1. CHAPTER FOUR Material Management

2. Introduction
Materials management is the planning, organizing and controlling of the flow of material from its initial purchase stage, through internal operations, to the distribution of finished goods.
Major Concerns About Material Management:-
purchasing,
transportation (incoming & outgoing),
control through production - and - inventory management (includes receiving, storage, shipping, materials handling and inventory counting) and
warehousing and distribution.

3. Four basic needs of Material management
To have adequate materials on hand when needed
To pay the lowest possible prices, consistent with quality and value requirement for purchases materials
To minimize the inventory investment
To operate efficiently

5. Basic principles of material management
Effective management & supervision.
It depends on managerial functions of:-
Planning, Organizing, Staffing, Directing, Controlling, Reporting, Budgeting
2. Sound purchasing methods
3. Skillful & hard poised negotiations
4. Effective purchase system
5. Must not increase other costs
6. Simple inventory control programme

6. Basic principles of Purchasing
Purchasing implies the act of exchange of goods and services for money,
Purchased parts and materials inventories have to be planned, procured and delivered when needed.
The real problem is to determine the inventory level which ensures a high rate of return on invested capital as well as satisfy the demands
Basic principles of Purchasing
Buying the right quality, right quantity and right price,
Buying from the right source
Buying at the right time and place

7. Fundamental Objectives of Purchasing
To maintain continuity of supply to support production schedules,
To minimize investment in store and materials inventory (must be insured, consistent with safety and economy
To avoid duplication of purchases, wastes, obsolescence and costly delay
Maintaining proper quality standards based on suitability criteria
Materials must be procured at lowest possible cost, consistent with quality and service requirements, and
Must maintain companies competitive position in the market
Right quality, significant elements like dimension, physical, chemical and other property
Right price, Value=Quality/Price, not just a mathematical formula but expresses an axiomatic truth
Right source, reliability and timely delivery have to be seriously considered
Right place, every purchase should clearly state the place of delivery and such other terms like free delivery or ex-factory delivery.
FOB, CIF, FOR

8. Purchasing Procedure Origination of Purchase Requisition (PR)
Description of the materials with quantity
Date of requires, and Date of issue
Estimated unit cost
An authorized signature
Verification of Authority and Budget Expediting and follow-up;
Request for Quotation or Bids
Evaluation of Bids & Selection of Suppliers:
In terms of price proposed by the suppliers, discount they offer, the shipping terms, delivery date, reliability of the supplier by analyzing past performance, and quality of work & other services
Items that are purchased repetitively, from known suppliers, with small quantity and with low value don’t require price quotation

9. Purchasing Procedure Issuing of Purchase Order
Follow-up and expediting the Order
Receiving, Inspecting and Storing
Closing the Order
Closing an order simply involves a consolidation of all documents and correspondence relevant to the order in filling them in closed order file
up-to-date list of vendors, which includes price, available discounts, estimated delivery time, and any other relevant information are required to issue the order

10. Storage Store must be of adequate space
Materials must be stored in an appropriate place
Group wise & alphabetical arrangement helps in identification & retrieval
First-in, first-out principle to be followed (but is a must)
Monitor expiry date
Must avoid Stock-outs
Reserve stock that will cover lead time and a small safety stock

11. Inventory control It means stocking adequate number and kind of stores, so that the materials are available whenever required and wherever required.
Scientific inventory control results in optimal balance
Inventory
One of the most expensive assets of many companies representing as much as 50% of total invested capital
Materials managers must balance inventory investment and customer service

12. Functions of Inventory Management
To decouple or separate various parts of the production process
To help the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers
To take advantage of quantity discounts
To protect against inflation
To provide maximum supply service, consistent with maximum efficiency & optimum investment.
To provide cushion between forecasted & actual demand for a material

13. Maintenance/repair/operating (MRO)
Types of Inventory
Raw material
Purchased but not processed
Work-in-process
Undergone some change but not completed
Maintenance/repair/operating (MRO)
Necessary to keep machinery and processes productive and functioning well
Finished goods
Completed product awaiting for shipment

14. ABC ANALYSIS :(ABC = Always Better Control)
Inventory Management
How inventory items can be classified
How accurate inventory records can be maintained
ABC ANALYSIS :(ABC = Always Better Control)
This is based on some measure of importance (cost, weight…).
It helps to exercise selective control when confronted with large number of items
It rationalizes the number of orders, number of items & reduce the inventory.
Divides inventory into three classes based on annual birr volume
Class A - high annual birr; low volume
Class B - medium annual birr; medium volume
Class C - low annual birr; high volume

15. Classifying inventory according to some measure of importance(cost criteria) and allocating control efforts accordingly.
A - very important
B - mod. important
C - least important
Annual
$ value
of items A B C
High
Low
Percentage of Items

