend
In the simple moving average models the forecast value is
•
At + At-1 + … + At-n
Ft+1 =
n
t is the current period.
Ft+1 is the forecast for next period
n is the forecasting horizon (how far back we look),
A is the actual sales figure from each period.
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Example:1 forecasting sales at Ambo spring water
Ambo sells (among other stuff) bottled spring water
Month Bottles
Jan 1,325
Feb 1,353
What will
the sales be
Mar 1,305
for July?
Apr 1,275
May 1,210
Jun 1,195
Jul ?
What if we use a 3-month simple moving average ?
F (July) =A(Jun)+A(May)+A(Apr)/3 =1,195+1,210+1,275/3=1,227
What if we use a 5-month simple moving average? Forecast of July =A(Jun)+A(May)
+A(Apr)+A(mar)+A(Feb)/5 =1,195+1,210+1,275+1,305+1,353/5=1.268

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Example:2
The demand for product A is observed for 10 months & it is given below:

Question:
Month Demand ( in unit)
• What is the forecast for
month 11 using a 3 month
1 420
moving average & 4 month
2 380
moving average methods ?
3 456
4 412
5 429
6 366
7 392
8 440
9 452
10 396
11
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? MM: By MM 52
 Solution:
• A three month moving average can be obtained by adding the
demand during the past three months & dividing the sum by
three, with each passing month the recent month data is added
by dropping the old to get new forecast.
 By using three months moving average, the demand in month 11
will be;
396 + 452 +440 = 429 unit
3
•  When a four months moving average is used, the forecast of
month 11 will be 420 units.
• Which can be obtained as follows:
392 + 440 + 452 + 396
4 = 420 units
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 Summary of chapter-II

 Used when situation is vague & little data  Used when situation is stable & historical
data exist. Existing products, Current technology
exist. New products, New technology  Involves mathematical techniques e.g.,
 Involves intuition, experience forecasting sales of color televisions
 e.g., forecasting sales on Internet
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11/20/2024 MM: By MM 55
CHAPTER III

PURCHASING
 CHAPTER III - PURCHASING
3.1.Meaning and Role
3.2.Objective of good purchasing
3.3.Purchasing polices
3.4.Purchasing procedures
3.5.Computer based purchasing system
3.6.Selection and motivation of supplies
3.7.Make or buy decisions
3.8.Value analysis
3.9.Global sourcing
3.10. Procurement and procedures in Ethiopia

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 3.INTRODUCTION
 Purchasing is a managerial activity that goes beyond the
simple act of buying, and it includes the planning and
policy activities covering a wide range of related and
complementary activities.

 Included in such activities are the

research and development required for the proper
selection of materials and sources;
the follow-up to ensure proper delivery;
the inspection of incoming shipments to ensure both
quantity and quality compliance with order;

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 Introduction………..
the development of proper procedures,
methods, and forms to enable the purchasing
department to carry out established polices;
the co-ordination of the activities of the
purchasing department to facilitate smooth
operations (traffic, receiving, storekeeping, and
accounting),
the development of a technique of effective
communication with top management.

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 3.1MEANING AND ROLE

a. Definition of Purchasing
Many authors have defined purchasing in
different ways and there is no single definition
accepted by everyone. Some of these definitions
are:
1. Purchasing is the process of acquiring goods or
services in exchange for funds.
2. purchasing refers to the day-to-day
management of material flows and information.
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 Definition ………….
1. Purchasing is obtaining goods, services,
capabilities and knowledge from external
sources to run, maintain and manage the
company's primary and support activities
2. The purchasing function comprises the essential
activities associated with the acquisition of
materials, services, and equipment .
3. Purchasing is the function of buying machinery,
tools, general supplies, raw materials.

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• From the above definitions it can concluded
that
 purchasing is the process of obtaining
material input, machineries, tools, supplies
and services for the smooth running of any
organization be it business, non-for- profit,
large or small from outside sources.
 It is a common function in almost all
organizations.

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 b.Role of Purchasing In Business
• To see the role of purchasing, the function will
be observed from three points of view.
1. Purchasing as a function of business
2. Purchasing as one of the basic elements
required to accomplish productive work
3. Purchasing as a key department responsible
for outside manufacturing

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 1. As a Function of Business
• Purchasing is one of the basic functions common to all type of business
enterprise. These functions are basic because no business can operate without
them.
• All businesses are managed by coordinating and integrating six functions
namely:
Creation : the idea or design function usually based on research
Finance : the capital acquisition and financial planning and control function
Personnel : the human resource and labor relation function
Purchasing : the acquisition of required materials, service and equipment
Conversion : the transformation of material in to economic goods and services
Distribution : the marketing and selling of goods and services produced

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• Depending on the company’s size, these six
basic functions may be supervised by a single
manager or individual managers for each
function.
• purchasing is a basic and integral part of
business management. For a business to be
successful, all its individual parts must be
successful.

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 2.As Elements Required For Productive Work

The basic goal of any individual activity is the

development and manufacturer of products that
can be marketed at a profit.
This goal is accomplished by the appropriate
blending of what management authorities
historically have called the five M’S:
-Machine, - Manpower, - Materials,
-Money and - Management
Materials today are the life blood of industry.
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Materials of
- the appropriate quality
- must be available at the right time,
- in the proper quantity,
- at the needed location and
- at an acceptable total cost.
Failure to fulfill any of these responsibilities
concerning materials management adds to
company’s cost and decrease company profit just
as surely do out mode production methods,
inefficient personnel and ineffective marketing
activity.
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 3.As the Manager for Outside Manufacturing
The materials that go in to a typical company’s
product can originate from either of two sources.
 production department- converts raw material in
to processed parts;
 purchasing department - not only purchase raw
material which the production department
converts in to processed parts but also purchases
finished parts and components.
The parts made by the production department are
combined in assembly with the items bought by
the purchasing department to make the company’s
final product.
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 3.2 .Objectives Of Good Purchasing
•The basic objective of the purchasing
function is
- to ensure continuity of supply of raw
materials, sub-contracted items and
spare parts and
- to reduce the ultimate cost of the
finished goods. In other words, the
objective is not only to procure the raw
materials at the lowest price but to
reduce the cost of the final product.
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 Objectives Of Good Purchasing……………
•The objectives of the purchasing department can be outlined as
under:
1) To avail the materials, suppliers and equipment's at the
minimum possible costs: These are the inputs in the
manufacturing operations. The minimization of the input cost
increases the productivity and resultantly the profitability of the
operations.
2) To ensure the continuous flow of production through
continuous supply of raw materials, components, tools etc. with
repair and maintenance service.
3) To increase the asset turnover: The investment in the
inventories should be kept minimum in relation to the volume of
sales. This will increase the turnover of the assets and thus the
profitability of the company.
4) To develop an alternative source of supply: Exploration of
alternative sources of supply of materials increases the
bargaining ability of the buyer, minimization of cost of materials
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and increases the ability to meet the emergencies.
1) To establish and maintain the good relations with the
suppliers: Maintenance of good relations with the supplier
helps in evolving a favorable image in the business circles. Such
relations are beneficial to the buyer in terms of changing the
reasonable price, preferential allocation of material in case of
material shortages, etc.
2) To train and develop the personnel: Purchasing department
is manned with varied types of personnel. The company should
try to build the imaginative employee force through training
and development.
3) Efficient record keeping and management reporting:
Paper processing is inherent in the purchase function. Such
paper processing should be standardized so that record keeping
can be facilitated. Periodic reporting to the management about
the purchase activities justifies the independent existence of
the department.
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 Parameters of Purchasing
 The success of any manufacturing activity is largely
dependent on the procurement of raw materials
- of right quality,
- in the right quantities,
- from right source,
- at the right time and
- at right price popularly known as ten ‘R’s’ of the art of
efficient purchasing.
 They are described as the basic principles of
purchasing.
 There are other well known parameters such as
- right contractual terms, - right material,
- right place, - right mode of transportation
and - right attitude are MM:
11/20/2024 also
By MMconsidered for purchasing.
72
1. Right price: 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. It is
very difficult to determine the right price; general
guidance can be had from the cost structure of the
product.
 The ‘tender system’ of buying is normally used in public
sector organizations but the objective should be to
identify the lowest ‘responsible’ bidder and not the
lowest bidder.
 The technique of ‘learning curve’ also helps the
purchase agent to determine the price of items with
high labor content.
 The price can be kept low by proper planning and not
by rush buying. Price negotiation also helps to
determine the right prices.
11/20/2024 MM: By MM 73
 2. Right quality:
Right quality implies that quality should be available,
measurable and understandable as far as practicable.
In order to determine the quality of a product
sampling schemes will be useful. The right quality is
determined by the cost of materials and the technical
characteristics as suited to the specific requirements.
The quality particulars are normally obtained from the
indents.

