Module 3

Purchasing

Objectives•After completing this module you should be able to do the following:

– Describe the various elements in a purchase transaction

– Explain the various sub processes of a Purchasing Cycle

– Understand the importance of procuring Product or Service of the Right Quality

– Appreciate the impact that “procurement of Right Quantity” has on the bottom-line of the Organization

Elements in a Purchase Transaction

Purchasing Process

What determines the Process?• The nature of the purchases made,

• the volume and variety of purchases,

• the degree of specialization needed to make the purchase, especially of items which have high quality control factor.

Techniques may Vary….

• The organization of the Purchasing Department and the procedures followed will vary considerably not only from industry to industry but also from company to company, in accordance with policies of a company.

• The systems best suited for an Engineering Firm might not suit a Service Provider or the procedures followed by a public sector company may not suit a private company.

But, Tactics are Common!

• One cannot say precisely what steps should necessarily be taken for completing a purchase transaction, they could be unique!

• However, there are some basic elements in every purchase transaction which are common.

Basic elements in every purchase transaction

1.Need for a material is recognised by the user Department and requirements determined.

2.Detailed specifications and requirements for materials / services spelt out.

3.Need transmitted to Purchase (P.R./Indent), who in turn will make out a purchase plan, float enquires (RFQ) etc.

4. Vendor Selection - A suitable source is selected for the supply. Sometimes a New Source will have to be developed

Elements in every purchase transaction – continued

5.Rates, terms & conditions of the purchase contract are negotiated and finalised.

6.A Purchase Order (P.O) is prepared and sent to the shortlisted supplier spelling out Quality, Quantity, Price, Deliveries and the terms & conditions of Purchase.

7.Supplier’s acceptance of the Purchase Order is obtained.

8.Follow up with supplier by Purchase, to ensure prompt delivery of the right quantity and quality of Goods

9.Material or service when received is inspected by Purchaser / End User against P.O. specification.

Elements in every purchase transaction – contd.

10.The supplier’s invoice is checked against the Purchase order and Goods / Services Received document (GRN / SRN).

11.A cheque is issued to supplier against their Invoice as payment for supplies / services received & accepted.

This entire Process is usually referred to, as the Purchasing Cycle.

Purchasing Cycle

Invoice, Payment

Receipt of Goods / Services, Inspect & GRN

Determine Need &Specify Requirements

Transmit needTo Purchase(P.R.,BOM, MPS)

Vendor Selection

P.O Release& Follow-up

Purchase Plan,Enquiries (RFQ)

NegotiationPrice, T&C

The start of the Purchasing CycleAUTHORITY TO INDENT is the first and foremost, essential step and can come in many ways. For example:

(i) Though the Purchase Requisition.

(ii) The permanent Order Card or travelling

requisition.

(iii) The Bill of materials or parts list made in

conjunction with the Production Dept.

Purchase Requisitions

Provides following essential information:• Quality specifications• The quantity required • Date by which the materials are required.• The account, job, department, project or work

center the expenditure is to be charged.• space for Purchase Department to make entries

e.g. P.O Number, Name of Supplier etc• Date and signature of the requisitioner and

authorisation where necessary.

The Permanent Order Card or The Travelling Requisition

• Often used when materials are requested for, on a repeat basis or for standard stock items

• A great deal of copying work can be saved by using this form.

• Further, avoiding possible errors like transcribing the information on to a regular Purchase Requisition.

• Also serves as a continuous record of transactions in a particular item as it passes through several Departments for action.

Travelling Requisition Card

Date Present

Stock

Qty Reqd

unit Date

Reqd

Reqd for Dept

Appd

byDte.

recd

At

PUR

P.O

No:

SupplrName

price

recd

Date

pay date

Classification …… Description ………… Code Number…………..

Appd.Supplier………..Min.Stock ………………Ave..Monthly Cons………Contract Ref…………

Bill of Materials or Parts List• When the Design Department designs a

particular equipment, a list of the various materials which are required to make that item is made out. This is called a Bill of Materials or Parts List.

• The production schedule and Bill of Materials are then exploded, to work out the gross Requirements that are netted with stock available, called the Net Requirements, which will give exactly what materials are required and when for any individual item.

• The Purchase Department can then establish the total material requirements and when exactly each would be required and in what numbers, etc.

Purchase Plan

• A plan is a predetermined course of action regarding what is to be done to achieve an objective.

• Without a plan, purchasing will tend to be carried out in fits and starts

• Hence need for a plan to carry out its activities in a structured manner.

• the department may be very much overloaded during some months and relatively without much work for the rest of the year.

Time is the essence in purchase!

• At the beginning of the year, the Purchase Department must determine what to buy and when. It must make time schedules and programme for purchase.

• a purchase budget is prepared giving estimates of the costs to be incurred on purchases during the year. This represents the spending plan.

• It is usual nowadays to prepare a PERT chart to determine when the various steps in purchasing should begin and end.

Vendor Selection• In most cases, the Purchases Department

would know where the material can be procured from.

• A regular list of approved suppliers is usually maintained by a Purchase Department.

