Operations and Materials Management

• Unit III
Materials Management
• Definition
• Objectives
• Functions
• Purchase procedure
• ABC analysis
• VED Analysis
• Economic Order Quantity.
• The goal of material management is to ensure that the right materials
are available at the right time and in the right quantities, to support
the production process and meet customer demand
• For example, an organization that manufactures cars needs to purchase
wheels, engines, and windows. The process by which these materials are
sourced, purchased, stored, and utilized is materials management.
• Materials managers (also called inventory control managers, inventory
analysts, and material planners)
• Effective management and supervision-Basic principle of MM
• Materials Management helps in achieving a competitive edge over rivals.
this is possible by timely delivering quality products or services to
customers, at a reasonable cost.
 Materials Management
• Tersine and Campbell (2004) defines
• Material management as the process to provide the right
materials at the right place at the right time in order to
maintain a desired level of production at minimum cost. The
purpose of material management is to control the flow of
materials effectively.
• L.J. De Rose defines
• “Material management is the planning, directing, controlling
and co-ordination of all those activities concerned with
material and inventory requirements, from the point of their
inception to their introduction into manufacturing process.”
 Types of Materials
1. Direct Materials
• Direct Materials represents the raw material or goods necessary to produce or manufacture a product.
The cost of direct material varies according to the level of output of the production system.
• Ex- Milk is the direct material of butter, Iron ore is direct material of steel.
2. Indirect Materials
• Indirect materials are the materials that are necessary for the production process, but it’s not directly
used in the product itself, which means these materials does not become an integral part of the
product.
• may be essential to a production line, but they are not part of the actual product created on that line .
• Ex-cotton waste, sandpaper, oil, greases, disposable gloves, personal protective equipment, tape etc.
 Materials Management
Materials Management - “is the process which integrates the flow of supplies into, through and
out of an organization to achieve a level of service which ensures that the right materials are
available at the right place at the time in the right quantity and quality and at the right cost".
 Is an integrating function of different sections of a company dealing with the supply of
materials and other related activities so as to obtain maximum coordination and optimum
minimum expenditure on materials.
 Involves organizing and coordinating all management functions that are responsible for every
aspect of materials movements and transformations.
 Also involves controlling the type, amount, location, movement, timings of purchase of
various materials used in an industrial concern.
Importance of Materials Management
1. The material cost content of total cost is kept at a reasonable level. Scientific purchasing
helps in acquiring materials at reasonable prices. Proper storing of materials also helps in
reducing their wastages. These factors help in controlling cost content of products.
2. The cost of indirect materials is kept under check. Sometimes cost of indirect materials
also increases total cost of production because there is no proper control over such
materials.
3. The equipment is properly utilized because there are no break downs due to late supply
of materials.
4. The loss of direct labour is avoided.
Importance of Materials
Management
5. The wastages of materials at the stage of storage as well as their
movement is kept under control.
6. The supply of materials is prompt and late delivery instances are only
few.
7. The investments on materials are kept under control as under and over
stocking is avoided.
8. Congestion(Blockage) in the stores and at different stages of
manufacturing is avoided.
Materials Management-Objectives
•To reduce materials cost.
•Efficient control of inventories, which helps in releasing the
working capital for productive purposes.
•Ensure uniform flow of materials for production.
•Ensure right quality at right price.
•Establish and maintain good relations with customer.
•Economy in using the imported items and to find their
substitutes.
Materials Management-Objectives
• To ensure continuous uninterrupted production or operation or project work
by maintaining a steady flow of materials
•To achieve the above objective in an efficient and economical manner;
•To effect economies in the cost of materials by purchasing materials of the right
quality, in the right quantity, at the right time, from the right source, at the right price;
•To affect economies in the costs incurred on materials after they have been
purchased, through storage, processing and warehousing, till the finished goods
ultimately reach the customer. These economies contribute towards cost thereby
leading to higher profits;
Scope of Materials Management
 Functions of Materials Management
 Materials Planning(involves forecasting demand, determining inventory levels, and creating
production schedules to ensure that materials are available when needed)
 Procurement or purchasing of Materials(responsible for identifying potential suppliers,
negotiating prices and terms, placing orders, and ensuring that deliveries are made on time
and in accordance with specifications)
 Receiving and Warehousing (involves receiving, storing, and tracking inventory in a
warehouse; managing warehouse staff; and optimizing storage space and costs)
 Storage and Store administration (to receive and safely keep the inventory and

avoid loss on account of damage)