 Since the objective of purchasing is to ensure

continuity of supply to the user departments, the
time at which the material is provided to the user
department assumes great
11/20/2024
importance.
MM: By MM 74
 3. Right time:
•For determining the right time, the purchase manager should have
lead time information for all products and analyze its components for
reducing the same.
Lead time is the total time elapsed between the recognition of the
need of an item till the item arrives and is provided for use. This
covers the entire duration of the materials cycle and consists of pre-
contractual administrative lead time, manufacturing and
transporting lead time and inspection lead time.

Since the inventory increases with higher lead time, it is desirable

to analyze each component of the lead time so as to reduce the first
and third components which are controllable. While determining the
purchases, the buyer has to consider emergency situations like
floods, strikes, etc. He should have ‘contingency plans’ when force
major clauses become operative, for instance, the material is not
available
11/20/2024 due to strike, lock-out,
MM: floods,
By MM and earthquakes. 75
4. Right source:
 The source from which the material is procured should be dependable
and capable of supplying items of uniform quality. The buyer has to
decide which item should be directly obtained from the manufacturer.
Source selection, source development and vendor rating play an
important role in buyer-seller relationships. In emergencies, open
market purchases and bazaar purchases are restored to.
5. Right quantity:
 The right quantity is the most important parameter in buying.
Concepts, such as, economic order quantity, economic purchase
quantity, fixed period and fixed quantity systems, will serve as broad
guidelines. But the buyer has to use his knowledge, experience and
common sense to determine the quantity after considering factors
such as price structure, discounts, availability of the item, favorable
reciprocal relations, and make or buy consideration.

11/20/2024 MM: By MM 76
6. Right attitude:

 Developing the right attitude too, is necessary as one often

comes across such statement: ‘Purchasing knows the price of
everything and value of nothing’; ‘
 We buy price and not cost’; When will our order placers
become purchase managers?’; ‘Purchasing acts like a post box’.
Therefore, purchasing should keep ‘progress’ as its key activity
and should be future-oriented. The purchase manager should be
innovative and his long-term objective should be to minimize the
cost of the ultimate product.

 He will be able to achieve this if he aims himself with techniques, such

as, value analysis, materials intelligence, purchases research, SWOT
analysis, purchase budget lead time analysis, etc.

11/20/2024 MM: By MM 77
7. Right contracts:
 The buyer has to adopt separate
policies and procedures for capital and
consumer items.
 He should be able to distinguish
between indigenous and international
purchasing procedures.
 He should be aware of the legal and
contractual aspects in international
practices.
11/20/2024 MM: By MM 78
8. Right material:
 Right type of material required for the production is
an important parameter in purchasing.
 Techniques, such as, value analysis will enable the
buyer to locate the right material.
9. Right transportation:
 Right mode of transportation has to be identified as
this forms a critical segment in the cost profile of an
item.
 It is an established fact that the cost of the shipping
of ore, gravel, sand, etc., is normally more than the
cost of the item itself.
10. Right place of delivery:
 Specifying the right place of delivery, like head office
or works, would often minimize the handling and
transportation cost.
11/20/2024 MM: By MM 79
 3.3. Purchasing policies

 Policy refers to the set of purposes, principles, and rules of action

that guide an organization in realizing its objectives”.

 Policy is an instrument of guiding employee behaviors by showing

direction or conditions in performing tasks and discharging
responsibilities.

11/20/2024 MM: By MM 80
1.Centralized/Decentralized Purchasing Policy

Purchasing Organization dependent on many

factors, such as market conditions & types of
materials required.

– Centralized Purchasing- purchasing department

located at the firm’s corporate office makes all the
purchasing decisions.

– Decentralized Purchasing- individual, local

purchasing departments, such as plant level, make
their own purchasing decisions.
11/20/2024 MM: By MM 81
 Centralized vs. decentralized
Advantages- Centralization Advantages- Decentralization
 Less bureaucracy
uniform policy and procedure at • Speed and
all level and companywide responsiveness
uniform quality standards • Understanding unique
minimize duplication of efforts in operational
requirements
purchasing
• Product development
centralization develops purchase support
specialists whose primary concern • Ownership
is purchasing
Minimizes ordering costs

11/20/2024 MM: By MM 82
2.Policies affecting external relationship and image
Good supplier relations contribute to the
formation of good public image.
3. Policies on pricing and supply source
 Competitive bidding and the use of negotiation, the size
of sourcing firms, local firms, international firms,
distributors and manufacturers selection criteria etc.

11/20/2024 MM: By MM 83
4. Policies on purchase orders and contracts
 Identifies person authorized to sign purchase order
and contracts, specifying the dollar amount that a
person is authorized to sign.

5. Policies on internal relationship

 Policies should define the scope and responsibility of
the purchasing function.
 These are related to line of authorities, channel or
procedure, and department’s relationship.

11/20/2024 MM: By MM 84
 6.Policies on rush order
 Rush orders are made under emergency
situation.
 Rush orders result from poor planning by user
department so that it should be discouraged.
7. Policies on small orders
 Small orders are permanent problems in most
organizations.
 They are costly to the buyer and the seller alike.

11/20/2024 MM: By MM 85
What Are the Advantages and Disadvantages of
Policies?
Advantages Disadvantages
Having written and implied policies is A policy is often difficult
an opportunity to define and clarify to communicate
top management objectives. throughout large
Policy statements are a means for organizations.
executive management to Employees might view
communicate its leadership and views policies as a substitute
Policies provide a framework for for effective
consistent decision making and management.
action. Policy development can
Finally, an effective policy provides an also restrict innovation
additional advantage by defining the and flexibility.
rules and procedures that apply to all
employees.
11/20/2024 MM: By MM 86
 What Makes for an Effective Policy?
Several characteristics of a policy render it effective.

