UNIT 4: OPERATING PROCEDURE

4.1 INTRODUCTION

Planning governs the survival, and progress of any organization in a competitive and ever-
changing environment. Further managers at every level of management perform the planning
function. However we should not induct from this view that planning is an isolated activity
required in the beginning only. It is really a continuous and unending process to keep the
organization as a going concern and other functions are also performed simultaneously.
Managerial operations in organizing, staffing, leading and controlling are designed to support the
accomplishment of enterprise objectives. Planning logically proceeded all other managerial
functions.

Procedures are plans that establish required methods of handling future activities. They are
guides to action rather than to thinking and they detail the exact manner in which certain
activities must be accomplished. They are chronological sequence of required actions.

Procedures often at across departmental levels for example, in a manufacturing company, the
procedure for handling orders will almost certainly involve the sales department (for the original
order), the finance department (for acknowledgement of receipt of funds and for customer credit
approval), the accounting department (for recording the transaction), the production department
(for the order to produce goods or authority to release them from stock) and the traffic
department (for determination of shipping means and rates).
4.2 PURCHASING PROCEDURE

The process of purchasing starts when the material requisitioned is not available at stores. That
is, the requesting department - be it finance, production, marketing, etc. will request for the
supply of materials from stores. If the material requisitioned is available at stores, the
storekeeper issues the material to the requested department. The form used in connection with
issue, requisition, transfer, return, etc. of materials is as illustrated below:-
ABC COMPANY LTD.
STORES REQUISITION
Requesting Dept.: _________________________________No.____________________
_________________________________No.____________________
Purpose: _________________________________ Date:___________________
SR. Item Unit of
No. No. Description Measures Quantity Remark

Prepared by _______________________ Chief of Stores _________________

Approved by ______________________ Recipient's name _______________
Distribution:-
Distribution:-
White - Accounts Yellow - Stores recording & control Blue - Stores
Pink - Requesting unit Green - Pad
ABC COMPANY LTD.
STORES ISSUE VOUCHER
Requesting Department: ___________________________ No.____________________
Classification of Goods Date:___________________
Consumables _______________ Spare parts ___________ ST.R.No________________
Fixed Assets ________________

SR. Item Description Unit of Unit Total

No. No. (Item issued) Measure Quantity Price Price Reasons

Issued by _________________ Approved by ______________ Received by __________

Distribution:-
Distribution:-
White - Accounts Yellow - Stores recording & control
Pink - Requesting or Gate passes Blue - Stores Green - pad
A purchasing department buys many different types of materials and services, and the procedures
used in completing a total transaction normally vary among the different types of purchases.
However, the general cycle of activities in purchasing most operating materials and supplies is
fairly standardized. The following steps constitute the typical purchasing cycle.

1. Recognize, define and describe the need

2. Transmit the need
3. Investigate, qualify and select the supplier
4. Prepare and issue the purchase order
5. Follow up the order (including expediting and de-expediting)
6. Receive and inspect the material (except in the case of some JIT systems and some
partnering agreements)
7. Audit the invoice
8. Close the order

4.2 RECOGNITION, DEFINITION AND DESCRIPTION AND TRANSMISSION OF

THE NEED

The need for a purchase typically originates in one of a firm’s operating departments or in its
inventory control section. The purchasing department is usually notified of the need by one of
the basic methods.

i) Standard purchase requisition or

ii) A material requirements planning (MRP) schedule. If the need is one time purchase, then
an engineering bill of materials is sometimes used.

a. Standard Purchase Requisition

The purchase requisition is an internal document, in contrast with the purchase order, which is
basically an external document. Most companies used a standard, serially numbered purchase
requisition form for requests originating in the operating departments. The user generally makes
a minimum of two copies.
 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 ___________

Distribution:-
Distribution:-
Original - General Accounts (white) 1st copy - Costs & stock Accounts (Yellow)

Red - Purchasing Pink - Stores recording and control

Blue - Storekeeper Green - pad

b. Material Requirements Planning Schedule

When a design engineer completes the design of a part or an assembly, he or she makes a list of
all the materials (and quantity of each) required to manufacture the item. This list is called an
engineering bill of materials. In firms using computerized production and inventory planning
systems such as an MRP system, the engineering bill of materials is first reconfigured into a
structured multilevel bill of materials. This structured bill of materials for each item being
manufactured can then be used in determining specific materials for each item being
manufactured can then be used in determining specific material requirements for a given
production schedule during a specific time period.

c. Engineering Bill of Material

In firm’s that do custom manufacturing work, or for various reasons are involved in unique one-
time projects, a similar but less sophisticated approach can be used. When purchase of the
required materials is a one-time affair, the engineering bill of materials, along with the
production department’s need for materials. The buyer then obtains total requirements simply by
manually extending the bill of materials for the production quantity scheduled. Thus,
communications are simplified and the need for purchase requisitions is eliminated.