• In some cases, it might become necessary to develop a new supplier.

• In some cases, it might be necessary to issue advertisements in the Press inviting suppliers to quote for specific materials.

• In such cases it is necessary to evaluate the capacity of suppliers to effect the supplies without-failure, and then decide upon placing contracts with him.

Placing the Order

• A Purchase Order is the commitment by a buyer to pay for goods ordered and the supplier’s authority to ship the goods & charge the buyer for them.

• A Purchase Order is a legal contract and all

precautions have, therefore to be taken by the buyer to safeguard his interests.

• In a P.O various terms & conditions pertinent to

the contract are spelt out.

Follow up

• Also known as expediting.

• After the Purchase Order has been issued and the supplier has accepted the Order, a regular watch has to be kept by the Purchase Department to ensure that the deliveries are effected on time.

• There are various follow-up procedures like in-house follow up or external expeditors.

• Larger companies normally have their own expediters

Receiving• Receiving is an important control point in the

purchase system. When the materials ordered for, have been received, they need to be checked for quantity and Quality with reference to the P.O.

• After inspection for quality and in respect of physical condition (i.e. whether it is damaged etc.), the receiving clerk prepares a report called the Material Receipt Note or Goods Inward Note (GIN).

• Properly maintained receiving records will show up the suppliers who are consistently late in their deliveries or whose supplies are often rejected for quality, or who give staggered deliveries uncalled for.

Inspection of Materials• It is also necessary for the Purchase to ensure

that supplier has complied with the ordered specifications. This is done by inspection of the materials before acceptance.

• Qualified inspectors are usually appointed for this purpose.

• The most common type of inspection is done at the purchaser’s Receipt Store.

• Inspection can also be done at the manufacturer’s premises. This is best because, quality defects can be detected before the final shape is given to the product and defects if any can be corrected then.

• Sometimes inspection has to be got done through outside sources, e.g., a test laboratory.

Handling Rejections• When goods supplied do not conform to the

quality specifications, they should be rejected. All negotiations with the supplier in regard to such rejections should be handled by the Purchase Department and not by the Inspectors or the Stores.

• When rejections becomes necessary, a clear statement of reasons should be recorded. It should include all pertinent facts and data, so that the possibility of arguments is reduced to the minimum.

• A close co- ordination is, therefore, necessary between stores Receipts Section and the Purchase Department.

Checking and Approval of Suppliers’ Payments

• Supplier’s bills, many times are received along with the goods, along with the receipted copy of the challan.

• The bill is checked for payment. This may be done by the Purchase Department or it may be done directly by the Accounts Department along with a copy of the Purchase Order and the Goods Inward Note (GIN) received from the receiving Section.

Approval of Suppliers’ Payments

• After the bill has been audited, the amount is paid to the supplier on the due date, usually by a Cheque.

• On-time payment is a crucial matter and the prestige of the Buyer and Company will be high in the supply market and attract good suppliers.

• Computerisation of Bill processing for payment is invariably resorted to, to avoid errors & delays in payment to suppliers.

What is Quality?

• Quality is Fitness For Use - Juran• Quality is conformance to stated requirements -

Crosby• Quality should be aimed at the needs of the

Customers present and future - Deming• Quality is never an accident; it is always the

result of high intention, sincere effort, intelligent direction and skillful execution; it represents the wise choice of many alternatives - William A. Foster

• Quality is not an act, it is a habit - Aristotle

Basic facts about Quality• We can define quality by several means, i.e.

dimensions, weight, chemical properties, physical properties, tensile strength hardness, surface finish, colour, conductivity, elasticity, capacitance, life characteristics, performance, characteristics, appearance, design, etc.

• For maintenance supplies, quality might be defined by factors like ease of application, economy of use, durability, etc.

• For machinery or equipment, factors like productivity, versatility, dependability, economy etc. are relevant.

Ensuring Right Quality

• Is the most important responsibility of Purchase.• Quality should, therefore, be just right, not more,

nor less than what is required for a given purpose.

• Before a purchase is made, therefore, it is necessary to determine and define the quality that we want. This can be done by:-

• Specifying quality • Right source selection: • Quality Control • Inspection

Quality SpecificationsQuality is usually described by quality

specifications. • The established specifications of the buyer• The established specifications of the supplier• The blue prints, drawings or dimension sheets• By brand or trade names:• By references to international Standards

specifications like - BSS (British Standards Specifications), -ISS (Indian Standards Specifications), -ASTM (American Society for testing Materials), -ASME (American Society of Mechanical Engineers)

Standards

• Certain industries have developed commonly accepted specifications which have come to be known as industry standards. Such standards are described in great detail and the quality specifications are spelt out at length.

• Besides industry standards, there are also international or national standards,

Advantages of Buying products of standard specifications

Considerable saving of time and money can be achieved because such items are

• often quickly available

• at lower cost and

• with better quality acceptance than products which are tailor made to conform to unique company standards.

Brand or Trade names

• A common and convenient method of buying.

• Established brand names often have an effective and dependable standard of quality.