1. Effective policies are action-oriented guidelines that

provide guidance.
2. They provide enough detail to direct behavior
toward a specific goal or objective but are not so
detailed that they discourage personnel from
following the policy.
3. An effective policy is relevant (avoiding trivial or
unimportant issues) and concise (stating a position
with a minimum number of words).

11/20/2024 MM: By MM 87
 General Purchasing Procedures
Recogniti
on of
need
Maintenance of Description of the
purchase records need

Clearance of the
Flow of purchasing
invoice and
requisition / need
payment for
transition
supplier

Receipt and Determination and

inspection of the analysis of possible
material source of supply

Follow up
Preparation and
and
placement of
expediting
purchase order MM: By MM
of the order
11/20/2024 88
 1.Recognition of needs:-

Any purchase originates with the recognition

of a need by someone /department/ in the
organization.
The recognitions of needs refers to the means
by which the needed materials are formally
accepted by requesting department.

11/20/2024 MM: By MM 89
 2.Description of needs

No purchase can be expected to buy without

knowing exactly what the using department
wants.
 Accurate description of requested goods and
service.

11/20/2024 MM: By MM 90
 3.Flow of purchase requisition
The delivery date should allow sufficient time to
secure quotation and sample.

Purchase requisition
 Date, numbers, description, quantity, measurement, &
price, Originated dep’t..

11/20/2024 MM: By MM 91
 Purchase requisition format
ABC COMPANY LTD.
Purchase requisition
Please supply the following materials to the -------------dept No.___________
Classification of Goods Date: _ __ _ __ __ _
Consumable __ _ __ __ __ _ Spare parts __ __ __ __ _ __ _ S.R. No. __ __ __ _ __ __ _
Fixed assets __ __ __ _ __ __ __ __ _ __ __ __ __ _ __ __ __ __
SR. Item Unit of Quantity Unit Total
No. No. Description Measure Ordered Received Price Price Remark

Prepared by _ __ __ __ _ __ Checked & Received by_ _ __ __ __ _ Approved by __ __ __ __ _ __

11/20/2024 MM: By MM 92
4.Determination and analysis of possible source of
supply

 Involves the location of qualified vendors and

assessing the probability that a purchase agreement
would result in one time delivery of satisfactory product
and needed service before and after the sales.
 The purchase of a new or high value item may require
a length investigation of potential suppliers.

 Bidding is one of the basic methods by which price can

be determined.

11/20/2024 MM: By MM 93
competitive bidding is subject to the following five basic
criteria:
Purchase money must be large enough to
justify the expense.
The market consists of an adequate number
of sellers
The market consists of sellers that are
technically qualified and actively want the
contract.
The time available is sufficient

The clear material or service specification to

11/20/2024
both buyer and seller. MM: By MM
94
5.Preparation and placement of purchase order
The placing of an order usually involves
preparation of a purchase order form .
It is done after selection of the right
supplier.
Purchase order becomes a legal binding
contract once accepted by the seller.

11/20/2024 MM: By MM 95
 6.Follow up and expediting

Purchasing bears full responsibility for an order

until the material is received, inspected and
accepted.
Follow up:-
 is the routine tracking of an order to assure
that the vendor will be able to meet delivery
promises. Or
Expediting:-
is the application of pressure on vendors to get
materials on the original delivery promise or
delivery ahead of the schedule.
11/20/2024 MM: By MM 96
 7.Receipt and inspection of goods

 The receiving clerk in conjunction with his or her

copy of the purchase order to verify that the
correct material has been received.

After a shipment has been inspected for quality
and for general condition of the material, the
receiving clerk issues a receiving report.

11/20/2024 MM: By MM 97
 Inspection note format
ABC COMPANY LTD.
I NSPECTION NOTE
Supplier Name: __ __ _ __ __ __ __ _ __ __ __ __ _ __ __ __ __ _ _ No.__ __ __ _ __ __ __ __ _ __ __
Invoice No.: __ __ __ __ __ _ __ __ __ __ _ __ __ __ __ _ __ __ Date:__ __ __ __ _ __ __ __ __ _ _
P.O. No. __ __ __ __ _ __ __ __ _
SR. Item Unit of Quantity
No. No. Description Measure Received Rejected Reasons

Distribution:-
st nd
Original - General Accounts1 copy - Costs & stock Accounts2 copy - Purchasing
rd th
3 copy - Stores recording and control 4th copy – Storekeeper5 -copy-Pad
11/20/2024 MM: By MM 98
 8. The invoice audit and completion of the
order
Occasionally,
its shipping department makes an incorrect or
incomplete shipment.

 To ensure that the purchaser makes proper payment for
the materials actually received, sound accounting
practice speaks that some types of review procedure
precede payment to the supplier.

11/20/2024 MM: By MM 99
 9.Maintaining Purchasing related Records

In the purchasing process, large number of files

and documents are produced to facilitate the
purchasing activity.

This documents and files contain a large volume

of data that flows among the participants in the
purchasing process.

11/20/2024 MM: By MM 100

The following basic records are essential for the
effective operation of most purchasing departments:
A record of open orders

A record of closed orders

Purchase log

Commodity record

Supplier record

Contract record

Special tool record

11/20/2024 MM: By MM 101
 3.6 Selection and motivation of supplies

Selection of the right supplier is the responsibility of the

purchase department.

It can contribute substantially to the fundamental

objectives of the business enterprise.

Different strategies are required for acquiring different

types of materials.

The selection of supplier for standardized products will

differ from non-standardized products.

Following factors are considered for the selection of

suppliers:
11/20/2024 MM: By MM 102
 A. SOURCES OF SUPPLIER

•The best buying is •A survey of the following will

possible only when the help in developing the possible
decision maker is familiar sources of supply:
with all possible sources 1. Specialized trade directories.
of supply and their 2. Assistance of professional
respective terms and bodies or consultants.
3. The buyer’s guide or
conditions.
purchase handbook.
•The purchase department
4. The manufacturer’s or
should try to locate the distributor’s catalogue.
appropriate sources of the 5. Advertisements in dailies.
supplier of various types 6. Advertisement in specialized
of materials. This is known trade journals.
as ‘survey stage’. 7. Trade fair exhibitions.
11/20/2024 MM: By MM 103
B. Development Of Approved List Of
Suppliers

•The survey stage highlights the existence of the

source.

• A business inquiry is made with the appropriate

supplier. It is known as ‘Inquiry Stage’.

11/20/2024 MM: By MM 104

1. Cost factors: Price, transportation cost, installation
cost if any, tooling and other operations cost, incidence
of sales tax and excise duty, terms of payment and
cash discount are considered in cost factor.
2. Delivery: Routing and F.O.B. terms are important in
determining the point at which the title to the goods
passes from vendor to the buyer and the responsibility
for the payment of the payment charges.
3. Design and specification factors: Specification
compliance, specification deviations, specification
advantages, important dimensions and weights are
considered in line with the demonstration of sample,
experience of other users, after sale services etc.
11/20/2024 MM: By MM 105
4. Legal factors: Legal factors include
warranty, cancellation provision, patent
protection, public liability, federal laws and
reputation compliance.
5. Vendor rating: The evaluation of supplier
or vendor rating provides valuable
information which help in improving the
quality of the decision.
In the vendor rating three basic aspects are considered namely
- Quality
- Service and
- 11/20/2024
Price. MM: By MM 106
 3.7 Make or Buy decision
 Make or Buy decision may originate in

any one of the following events.