16. ‘A’ ITEMS
Small in number, but consume large amount of resources
70-80% of the annual consumption value and accounts for only 10-20% of total inventory volume
Must have: Tight control, Rigid estimate, Strict & closer watch, Low safety stocks, and Managed by top management
‘B’ ITEMS
Intermediate
15-25% of annual consumption value and accounts for 30% of total inventory volume
Must have: Moderate control, Purchase based on rigid requirements, Reasonably strict watch & control, Moderate safety stocks, and Managed by middle level management
‘C’ ITEMS
Larger in number, but consume lesser amount of resources
5% of the annual consumption value typically accounts for 50% of total inventory
Must have: Ordinary control measures, Purchase based on usage estimates, High safety stocks,

18. Percent of Number of Items Stocked Percent of Annual Birr Volume
ABC Analysis
Item Stock Number
Percent of Number of Items Stocked
Annual Volume (units) x
Unit Cost =
Annual Birr Volume
Percent of Annual Birr Volume
Class
#10286
20%
1,000
ETB 90.00
ETB 90,000
38.8%
72% A
#11526
500
154.00
77,000
33.2%
#12760
1,550
17.00
26,350
11.3% B
#10867
30%
350
42.86
15,001
6.4%
23%
#10500
12.50
12,500
5.4%
#12572
600
ETB 14.17
ETB 8,502
3.7% C
#14075
2,000
.60
1,200
.5%
#01036
50%
100
8.50
850
.4% 5%
#01307
.42
504
.2%
#10572
250
150
.1%
Total Annual Cost = 232, 057

19. ABC Analysis A Items 80 – 70 – 60 – 50 – Percent of annual Birr usage
80 –
70 –
60 –
50 –
40 –
30 –
20 –
10 –
0 –
| | | | | | | | | |
Percent of inventory items
A Items
B Items
C Items

20. Classify the Following Inventory Items
Item No
Unit Cost
Annual Demand
101 5
48000
102 11
2000
103 15
300
104 8
800
105 7
4800
106 16
1200
107 20
18000
108 4
109 9
5000
110 12
500

21. Record Accuracy
Accurate records are a critical ingredient in production and inventory systems
Allows organization to focus on what is needed
Necessary to make precise decisions about ordering, scheduling, and shipping
Incoming and outgoing record keeping must be accurate

22. Cycle Counting
Items are counted and records updated on a periodic basis
Eliminates shutdowns and interruptions of production
Trained personnel audit inventory accuracy
Allows causes of errors to be identified and corrected
Maintains accurate inventory records

23. Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C items
Policy is to count A items every month (20 working days), B items every quarter (60 days), and C items every six months (120 days)
Determine the no. of count items per day?
Item Class
Quantity
Cycle Counting Policy
Number of Items Counted per Day A
500
Each month
500/20 = 25/day B
1,750
Each quarter
1,750/60 = 29/day C
2,750
Every 6 months
2,750/120 = 23/day
77/day

24. Inventory
Independent Demand A
B(4)
C(2)
D(2)
E(1)
D(3)
F(2)
Dependent Demand .
Independent demand: – finished goods, items that are ready to be sold. Independent demand is uncertain
E.g. a computer
Dependent demand: – components of finished products. Dependent demand is certain.
E.g. parts that make up the computer, cpu, hardware, motherboard, etc.

25. 1. Economic Order Quantity Models
Inventory Models for Independent Demand
Need to determine when and how much to order
1. Economic Order Quantity Models
Economic order quantity (EOQ) model
Economic production model
Quantity discount model

26. Basic EOQ Model Important assumptions
The order size that minimizes total annual cost
Important assumptions
Demand is known, constant, and independent
Lead time is known and constant
Receipt of inventory is instantaneous and complete
Quantity discounts are not possible
Stockouts can be completely avoided

27. EOQ Model Costs Involved:
Ordering and setup costs:- are expenses for placing orders, expediting, inspection and changing or setting up facilities for home made production.
Carrying costs:- cover storage handling, insurance, taxes, obsolescence, spoilage and data-processing costs.

28. EOQ Model
3. Item/Purchase costs:- include the price paid, or the labor, material and overhead charges necessary to produce the item.
4. Stock out cost:- results from lost sales and possibly lost customers as a result of the variation in demand during lead time and the forecast.

29. Inventory Order Cycle Average inventory Demand rate Time Lead time
Order placed
Order receipt
Inventory Level
Reorder point, R
Order quantity, Q
Average inventory Q 2

30. EOQ Cost Model Co - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity
Annual ordering cost =
CoD Q
Annual carrying cost =
CcQ 2
Total cost =

31. EOQ Cost Model Order Quantity, Q Annual cost ($) Total Cost
Carrying Cost =
CcQ 2
Slope = 0
Minimum total cost
Optimal order
Qopt
Ordering Cost =
CoD Q

32. EOQ Cost Model TC = + CoD Q CcQ 2 = – + Q2 Cc TC Q 0 = – + C0D
= – Q2 Cc
TC Q
0 = –
C0D
Deriving Qopt
Proving equality of costs at optimal point =
Q2 =
2CoD
Qopt =
2CoD Cc
Qopt =