 Inventory Control(It involves monitoring inventory levels, forecasting demand, and
adjusting inventory levels to meet production requirements while minimizing waste)
 Standardization, Simplification and Value Analysis(standard processes and procedures
for the acquisition, use, and disposal of materials,aims to streamline processes and
reduce the time and effort required to manage inventory, kills used to improve the
value of a product by eliminating unnecessary costs,reduce cost)
 External Transporation and Material Handling

 Disposal of Scrap, Surplus and Obsolete Materials

 Purchase Procedure
v It is a Staffing Function

v It is on a Line Basis

v Purchase Manager

vIs responsible for overall

efficient operation of the

department

vHas powers to execute

purchasing contracts

vDelegates duties among

subordinates
Purchase Requisition
Purchases of materials are initiated through purchase requisitions. It is a formal
request by the head of the department or other authorities to the purchase manager
to purchase the specified materials.
Selection of Suppliers
The purchase department generally maintains a list of suppliers for each type of
material and selects a particular supplier after inviting tenders
Purchase Order and Follow-Up
The purchase order is the form used by purchasing department authorising the
suppliers to supply the specified materials at a price and terms stated therein.
A purchase order should be carefully prepared as it forms a basis of legal contract
between the parties concerned
Receipt of Materials
All incoming material should be received by the receiving department.
This department performs the functions of unpacking the goods
received and verify their quantities and conditions
Inspection and Testing of Materials
Goods received should be inspected for quantity to ensure that they
comply with specifications stated on the purchase order
Passing Invoices for Payment
When the invoices are received by the purchasing department, the
process of assembling the business paper concerned with each
purchase and preparation of vouchers begins
Types of Purchasing
Centralized Purchasing:
When all types of purchasing is done at one level, it is known
as centralised purchasing. A separate department, known as
purchase department, is set up for this purpose. All
departments send their purchase requirements to purchase
department and it arranges procurement of various goods
needed.
Decentralized (or Localized) Purchasing:
This type of purchasing is suitable for concerns or when there
are more than one plant or the plants are situated at different
places. Every department or plant, as the case may be, is
authorized to make its own purchases
 Types of Purchase – Centralized Purchasing
Disadvantages
Advantages
 Is Slow when compared to Decentralized
v Makes efficient ordering of materials
Purchasing
v Forms a basis to gain bargaining advantage
Applications
v Eliminates Duplication of efforts
 For Organizations using few materials
v Helps procuring uniform and consistent
 Quality and Availability are Vital
materials
 For purchasing small items of fairly high value
v Simplifies purchasing procedure
 For goods which have bigger quantity
v Simplifies the payment of invoices
discounts
v Permits degree of specialization among buyers
 Types of Purchase – Decentralized Purchasing
Disadvantages
Advantages
 Less Quantity Discounts
v Improves Efficiency
 Involves Duplication of Efforts
v Faster Procurement of Materials
Applications
v Control over purchases in not remote
 For Organizations requiring different types of
v Are more Flexible
materials
 If Branch Plants require heavy and bulky items

 For purchases are made within local community

to promote better public relations.
 Standards with respect to Quantity and Quality

v Quality Standards(defined as documents that provide

v Quantity Standards(Quantity
requirements, specifications, guidelines, or characteristics that can
standards indicate how much of an
be used consistently to ensure that materials, products, processes,
input, such as labor time or raw
and services are fit for their purpose)
materials, should be used in

manufacturing a unit of product or v Should be stated with the help drawing by making a specific

in providing a unit of service.) mention about dimensional tolerances / written specifications

v Maximum Inventory v Dimensional Specifications

v Minimum Inventory v Performance Specifications

v Standard Point
v Blueprints
v Reorder Point
 Purchase Procedure
v Recognition of Need, Receipt and Analysis of purchase Requisition

v Selection of possible Potential sources of Supply

v Making Request for Quotations

v Receipt and Analysis of Quotations

v Selection of the Right Source of Supply

v Issuing the Purchase Order

v Follow-up and Expediting(speed up) the Order

v Analysing receiving reports and Processing discrepancy and rejections

v Checking and approving Vendor's Invoices for payment

v Closing completed Orders

v Maintenance of records and files

ABC Analysis
 ABC Analysis
• ABC analysis is an inventory management technique
that determines the value of inventory items based
on their importance to the business.
• ABC ranks items on demand, cost and risk data, and
inventory mangers group items into classes based on
those criteria.
• This helps business leaders understand which
products or services are most critical to the financial
success of their organization.
 Use ABC Analysis