 When we are planning to produce a
new product or modifying the existing
product.
 When the current performance of
supplier is unsatisfactory.
 Changing demand in the external
environment. (increase or decrease of
11/20/2024 demand.) MM: By MM 107
 Now before buying or making the parts the costs should
be evaluated.
 The relevant costs of buying are;
- purchase cost of the parts,
- transportation costs and
- receiving and inspection costs.
 The cost of making includes; In general,
- Delivered raw material costs - Direct labor costs
- Incremental managerial costs - Inventory Carrying
costs
- Costs of Capital and -Opportunity Costs
 In order to make a sound managerial decision,
 we should have to consider the factors specifically
11/20/2024 MM: By MM 108
favoring the making or buying decisions.
Factors that specifically support 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.

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

When transportation costs can be saved by gathering local

materials to make the products
When research break through occurs & the company wants to
maintain trade secrets concerning the product, materials in it &
11/20/2024 the process involved MM: By MM 109
 Considerations 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 rates are inherent in the manufacture of the product and when the
company is assured of getting the same from suppliers.
11/20/2024 MM: By MM 110
 3.8 VALUE ANALYSIS
 Value analysis is an attempt to see any material or any
component can be substituted or eliminated to achieve
the proper function at a lower cost.
 Value analysis is concerned with examination of the
design function and cost of any product with the aim
of reducing cost by
- modification of design material specification,
- more efficient process,
- possibly the elimination of an item without sacrificing
reliability and quality.

11/20/2024 MM: By MM 111

The two basic conceptual tools in the operation of value analysis are:
1. Design analysis of the required material
 Design analysis is a methodical step by step study of all phases of
the design of a given item in relation to the function it performs.
 To see and examine each part in relation to their function to
avoids or eliminates redundant or idle ones.
This can be examined by:
 Can any part be eliminated without damaging the operation of
the other unit?
 Can the design of the part be simplified to reduce its basic cost?
 Can design of the parts be changed to permit the use of simplified
and less costly production method?
 Can less expensive, but equally satisfactory materials be used in
the part?

11/20/2024 MM: By MM 112

2. Cost analysis of the required material
 Cost analysis involves the investigation of the
supplier’s probable cost of producing a given
materials.
To get actual selling price of a suppler.
Construct estimated elemental cost for labor,
material, manufacturing overhead and general
overhead.
Total these cost, to arrive at approximate actual
costs of producing for an efficient producer.
Make-up reasonable profit and arrive at selling
price.
11/20/2024 MM: By MM 113
 Possible procedure in value analysis
Select the material

Gather information

Define the prime functions;

Estimate the present cost of each function.

Generate alternatives ideas.

Evaluate alternatives in terms of cost,

Present proposals

Implement the plan

11/20/2024 MM: By MM 114

In sum, the purpose of value analysis is to
bring together the combined talents of:-
purchasers
vendors
 engineers and
other operating personnel
 to review the components of materials
used in the making of the product with the
view to improve its function and lower its
cost.
11/20/2024 MM: By MM 115
 3.9 Global sourcing
One of the major supply chain developments of recent years
has been the expansion in the proportion of products and
(occasionally) services which businesses are willing to source
from outside their home country; this is called global
sourcing.

It is the process of identifying, evaluating, negotiating and

configuring supply across multiple geographies.

This has changed – companies are now increasingly willing to

look further a field for their supplies, and for very good
reasons.

Most companies report a 10 per cent to 35 per cent cost

savings by sourcing from low-cost-country
11/20/2024 MM: By MM suppliers. 116
•The factors that must be understood and
included in evaluating global sourcing
opportunities are as follows.
1. Purchase price
2. Transportation costs
3. Inventory carrying costs
4. Cross-border taxes, tariffs and duty costs
5. Supply performance –
6. Supply and operational risks
11/20/2024 MM: By MM 117
 Advantages

 The formation of trading blocs in different parts of the

world has had the effect of lowering tariff barriers, at
least within those blocs.

 Transportation infrastructures are considerably

more sophisticated and cheaper than they once
were.

 Super-efficient port operations ,integrated road–

rail systems, jointly developed auto route systems,
and cheaper air freight have all reduced some of
the cost barriers to international trade.
11/20/2024 MM: By MM 118
 Disadvantages
 The risks of increased complexity and increased distance
need managing carefully.

 Suppliers that are a significant distance away need to

transport their products across long distances.

 The risks of delays and hold-ups can be far greater than

when sourcing locally.

 Also, negotiating with suppliers whose native language is

different from one’s own makes communication more
difficult and can lead to misunderstandings over contract
terms.
11/20/2024 MM: By MM 119
 Therefore global sourcing decisions require
businesses to balance cost, performance, service
and risk factors, not all of which are obvious.

 These factors are important in global sourcing because of non-

price or ‘hidden’ cost factors such as cross-border freight and
handling fees, complex inventory stocking and handling
requirements, and even more complex administrative,
documentation and regulatory requirements.

11/20/2024 MM: By MM 120

End of Chapter
Three

11/20/2024 MM: By MM 121

 Chapter-4

Inventory Management

By: Merkineh M (MBA)

 CHAPTER IV - INVENTORY MANAGEMENT
4.1.Introduction
4.2.Functions and types of inventory
4.3.Independent vs. dependent demand
4.4.Inventory Costs
4.5.Economic Order Quantity (EOQ)
4.6.Economic Production Quantity (EPQ)
4.7.Materials Requirements Planning (MRP)
4.8.Inventory systems
4.9.Just in time (JIT)
11/20/2024 MM: By MM 123
 4.1 introduction
 The fundamental problem of inventory management can be
briefly described by the two questions: When should an order be
placed and How much should be ordered?

 In general, the model that we discuss can be used

interchangeably to describe either replenishment from an
outside vendor or internal production.

 This means that from the point of view of the model, inventory
control and production planning are often synonymous.

11/20/2024 MM: By MM 124

 Definition of Inventory
 Inventory is an idle resource (physical stock of goods)
possessing economic value which is waiting (kept) for future
use.

 Here the responsibility of materials management is to

maintain sufficient inventories to meet demand for goods and
incurring the lowest inventory handling costs.

• Inventory management-
Make inventory information available to stakeholders and
respond to information requests, records all documentation
and results, Continuous improvement of material feedback
system.
11/20/2024 MM: By MM 125
 4.2 Function and Types of Inventories
4.2.1 Types of Inventory
When we consider inventories in the context of manufacturing and distribution,
there is a natural classification scheme suggested by the value added from
manufacturing or processing.
 Based on this concept there are five types of Inventories. They are;

11/20/2024 MM: By MM 126

 Inventory types Con…………t
1. Raw Materials
 These are the resources required in the production or
processing activity of the firm.
2.Components
 Components correspond to items that have not yet
reached completion in the production process.
Components are sometimes referred as Sub-
assemblies.

11/20/2024 MM: By MM 127

 Inventory types Con…………t
3.Work –in-process
 Work-in-process (WIP) is inventory either waiting in the
system for processing or being processing.
 Work-in-process inventories include component
inventories and may include some raw materials
inventories as well.
 The level of work-in-process inventory is often used as a
measure of the efficiency of a production scheduling
system

11/20/2024 MM: By MM 128

 Inventory types Con…………t
4. Finished goods
 These are also known as end items, these are the final
products of the production process.
5.Supplies
 These are items that facilitate the production and
administrative functions. They are not part of the final
item. (eg. Tools, office supplies, lubricants, stationary
items etc…).