33. EOQ Example Cc = ETB 0.75 per Litter Co = ETB 150 D = 10,000 Litters
311 working days per year
Qopt =
2CoD Cc
2(150)(10,000)
(0.75)
Qopt = 2,000 Litters
TCmin =
CoD Q
CcQ 2
TCmin =
(150)(10,000)
2,000
(0.75)(2,000)
TCmin = = ETB 1,500
Orders per year = D/Qopt
= 10,000/2,000
= 5 orders/year
Order cycle time = 311 days/(D/Qopt)
= 311/5
= 62.2 store days

34. Lead time for a new order in days Number of working days in a year
Reorder Points
EOQ answers the “how much” question
The reorder point (ROP) tells when to order
ROP =
Lead time for a new order in days
Demand per day
ROP= d x L
d = D
Number of working days in a year

35. Reorder Point Curve Q* Inventory level (units) Slope = units/day = d
Time (days) Q*
Slope = units/day = d
ROP (units)
Lead time = L

36. Number of working days in a year
Reorder Point Example
Demand = 8,000 smartphones per year
250 working day year
Lead time for orders is 3 working days
d = D
Number of working days in a year
d = 8,000/250 = 32 units
Therefore:-
ROP = d x L
ROP= 32 units per day x 3 days = 96 units

37. 2. Economic Production Quantity (EPQ)
Assumptions
Only one product is involved
Annual demand requirements are known
Usage rate is constant
Usage occurs continually, but production occurs periodically
The production rate is constant
Lead time does not vary
There are no quantity discounts

38. Production Quantity Model
Q(1-d/p)
Inventory
level
(1-d/p) Q 2
Time
Order
receipt period
Begin
order
receipt
End
Maximum
inventory level
Average

39. Production Quantity Model
p = production rate d = demand rate
Maximum inventory level = Q d
= Q 1 - Q p d
Average inventory level = 2
TC =
CoD
CcQ
Qopt =
2CoD
Cc 1 -
CoD Q
Annual ordering cost =
CcQ 2 1- d p
Annual carrying cost =

40. Production Quantity Model
Cc = $0.75 per gallon Co = $150 D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day p = 150 gallons per day
Qopt = = = 2,256.8 gallons
2CoD
Cc 1 - d p
2(150)(10,000)
32.2
150
TC = = $1,329
CoD Q
CcQ 2
Production run = = = days per order
2,256.8

41. Production Quantity Model
Maximum inventory level = Q = 2,
= 1,772 gallons d p
32.2
150

42. EPQ Example Annual demand = 18,000 units
Production rate = 2500 units/month
Order Setup cost = $800
Annual holding cost = $18 per unit
Lead time = 5 days
No. of operating days per month = 20

43. 3.Quantity Discounts Model
Price reduction offered to customers for placing large orders
Price per unit decreases as order quantity increases
TC = PD
CoD Q
CcQ 2
Where:-
P = per unit price of the item D = annual demand

44. Quantity Discount Model
Qopt
Carrying cost
Ordering cost
Inventory cost ($)
Q(d1 ) = 100
Q(d2 ) = 200
TC (d2 = $6 )
TC (d1 = $8 )
TC = ($10 )
ORDER SIZE PRICE
$10
100 – (d1)
(d2)

45. Quantity Discount QUANTITY PRICE 1 - 49 $1,400 50 - 89 1,100 90+ 900
$1,400
,100
Co = $2,500
Cc = $190 per TV
D = 200 TVs per year
Qopt = = = 72.5 TVs
2CoD Cc
2(2500)(200)
190
TC = PD = $233,784
CoD
Qopt
CcQopt 2
For Q = 72.5
TC = PD = $194,105 Q
CcQ
For Q = 90

46. EOQ Example
Computronics is a manufacturer of calculators, currently producing 200 per week. One component for every calculator is a liquid crystal display (LCD), which the company purchases from Displays, Inc. (DI) for $1 per LCD. Computronics management wants to avoid any shortage of LCDs, since this would disrupt production, so DI guarantees a delivery time of 1/2 week on each order. The placement of each order is estimated to require 1 hour of clerical time, with a direct cost of $15 per hour plus overhead costs of another $5 per hour. A rough estimate has been made that the annual cost of capital tied up in Computronics’ inventory is 15 percent of the value (measured by purchase cost) of the inventory. Other costs associated with storing and protecting the LCDs in inventory amount to 5 cents per LCD per year. What should the order quantity and reorder point be for the LCDs?

47. Condemnation & Disposal
The equipment has become:
Non-functional & beyond economical repair
Non-functional & obsolete
Functional, but obsolete
Functional, but hazardous
Functional, but no longer required

48. DISPOSAL Circulate to other units, where it is needed
Return to the vendor, if willing to accept
Sell to agencies, scrap dealers, etc
Auction
Local destruction