• Using ABC analysis for inventory helps better control working

capital costs.
• The information gained from the analysis reduces obsolete
inventory and can boost the inventory turnover rate or how
often a business has to replace items after selling through
them.
• An example of ABC analysis in action is for a device manufacturer.
• They may categorize their high-value items such as mobile phones
or cameras as category A items. They are very important, worth a
lot but make up a smaller component of inventory.
• Genuine replacement components such as screens,
motherboards and lenses may be categorised as B items where
they are not quite as valuable but still hold some value and should
be managed accordingly.
• Accessories such as cases, earphones, screen protectors and add-
ons could be denoted to category C where they are low-value
items but account for the vast majority of inventory.
 ABC Analysis
• ABC analysis is a technique of controlling inventories
based on their value and quantities.
• ABC analysis does not depend on the unit cost of the
items but on its annual consumption.
• ABC analysis is a basic technique of materials
management and tool of inventory control.
Category A: Items in this category are essential and,
sometimes, business-critical for a company. Typically, these
items either have a high value or a large market. Hence, this
category requires frequent value analysis(a set of techniques,
knowledge, and skills used to improve the value of a product
by eliminating unnecessary costs).

Category B: Items in this category are important, but not as

important as those in category A. Typically, these items
constitute mid-range in inventory value and have relatively
lesser market demand.

Category C: Items in this category are marginally important

and constitute a tiny portion of the overall inventory value.
 Steps in ABC Analysis
• Identify the Objective: An ABC analysis can help you meet one of two
targets: lower procurement costs or raise cash flow by optimizing
inventory levels of the right items based on customer sales or production.
• Collect Data: The most common data to collect is the annual spend on
each item. This data is in raw purchase dollars. If it’s easy to calculate, you
can gather the weighted cost, including gross profit margin, ordering and
carrying cost data.
• Sort by Decreasing Order of Impact: Use the ABC analysis formula to rank
each inventory item’s order by cost — from highest to lowest impact.
 Steps in ABC Analysis
• Calculate the Sales Impact: For each inventory item, calculate its impact on sales
as a percentage by dividing the annual item cost by the aggregated total of all
items spent. This number is the percent, or fraction, that you will use to
compare items in the list. Here’s the formula:% Impact = (annual item
cost) / (aggregated total of all items spent) x 100
• Sort Items into Buy Classes: Once you define the classes, work on contract
renegotiation, vendor consolidation, shifting strategic sourcing methodology
or implementing e-procurement. Making changes in these areas can provide
significant savings or ensure the in-stock availability of Class A items. Take a
holistic view rather than being strict about the 80/20 rule.
• Analyze Classes: Once categories and strategic cost management are defined,
schedule reviews to monitor the success or failure of decisions.
 Limitations of ABC Analysis

1. In big industries, the items are in thousands. Hence the

listing and calculation is a bit difficult.
2. The analysis takes care of annual consumption values and
hence importance of items is not taken care of.
3. Price factor, fluctuations, seasonal variations in prices and
consumption pattern is not taken care of.
4. There could be excess stock of C-category items leading to
deterioration, obsolescence.
5. Some B-category items could be vital. Hence they need
more attention.
 VED Analysis
• VED analysis is an inventory management technique that classifies inventory based on its functional
importance.

• It categorizes stock under three heads based on its importance and necessity for an organization for
production or any of its other activities.

• The degree of criticality can be stated as whether the material is vital to the process of production, or essential
to the process of production or desirable for the process of production
• VED analysis stands for Vital, Essential, and Desirable.

• The best example of the VED classification of inventory is medical inventory. Hospitals need to keep updating
and maintaining the stock of medicines required by patients.

• Importance-making it easier for businesses to allocate their resources and budget accordingly.
 V-Vital category

• As the name suggests, the category “Vital” includes inventory, which

is necessary for production or any other process in an organization.
• The shortage of items under this category can severely hamper or
disrupt the proper functioning of operations.
• Hence, continuous checking, evaluation, and replenishment happen
for such stocks. If any of such inventories are unavailable, the entire
production chain may stop.
• Also, a missing essential component may be of need at the time of a
breakdown. Therefore, order for such inventory should be before-
hand.
• Proper checks should be put in place by the management to ensure
the continuous availability of items under the “vital” category.
 E- Essential category

• The essential category includes inventory, which is next to being vital.