11/20/2024 MM: By MM 129

4.2.2 WHY CARRY INVENTORY ( FUNCTION /MOTIVES)
• Organizations may hold inventories with the various motives as
stated below.
1. Economies of Scale:-
• situation where a firm’s long-run average cost (LRAC) declines
as output increases
• This means that it could be economical to produce a relatively
large number of items in each production run and store them
for future use.
• This allows the firm amortizes fixed set up costs over a large
number of units.

11/20/2024 MM: By MM 130

 FUNCTIONS Con…………t
2.Uncertainties
• If a customer requests an item that is not available immediately,
it is likely that the customer will go elsewhere.
• Inventory provides a safeguard against the uncertainty of
demand.
• Other uncertainties provide a motivation for holding is the
uncertainty of lead-time.
 Lead-time is defined as the amount of time that elapses from the
point that an order is placed until it arrives.

11/20/2024 MM: By MM 131

 FUNCTIONS Con…………t
3. Speculation
• In this case the higher the price the higher will be the
demand because of the expectation to increase the
price in the future. E.g., shares, gamble
• If the value of an item or natural resource is expected to
increase,
it may be more economical to purchase large
quantities at current price and
 store the items for future use than to pay the
higher price at a future date.

11/20/2024 MM: By MM 132

 FUNCTIONS Con…………t
4Transportation
• In-transit or pipeline inventories exist, when
transportation times are long, as is the case when
transporting oil from the Middle East to Ethiopia , the
investment in pipelines inventories can be substantial.
• One of the disadvantages of producing Overseas is the
increased transportation time and hence the increase in
pipeline inventories

11/20/2024 MM: By MM 133

 FUNCTIONS Con…………t
5.Smoothing
• Change in the demand pattern for a product can be deterministic
or random.
• Seasonality is an example of a deterministic variation.
• While unanticipated change in economic conditions can result in
random variations.
• Producing and storing inventory in anticipation of peak demand
can help to alleviate the disruptions caused by changing
production rates and work force levels.

11/20/2024 MM: By MM 134

 FUNCTIONS Con…………t
6. Logistics
• We use the term logistics to describe the reasons for holding
inventory different from those outlined above.
• Certain constraints can arise in the purchasing, production,
distribution of items that force the system to maintain inventory.
• One such case is an item that must be purchased in minimum
quantities.
• Another is the logistic of manufacture; it is virtually impossible to
reduce all inventories to zero and expect any continuity in a
manufacturing process.

11/20/2024 MM: By MM 135

 Objectives of Inventory Management

• Provide acceptable level of

customer service (on-time delivery)
• Allow cost-efficient operations
• Minimize inventory investment

11/20/2024 MM: By MM 136

 4.3 Independent vs. Dependent Demand
• Independent demand items are finished goods or other items sold to
someone outside the company
• Dependent demand items are materials or component parts used in the
production of another item (e.g., finished product)
Direct and Derived Demands:
– direct demand is demand for goods meant for final consumption
– derived demand refers to demand for goods which are needed for further
production.
Domestic and Industrial Demands:
– Demand could also be for domestic purpose or for
industrial use. This distinction is important from the
standpoint of pricing and distribution.
Autonomous and Induced Demand:
– When the demand for a product is tied to the purchase of
some parent product, its demand is called induced or
derived
11/20/2024 MM: By MM 137
Perishable and Durable Goods’ Demands:
– Both consumers’ goods and producers’ goods are further
classified into perishable/non-durable/single-use goods and
durable/nonperishable/repeated-use goods.
– Non-durable items are meant for meeting immediate (current)
demand, but durable items are designed to meet current as
well as future demand as they are used over a period of time.
New and Replacement Demands:
– If the purchase or acquisition of an item is meant as an addition to stock,
it is a new demand. If the purchase of an item is meant for maintaining
the old stock of capital/asset, it is replacement demand.
Final and Intermediate Demands:
– In the context of input-output models, such distinction is often employed.
– The demand for semi-finished products, industrial raw materials is the
demand for intermediate products

11/20/2024 MM: By MM 138

Total Market and Segmented Market Demands:
– Different individual buyers together may represent a given
market segment; and several market segments together may
represent the total market.
– Individual and Market Demands:
– This distinction is often employed by the economists to study
the size of the buyers’ demand, individual as well as
collective (market demand).
– This information is useful for personalized service or target-
group-planning as a part of sales strategy formulation.

11/20/2024 MM: By MM 139

 4.4.INVENTORY COSTS
• Cost minimizations and profit maximizations are essentially
equivalent criteria for most inventory control problems.
1.Item Cost- Cost per item plus any other direct costs associated
with getting the item to the plant
2.Holding Costs-Capital, storage, and risk cost typically stated as a %
of the unit value, e.g. 15-25%
3.Ordering Cost-Fixed, constant dollar amount incurred for each
order placed
4.Penalty Costs-Loss of customer goodwill, back order handling, and
lost sales

11/20/2024 MM: By MM 140

 4.4.1.Holding cost
 The holding cost, also known as the carrying cost or the
inventory cost, is the sum of all costs that are proportional to the
amount of inventory physically on hand at any point in time.
The components of the holding cost include a variety of
seemingly unrelated items. Cost of providing the physical space to
store the items
Some of inventory holding costs
Taxes and insurances
Breakage, spoilage, deterioration, and obsolescence
Opportunity cost of alternative investments
The salaries and wages of storing, receiving and issue of material
personnel.
Stationary and other consumables use by the stores.

11/20/2024 MM: By MM 141

 For example
, we will use the term cost of capital to refer to this component of
the holding cost.
Therefore, we may think of the holding cost, as an aggregated
interest rate comprised of the four components listed above.
For example;20% =cost of capital,2% =Taxes & Insurance,6% =
Cost of Storage,2% =Breakage & Spoilage = Total interest charge
30%
This would be interpreted as follows:
 We would assess a charge of 30 cents for every birr that we have
invested in inventory during a one-year period.

However, as we generally measure inventory in unit rather than in

birr's,
it is convenient to express the holding cost interns of birr per unit
per year rather than birr per year.
11/20/2024 MM: By MM 142
 4.4.2.Ordering Costs
The holding cost includes all of those costs that are proportional to the amount
of inventory on hand,
whereas, the ordering cost depends on the amount of inventory that is ordered
or produced.

The cost associated with ordering would, therefore, consists of;

Salaries of the staffs in the purchasing department.

Negotiating purchases, placing orders and follow up.
Rent for the space used by the purchasing department.
The postage, telegram, telephone bills.
 The stationary and other consumables used by the purchasing department.
 Entertainment charges for vendors.
 Traveling expense.
 Lawyers and court fees due to any legal matters arising out of purchase.
 Inspecting shipment & moving goods to storage.

11/20/2024 MM: By MM 143

 Con…………t
When more order placed in a period, the more would be the
stationary and postage consumed, more staff and officers will be
required for handling the work, the more will be the space
required for accommodating them and soon.

Thus the total expenditure on purchasing or ordering would

depend on the number of orders placed.

 It is assumed that the expenditure on ordering of material is

directly proportional to the number of orders placed.