• If the buyer’s needs are satisfied by these

brands, it is easier and simpler to buy these products than having products manufactured to particular design.

Buying by Brand Names - Disadvantage

• Limits buying to one single source for a particular product and this destroys the competitive element in sound procurement.

• Also any production shut down in the supplier’ factory, e.g., a strike or a fire, non-availability of raw material can cause serious production problems in the buyer’s factory.

Performance

• In some materials or product’s performance might be the quality specification.

• For example a pump - we may specify a flow rate, pressure etc. In such cases, the performance standards are specified with limits or variables clearly stated.

• In such cases, the buyer specifies not only the performance aspects, but may also specify other aspects like size, appearance etc.

Situations Difficult to Specify

• When specifications are difficult to spell out, as for example, the shade of a colour, it is usual to provide a sample of the material or product to the vendor for duplication. Buying by sample is a common method of buying.

• Where the specifications cannot be expressed solely by any of the above means, a combination of two or more methods may be resorted to.

Specifying the Right Quality

• It is important that the buyer knows exactly what he needs and is able to clearly communicate to the vendor precisely what he expects.

• Specifying the quality of the material is of utmost significance in buying, and doing a through job of it can save considerable time, effort and expense during manufacture and inspection.

Buying the Right Quantity

One of the principal tasks of the Buyer is to buy the right quantity at the right time.

Determination of quantity is one of the difficult tasks, since.

• Some items are regularly consumed• Some have Fluctuating Requirements• Suppliers attract with Volume Discounts for

larger quantities purchased• prices may fluctuate sometimes very sharply• there can be fluctuation in the lead time too

Right Quantity- For regularly consumed items

• Buying once a year will result in purchase costs being incurred once, while buying 12 times will mean the purchases costs going up 12 times.

• Similarly, buying once a week will result in negligible inventory carrying cost, while buying once a year will involve very high expenditure on this account.

• The question would, therefore, arise as to what is the optimum size of the purchase that should be made at a time.

Right Quantity - Volume Discounts

• The supplier also has the interest in the “quantity” and he is usually prepared to give a discount for larger quantities purchased.

• The tendency on the part of the buyer would be to place orders for larger quantities because of these attractive discounts.

• However, in most cases, it might not be the most economical thing to do, because a Buyer might incur greater inventory carrying costs than the discounts that he is able to get.

Right Quantity- For Fluctuating Requirements

• Requirements of a particular material may be fluctuating and the consumption is not uniform throughout the month or year.

• This makes it difficult to determine how much quantity should be purchased at a time to meet the needs of production.

Right Quantity- For prices may fluctuate

• Another factor is that prices may fluctuate sometimes very sharply.

• For example, certain products are seasonal in nature, like cotton, groundnuts, etc. It would, therefore, be necessary to buy such materials when the opportunity is best and

• not make periodic purchases as in the case of commodities which are available all trough the year.

Right Quantity- For fluctuation in the lead time

• It certain cases, there can be fluctuation in the lead time. (Lead time means the time taken by the supplier to deliver the product after the order has been placed on him).

• This might make it necessary to alter the quantum of purchase made each time.

Determine the quantity to be purchased at one time

• Quantities determination has a very large number of factors influencing a decision and the buyer has necessarily to consider all these aspects before he determines the quantity that he should purchase.

• The factors for determination can be divided into two categories - internal and external conditions

Internal conditionsthat Determine Qty to Buy

• Is the item needed at all, and at any rate, is it really needed now? Or much later.

• How much Is needed ? Assume only 15 Nos. are needed now and 500 Nos. are needed for the whole year. May be the best policy is to buy the entire annual consumption quantity at one time, if the item is less expensive. If it is a very expensive item may be 15 pieces should be purchased now.

• What is requirement profile ? Is there a regular, consistent requirement, or is it sporadic depending upon special require ments of customers?

A regular, consistent requirement

WEEKS0 1 2 3

Units in Stock

Uniform Usage - EOQ environment

Sporadic Requirement

WEEKS

Units In Stock

LUMPY USAGE - ideal MRP Environment- depending upon special requirements of customers?

Internal conditions – some more

• How much of storage space do we have? This is an important criterion and quite often not taken into consideration.

• Financial considerations : Do we have enough money right now to buy the material in the quantities desired. Is it worthwhile to borrow money from the market where there is a clear trend of rising prices?

• The administrative effort to place an order. • Shelf life of Item : What is shelf life of the item? • Bad storage may compound the problem too.• Problems of obsolescence : This happens to a great

extent when one buys spares.

External conditionsthat Determine Qty to Buy

• Availability: How easily is the material available in the market?

• Seasonality: Practically all commodity fall into this category.

• Market conditions : -The market may be fluctuating, with plenty today and shortage tomorrow. - Are there many suppliers or is there just one or-two and do these few manipulate?

External conditions – some more

• Packaging sizes : item may be packed in a standard gross or a barrel and buying loose may be costlier.

• Imports: If the item is imported it may cause problems when buying small quantities at a time

• Lead time : If lead time is more it may be necessary to buy more at one time.

• Price discounts for larger volumes

The End