These, too, are very important for any organization because they may
lead to a stoppage of production or hamper some other process. But
the loss due to their unavailability may be temporary, or it might be
possible to repair the stock item or part.
• The management should ensure optimum availability and
maintenance of inventory under the “Essential” category too. The
unavailability of inventory under this category should not cause any
stoppage or delays.
 D- Desirable category

• The desirable category of inventory is the least

important among the three, and their unavailability may
result in minor stoppages in production or other
processes. Moreover, the easy replenishment of such
shortages is possible in a short duration of time
 Usage of VED Analysis

• Small and big organizations both widely use VED analysis. The most
important application of this analysis is in maintaining medical
inventory in hospitals and their drug stores.
• Drugs and related supplies comprise a significant portion of a hospital’s
budget. Moreover, maintaining the right quantity of the right drugs is
an extremely challenging task for management.
• While a shortage of critical medicine can lead to crises and even loss of
lives, an abundance of non-important medications can lead to blockage
of money and space, both.
 Usage of VED Analysis
• VED analysis helps in dividing medicines into the three categories as per
their usage and importance. Therefore, medication in the vital group is to
be kept in stock compulsorily, as they would be critical for patients.
• Medicines which are a bit less risky, or which can be obtained from other
sources too at short notice, become part of an essential category.
• Those that are least critical and their shortage will not pose any danger to
a patient’s health, and lives get its place in the desired class.
• As a result, the hospital’s management can wisely allocate resources on
medical inventory as per their respective VED categories.
EOQ
• Economic order quantity (EOQ) is the ideal quantity of units a
company should purchase to meet demand while
minimizing inventory costs such as holding costs, shortage
costs, and order costs.
• This production-scheduling model was developed in 1913 by
Ford W. Harris and has been refined over time.
• The economic order quantity formula assumes that demand,
ordering, and holding costs all remain constant
• The economic order quantity (EOQ) is a company's optimal
order quantity that meets demand while minimizing its total
costs related to ordering, receiving, and holding inventory.
• The EOQ formula is best applied in situations where demand,
ordering, and holding costs remain constant over time.
• One of the important limitations of the economic order
quantity is that it assumes the demand for the company’s
products is constant over time.
• Formula for Calculating Economic Order Quantity (EOQ)
Q=√2DS​/H
where:
Q=EOQ unitsD=Demand in units (typically on an annual basis)
S=Order cost (per purchase order)
H=Holding costs (per unit, per year)​
• The goal of the EOQ formula is to identify the optimal number
of product units to order. If achieved, a company can minimize
its costs for buying, delivering, and storing units.
• The EOQ formula can be modified to determine different
production levels or order intervals, and corporations with
large supply chains and high variable costs use an algorithm in
their computer software to determine EOQ.
EOQ IMPORTANCE
• Economic order quantity is a key metric for your organization’s
sustainability because ordering too much can lead to
high holding costs and take resources away from other
business activities, like marketing or R&D, that could further
boost sales or reduce costs.
• Inventory is a type of working capital. Working capital
represents business assets needed for regular operations. But
too much working capital can eat into your profits, and it also
represents a big opportunity cost.
• The EOQ model is based on several assumptions that may not
hold true in reality.
• For example, it assumes that the demand, costs, and lead
times are constant and known, that there are no stockouts or
shortages, and that there are no quantity discounts or price
fluctuations.
• EOQ factors
• Demand
• The demand remains constant according to the assumptions
made by EOQ. The demand is how much inventory is used per
year or how many units are sold per year.
• Ordering cost
The EOQ formula contains the ordering cost which is a fixed
cost. This is how much you spend on placing and then receiving
your order.
• Holding costs
Holding costs are otherwise referred to as carrying costs. These
costs occur while the company owns the inventory in a
warehouse, storage, or store. The larger are the ordered product
volumes; the higher are the holding costs. Holding costs
generally include storage rent, storage utilities, property tax,
insurance, and other expenses.
• Advantages of the EOQ model

• Because the model helps determine the perfect quantity for an order, the company will not hold
extremely high inventory levels. As a result, it will have lower holding costs and save money on rent
and other expenses.
• The company will also get its ordering prices reduced. It will reduce the frequency of the orders to
the optimal level. As a result, there will be no need for ordering too often.
• The EOQ improves the overall inventory management due to the reduction of operational expenses
and increases in profits.

• Disadvantages of the EOQ model

• There are assumptions under the model, which might not always be practical in real-life business
scenarios. For example, the EOQ model assumes that the demand is fixed and does not consider its
seasonal effects.
• Sometimes, the supplier might not fulfill the orders because of a lack of materials, for example. As a
result, the company may face losses or supply chain challenges.