 The ordering cost is expressed as cost/order

11/20/2024 MM: By MM 144

 ECONOMIC ORDER OF
QUANTITY(EOQ)

PURCHASING CARRYING
COST COST

11/20/2024 MM: By MM 145

 4.4.3. Penalty Costs
The penalty cost, also known as the shortage cost or
the stock-out cost,
is the cost of not having sufficient stock on hand to
satisfy demand when it occurs.
This cost has a different interpretation depending on
whether excess demand is back-ordered
(orders that cannot be filled immediately are held on
the books until the next shipment arrives)
or lost (known as lost sales).

11/20/2024 MM: By MM 146

 Con…………t
 In the back-order case, the penalty cost includes
whatever bookkeeping and /or delay costs might be
involved.
 In the lost-sales case, it includes the lost profit that
would have been made from sales.
 In either case, it would also include the “lost good-
will” cost, which is a measure of customer satisfaction.
Estimating the loss of goodwill component of the
penalty cost can be very difficult in practice

11/20/2024 MM: By MM 147

4.5 Inventory controlling Models
1. Economic Order Quantity (EOQ)
– An optimizing method used for determining order quantity
and reorder points
– Part of continuous review system which tracks on-hand
inventory each time a withdrawal is made
2.Economic Production Quantity (EPQ)
– A model that allows for incremental product delivery
3.Quantity Discount Model
– Modifies the EOQ process to consider cases where quantity
discounts are available

11/20/2024 MM: By MM 148

 4.5.1 THE EOQ MODEL
 The EOQ (Economic Order Quantity) model is one method of
determining the adequate (optimum) inventory level for
independent demand materials.
 This model is one of the mathematical models and it results in
an inventory level which is not too large or too small. i.e.
It is the economical level of inventory. Here very large order size
may result in few numbers of orders there by low ordering cost.
However, the annual carrying cost may be high for large size of
inventory.
On the other hand, small order size involves many orders which
decreases the annual carrying cost and increases the annual
ordering cost of the item.

11/20/2024 MM: By MM 149

• EOQ is an order size that balances the annual carrying
cost & annual ordering cost.
• At EOQ the annual carrying cost is equivalent to the
annual ordering cost.
• Now in order to calculate the annual carrying cost (ACC)
let us look at the concept of average inventory.

11/20/2024 MM: By MM 150

 Material Requirement
Planning
• MRP is a systematic planning-and-control
methodology for production and inventory.
• Specifically, it is a procedure for planning and
controlling the raw material, purchased parts, and
work in progress (WIP) inventories required in
manufacturing a product.

• MRP is designed to answer three questions: what is

needed, how much is needed, and when is it needed.

11/20/2024 MM: By MM 151

• MRP is a system that controls inventory levels,
plans production, helps supply management
with important information, and helps with the
manufacturing control system with respect to
the production of assembled parts.

11/20/2024 MM: By MM 152

 The Benefits of MRP

Reduction in
Inventory Increased
production &
reduction. efficiency.
delivery time.

Improved labour & Better inventory

Faster response to
equipment planning &
market changes.
utilization. scheduling.

Reduced inventory
levels without
reduced customer
service.

11/20/2024 MM: By MM 153

 Objectives of MRP

• Ensure materials and products are available for

production and delivery to customers.
• Maintain the lowest possible level of inventory.
• Plan manufacturing activities, delivery schedules and
purchasing activities

11/20/2024 MM: By MM 154

 Three Basic Steps of MRP

• The three basic steps of MRP are

1) Identifying requirements for items to be included in an MRP run,
2) Running the MRP and creating suggestions for action, and
3) firming the suggestions to release manufacturing orders and
purchase orders.

11/20/2024 MM: By MM 155

Information Needed for MRP

• It collects information through….

1. Master Production Schedule (MPS),
2. The Bill of Material (BOM), ingredients for the end
product,
3. Inventory Data,
4. Balance on Hand (BOH),
5. Scheduled receipts,
6. Purchasing/Fabrication lead times

11/20/2024 MM: By MM 156

 MRP inputs

Master
Product Inventory
Production
Structure File Master File
Schedule

11/20/2024 MM: By MM 157

 Master Production Schedule

Schedule of Finished
Products

Represents
Production, not
Demand

Combination of
Customer Orders and
Demand Forecasts

What Needs to be
Produced

11/20/2024 MM: By MM 158

 Inventory Master File

On-Hand On-Order
Lot Sizes.
Quantities. Quantities.

Safety Past-Usage
Lead Time.
Stock. Figures.

11/20/2024 MM: By MM 159

11/20/2024 MM: By MM 160
Chapter 5
Storage management
By Merkineh M. (MBA)
 INTRODUCTION
• Store keeping is a function of receiving, storing and
issuing of materials. In almost all industries, the materials
represent a very large investment.
• Method are employed to ensure accuracy, preservation,
and safety at all stages of materials movement and
supervision.
• Stores are defined as supplies of goods and storage is
defined as the act of storing the goods
• Stores or storage is the function of receiving, storing and
issuing material
• Basically the function of stores management is to be a
keeper, looking after the items and controlling their flow
11/20/2024 MM: By MM 162
 Meaning of store;
• Store is the space, room, and the building where
various types of

materials,
semi-finished goods, and
items purchased and manufactured in the
organization are kept temporarily until they are
removed to supply for production and sales or
used for consumption.

11/20/2024 MM: By MM 163

5.1. Storage Function and Responsibilities
5.1.1 Store function
The functions of stores may be listed as follows:
• receiving and inspection: to receive and inspect raw
materials.
• Issue and dispatch-to meet the demands of the
customer(user dept )by proper issuing
• Stock records- to know the balance and assist in
verification and providing supporting information for
effective purchase items.
• Stock accounting

11/20/2024 MM: By MM 164

 5.1.2 Major responsibilities of store
• A).Identification- is the process of systematically
defining and describing all items of materials in
stock.
• B).Receipt- the process of checking and accepting
from all sources
• C).Inspection-involves the examination of the
incoming consignment for quality
• D).Storage and preservation-items are required to
be binned and kept in storage bins and impounds
on racks and shelves and some times in the yard
11/20/2024 MM: By MM 165
 5.2. Location and Layout
• All materials shall be stocked in a systematic way so
that minimum time is spent in picking out the
materials for day-to-day issues.
• The layout of the store house help to develop an
efficient work flow that minimizes the transportation
problem and handling of materials
• The two aspects of stores are:
storage system and
type of store layout
• Storage system – choosing the most suitable storage
system means dealing with the number of
interactions
11/20/2024 MM: By MM 166
 Location………………..
• Fixed Location
– Store Keeping Unit assigned a permanent location, & no
other items are stored there
– Fixed-location systems usually have poor cube utilization
– Usually used in small warehouses; throughput is small, &
there are few SKUs
• Floating (Random) Location
– Goods stored wherever there is appropriate space
– Advantage is improved cube utilization
– It requires accurate and up-to-date information
– Warehouses using floating-location systems are usually
computer-base

11/20/2024 MM: By MM 167

 Location………………..
• Two other systems sometimes used are
– Point-of-use storage
• Inventory stored close to where it will
be needed
• Used in repetitive manufacturing & JIT
systems
– Central storage
• Contains all inventory in one central

11/20/2024 MM: By MM 168

 Location………………..
Advantages of Advantages of Central
Point-of-use Storage
Storage

– Ease of control
– Materials are readily
– Inventory record
accessible to users
accuracy is easier to
– Material handling is maintain
reduced or eliminated – Specialized storage can
– Central storage costs be used
are reduced – Reduced safety stock,
since users do not need
– Material is accessible to carry their own safety
all the time stock
11/20/2024 MM: By MM 169
 Layout of storage area

The following factors should be considered

when stockroom layout is being planned:

A. Commodity factors – the characteristics of the

items to be stored.

B. Capacity factors – the characteristics of

the available storage area.

B. Activity factors – the activities that must

be accommodated

11/20/2024 MM: By MM 170

 1.Commodity Factors
a. Nature of the Material
 Items subject to deterioration need to be properly
protected from extremes of temperature, humidity,
rodents, insect infestation.
 Security items should be stored in vaults, safes, or
caged areas; sensitive items must be properly
safeguarded.
 Hazardous commodities including ammunition, flammable
material, and oxidizing items need to be segregated from each
other and from other types of supplies and stored in
appropriate containers.
11/20/2024 MM: By MM 171
 b. Size, Weight, and Shape

• Extremes of size, weight, or shape need to be

considered.
• Large awkward containers and unusually heavy
items must generally be stored near shipping doors.

• Light and fragile items should not be stacked to a

height that would cause crushing or other damage to
the containers and their contents.
C. Turnover
• Fast-moving items must be stored in readily accessible
areas, where they can be handled quickly and efficiently.
11/20/2024 MM: By MM 172
 d. Quantity

• Large quantities of uniform packages are

conducive to simple layouts.
• In contrast, small quantities of various-sized
items require special storage planning:

11/20/2024 MM: By MM 173

 Storage system

• The procedures' document defines step by step how

the activities in the warehouse should be carried out
and clearly defines the processes to be adopted.

11/20/2024 MM: By MM 174

 Storage Systems

• The two main storage systems are:

Centralized and Decentralized Stores.
• In small privatizations, one store will be sufficient to
store all the materials which can be supplied by this
centralized place to the other places or requirements.
• But, in large industrial organization since the
production shop floors or workshops are lying at
different place and sometimes located far away.

11/20/2024 MM: By MM 175

 Store System

• Decentralized storing needs efficient planning

of materials as well as location of storing them.

• But, the type of materials like small parts as

nut, bolts, screw, fixtures, chemicals, paints,
etc… have to be stored at separate places,
whose requirements may be at many place

11/20/2024 MM: By MM 176

 Disposition of Surplus, Obsolete, Scrap and Waste

• A final objective of stock control is the detection

of inactive stock item that increase the inventory
investment without contributing any
corresponding service or utility.

• Surplus may arise from Over questioning ,

over buying, cancellation of sale order
Undetected errors, Error in record keeping

11/20/2024 MM: By MM 177

 …
• Reason for Disposal

Obsolescence
Irrevocable damage
Deterioration in value
Surplus

• Alternative possibilities for disposal:

Utilization as a substitute
Utilization by transfer to another department
Utilization by remanufacture
Return to original manufacturer
11/20/2024 MM: By MM 178
 Stock accounting and Stock Verification

• Stores Accounting
Materials costing can be discussed under
classification
1. the receipt of material: actual cost of
materials received
2. the issue of materials to production
3. the stocks held at the end

11/20/2024 MM: By MM 179

 Stock verification

• Store verification means, testing or checking the stores record

with the actual items stoked in the store.

• The store record at any time should show the exact physical
quantity of raw materials and parts which are available for use.

• Store verification also referred as to stock taking is meant to

ascertain any discrepancy of actual store when comparing with
record.
•
• Store verification or stocktaking is also sometimes called internal
audit of store

11/20/2024 MM: By MM 180

• Discrepancy revealed by physical verification may
be one of the two types:
• Store materials (stores) short of what the record shows
• They are in excess of what the record shows
• Store verification revels if there is any
discrepancy of stored materials with the stores
record; discrepancy may arise due to:
 Clerical error
 Wrong description
 Incorrect counting
 Omission in issue of material
 Omission in recording issued material
11/20/2024
Loss due to damage, breakage or deterioration.. 181
MM: By MM
11/20/2024 MM: By MM 182
CHAPTER SEVEN
LOGISTICS
 7.1 TRANSPORTATION
Introduction

 Transportation is the management of the

movement of goods and materials through
space and time from the original source to the
ultimate destination.
 Transportation costs account for a very
significant portion approximately 40% of the
material cost.

11/20/2024 MM: By MM 184

 7.2 Functions in Transport-

1. Functions related to incoming shipments

Selecting the appropriate mode of transport.
Arranging collection of materials from the
suppliers.
Notifying discrepancies
Verifying freight bills.
 Attending miscellaneous activities

11/20/2024 MM: By MM 185

 Transport function
2. Functions related to outgoing shipments
Collecting, packaging and packing).
Selecting the most suitable mode of transport
Attending customers’ sales orders.
Prosecuting claims for damages and losses in
transit and following up until final settlement.
Attending to customers' complaints
Verifying freight bills and forwarding them to
accounts for payments.

11/20/2024 MM: By MM 186

 General functions
Records maintenance, claim settlements
Maintenance of up-to-date transportation
Keeping track of all the papers
Compilation of transportation costs
Preparing transport budgets & expenses
Ensuring safe and speedy movement of men
and materials at minimum transport cost.

11/20/2024 MM: By MM 187

 7.3 Constituents of Transportation Cost

 Packing cost  Losses due to breakages

 Documentation cost,  Cost of tracing missing
 Loading charges, consignments,
 Local clearance charges  Transit insurance,
 Cost incurred in lodging
insurance

11/20/2024 MM: By MM 188

 Factors Determining Transportation Costs
1. Value of the product- higher the value , the
higher is the transportation rate.
2. Volume of goods moved- transportation costs
are lower, if more volume of goods
transported.
3. Density- the denser the product, the easier it is
to load into a carrier and consequently lower
are the transportation rates
4. Space required-bulky items cost more to
transport, as they require more space and
transportation rates are higher.
11/20/2024 MM: By MM 189
 Factors….
6.The place to which the goods are to be transported
 if the goods are to be transported to a small city or town from
where there is little or no chance of getting a return shipment,
the rates are higher.
7. Special services required
 special services such as special connection and stopover
privileges increase transportation costs.
8.Packaging requirements
 The greater the packaging requirements, the higher are the
rates.
9.Competition
 The rates also depend on the demand and supply of the carriers.
If a large number of carriers MM:
11/20/2024 areBy MM
available, the rates will be lower.
190
 7.4 Modes of Transport
• There are various modes of transport available in/out
of the country that the user can utilize(land ,maritime
and air transport .
1) Post package- Parcel post is suitable for
valuable materials that are small in size. Parcels
weighing more than 4 kg but up to 20 kg are
accepted as registered parcels.
2) Road Transport
 Includes the different means of transport such as
motor cars, trucks, tankers, annuals and carts and is the
most important mode of transport in the industry.
11/20/2024 MM: By MM 191
 Modes…………

 Road transport is the country's second largest

internal transport, which provides the only
mechanized transport in hilly, rural and backward
areas which are not connected by rail.
 It also serves as a feeder to rail heads

11/20/2024 MM: By MM 192

 Advantages of road transport

1. Multiple use of roads

 Road transport is convenient for carrying goods to the
interiors and remote parts of the country,
2. Flexibility
 Road transport is a flexible means of transport as changes
can be made easily, quickly and with limited expenditure.
3. Safety
 Road transport is reasonably safe and secure, particularly
when goods are door delivered without any break and
loading and unloading in transit..
11/20/2024 MM: By MM 193
 Advantages of road transport

4. Door-to-door service
Road transport provides door-to-door service.
This is the most important reason for its
popularity.
5. Suitable for short distance
Road transport generally proves to be quicker
and cheaper than railway transport, when the
distance involved is small.

11/20/2024 MM: By MM 194

 Disadvantages of Road Transport:

1. Less reliable
 Road transport is less reliable than railways. Breakdowns, road
congestions, delays due to road accidents, floods, heavy rainfall
etc. It is also affected by weather conditions.
2. Absence of uniform rates
 Road transport is managed by the private sector. The transport
charges are not uniform and subject to frequent changes.
3. Not suitable for long distances
 Road transport is inconvenient and uneconomical for transporting
heavy, bulky and low value goods over long distance.
4. Not suitable for bulky goods
 Road transport has limited carrying capacity. It is not suitable for
carrying heavy and bulky goods, costly and low grade goods.

11/20/2024 MM: By MM 195

 3) Railway Transport
• Railway transport is the most important and
popular means of transport. It is most suitable
for long distances and for bulky goods.
• Advantages of Railway Transport
1. High speed- Railways has considerable speed because
of the use of electricity and automation, straight
railway lines and absence of disturbances on railway
tracks.
2. High carrying capacity- railways have very
large carrying capacity

11/20/2024 MM: By MM 196

 Modes…………….
3. Regularity of service-railways offers regular, reliable
and dependable service. Railway is a public utility. It
has a fixed time table from which it does not deviate.
4. Transport charges- railways are owned and managed
by the state. Naturally railway freight rates are low and
also uniform in all parts of the country.
5. Dependable - railway network operates regularly and
continuously, as per fixed schedule. Railway is less
affected by weather conditions and is a dependable
mode of transport.
11/20/2024 MM: By MM 197
 Disadvantage of Railway Transport

• Absence of flexibility- railway transport is rigid

and lacks flexibility. Railway provides transport
facilities only between certain fixed points. It
carries goods from one railway station to
another only.

11/20/2024 MM: By MM 198

 4) Water Transport

• Water transport (rivers, canals, sea and creek)

is the oldest, cheapest and the most natural
means of transport.
• Water transport is suitable for carrying bulky
and low cost goods.
• There are two kinds of water transport: Inland
water transport and Ocean transport

11/20/2024 MM: By MM 199

 a. Inland water transport-
• It includes river transport and canal transport and useful for
internal transportation of goods.
In river transport,
 rivers are used for internal transport of passengers and goods.
• Small boats and steamers are used for this purpose.
• This transport is cheap and convenient.
Canals
 are the artificial waterways specially constructed for navigation
and irrigation.
 The well known Suez Canal in Egypt is the finest example of the
use of canal for transportation.
 This type of transportation is mainly useful for local
transportation. Like river transport, it is cheap and safe.
11/20/2024 MM: By MM 200
 b. Ocean transport
• Ocean transport refers to the transport facilities in the
open sea.
• Big passenger ships, cargo ships, tankers and tramps are
used in ocean transport.
• Ocean transport is classified into two categories, namely
coastal shipping and overseas shipping.
a) Coastal shipping is possible in the case of countries
where borders touch the sea shores and is carried by big
ships and boats. It is an economical means of transport
and generally restricted to the national shipping
companies.
b) Overseas shipping is the transportation between
different countries
11/20/2024 MM: By MM 201
 Advantages and disadvantages Ocean Transport
Advantages
1. Cheapness-ocean transport is the cheapest
mode of transport.
2. Suitability-it is very suitable for carrying bulky
goods over a long distance.
Disadvantages
• Cargo carried by sea is subject to deterioration in
quality because sea water is corrosive.
• Sea transport requires strong and much better packing
of goods.
• Sea transport runs the risk of losses due to inclement,
weather choppy seas andMM:possibly
11/20/2024 By MM of shipwreck. 202
 5) Air Transport
Air transport has made a revolution in the field of transport. It has
made the world smaller.
Merits of Air Transport
1. High speed- Air transport is the speediest of all means of
transport.
2. Suitable for light/valuable articles-Air transport is particularly
suitable for movement of delicate and perishable goods.
3. Low packaging cost- Air transport entails low packaging cost,
which partially offsets the higher freight cost
4. Lower lead time- Being the fastest mode of transport, it
reduces lead time and therefore enables the firm to operate
with smaller inventories.

11/20/2024 MM: By MM 203

 Demerits of Air Transport

1. High costs of operation- freight rates are very

high due to high operational cost.
2. Unreliable-Air transport is also uncertain and
unreliable. Flights are cancelled very often due
to unfavorable weather conditions.
3. Lacks flexibility- Air transport lacks flexibility. It
provides service from one airport to the other.

11/20/2024 MM: By MM 204

 6) Pipeline
• Pipelines are used to bring crude and finished
products to and from the refineries.

7) Overhead Ropeways Service

Steel, cement and similar other sectors use overhead

ropeways to transport materials from the mines to
factory. The initial investments are high but the
operating costs are lower

11/20/2024 MM: By MM 205

7.5 Factors Affecting the Selection of Mode of Transport

1. Value of shipment-

 Costly items require more careful handling and carry

greater liability on the part of the carrier. (lesser
concern for transport cost). Road transport preferred
over rail transport for expensive goods.

11/20/2024 MM: By MM 206

 Factors…………..
2. Nature of consignment-
 Bulk liquids, inflammable liquids, dangerous articles etc.
are transported via tankers, tanks and trucks. Perishable
goods are routed through carriers who provide heater or
refrigerator services.
3. Speed of transport-
 Air transport is the speediest among the modes of
transport. Railways ranks next for speed where long
distances (over 500 km) are involved.

11/20/2024 MM: By MM 207

 Factors …………….
4. Cost of service-
 Inland waterways is the cheapest method of transport and air
transport is the costliest. Air transport is 40 times costlier than
water transport, 20 times costlier than rail transport and 10 times
costlier than road transport.
5. Flexibility of service- Road transport provides
the maximum flexibility of service compared to
any other mode of transport.

11/20/2024 MM: By MM 208

 Factors…………..
6. Regularity of service-
Railways ranks the first among all modes of transport in
terms of regularity of service.
Air transport may be placed second (next to railways),
road transport third and water transport fourth,
considering regularity of service.
7. Distance involved-
Road transport is generally economical for transporting
goods or consignments weighing between 1 to 15
tones, within city limits,
 over short distances and medium distances of about 500 km.
 For longer distances (over 500 km) rail transport is usually
economical
11/20/2024 MM: By MM 209
 7.6 Transport Documents
• Transport documents are
 The receipts issued by the transport
organization
 to the consigners (or sender of goods)
Acknowledgement of the receipt of goods by
them and
 Acceptance of responsibility for carrying the
goods to the destinations,
 In return for specified charges which are called
freight.
11/20/2024 MM: By MM 210