Bill of Material

No._______________
Date of Issue: ______________________ Production / Job Order No._______________
Department Authorized _______________________________

For Department use only

Serial Code Material Quantity
No. Description No. Quantity Reqn. No. Date Demanded Remark

d) Definitions and Description of the need

Regardless of the form of transmission used, material requirements must be defined effectively
and the most appropriate methods of description should be selected for the situation at hand. The
point to be understood here is that clear, complete, appropriate definition and description is a
joint responsibility of the user and the buyer. One of the reasons why every purchase
authorization document should be approved by designated departmental supervisors is to ensure
that qualified individuals initially review it and subsequently comes to purchasing in correct
form.

e) The stock check

Some companies route all requisitions for tools, supplies and production type materials to
inventory control before they are sent to purchasing. If a sizeable percentage of a firm’s
requisitions involve stores-type items, this procedure expedites the supply process and reduces
clerical work in the purchasing department. Supplier’s selection and preparation of the purchase
order.

4.2.2 Supplier selection and preparation of the purchase order

The purchase of a new or a high value item, on the other hand, may require a lengthy
investigation of potential suppliers. If the item to be purchased is complex or highly technical,
the firm may utilize across functional sourcing team, first to qualify potential suppliers and
perhaps eventually to make a team decision about the most desirable supplier.

After qualifying a preliminary group of potential sources, the buyer may employ the techniques
of competitive bidding or negotiation or both when competitive bidding is used the buyer
initiates the procedure by requesting quotation from a reasonable number of firms with whom the
buying group is willing to do business. Although “request for quotation” forms vary widely
among firms, typically they contain the same basic information that will subsequently be
included on the purchase order.

a) Sources of Supply

While purchasing and supply management has the ultimate responsibility for selecting the
“right” source, the process in handled in many ways. Procedurally, the simplest approach is
when the buyer alone conducts the analysis and makes the selection. A second common
approach calls for the use of a cross-functional team consisting of representatives of purchasing
and supply management, design engineering, operations, quality and finance. The third common
approach is the use of a commodity team.

b) Commodity teams

Many progressive firms use commodity teams to source and manage a group of similar
components.

Commodity teams frequently consists of buyers, materials, engineers and production planners.
Large commodity teams include a commodity manager (normally from purchasing and supply
management) and representatives of materials, design and manufacturing engineering, quality
and finance. Commodity teams are essentially a type of cross-functional team. The principal
difference between them is that commodity teams tend to be fairly permanent, while cross-
functional teams tend to be one-time assignment.

c) Evaluating a potential supplier

After developing a comprehensive list of potential suppliers, the buyer’s next step is to evaluate
each prospective supplier individually. A process of elimination develops a selected list of
potential suppliers with whom the buying company may be willing to do business. Unless a
decision has been made to employ a single source of supply, the supplier list should be complete
enough to bring to bear every type of competition desired, including:-

- Technological and quality competitions, resulting from identifying potential suppliers

who excel in good ideas, engineering planning, design, material quality and production
techniques.
- Price competition, resulting from identifying the lowest cost producers or distributors.
- Service competition, resulting from identifying those suppliers that are especially
anxious to get contracts and that are willing to add “plus” values over and above
functional value (quality) and price.

What kind of company makes the best supplier? It would be difficult to improve on the
definition given by Professor Wilbur England of Harvard University.

A good supplier is one who is at all times honest and fair in his dealing with the customers, his
own employees, and himself. Who has adequate plant facilities, and know-how so as to be able
to provide materials which meet the purchaser’s specifications, in quantities required and at the
time promised, whose financial position is sound whose price are reasonable both to the buyer
and to himself, whose management policies are progressive, who is alert to the need for
continued improvement in both his products and his manufacturing process. And who realizes
that in the last analysis his own interests are best served when he best serves his customers.

d) Type of Evaluation Needed

The type of evaluation needed required determining supplier capability varies with the nature,
criticality, complexity and dollar value of the purchase to be made. It also varies with the
buyer’s or buying team’s knowledge of the firms being considered for the order. For many
uncomplicated low dollar value purchases, an examination of the information already available
in the department library (such as supplier information file, catalogue and brochures) is
sufficient. To differentiate among those suppliers who understands the complexities of the
purchase and those who do not. By eliminating those who do not, the search for the right
supplier is further narrowed.

1. Preliminary surveys
If an examination of existing data indicates that a firm appears to be an attractive supplier
for existing or anticipated requirements, a telephone or mail survey should be conducted
to obtain additional information. Such a survey should provide sufficient knowledge of
the supplier to make a decision to include or exclude the firm from further consideration.
Clearly, this sound precedes any plant visits.
The survey is based on a series of questions, which cover the following areas:
i) The principal officers and titles
ii) Bank reference
iii) Credit references
iv) The annual history of sales and profit for the past five years
v) A referral list of customers
vi) The number of employees
vii) The space currently occupied
viii) Expansion plans (including sources of funds)
ix) The current production defect rate for similar products
x) The number of inspection used
xi) The date when statistical process control was adapted
xii) A list of all equipment and tools, which would be used to manufacture, test, and
inspect the purchase in question.

2. Financial condition
Preliminary investigation of a potential supplier’s financial conditions often can avoid the
expense of further study. A qualified buyer or professional from the finance department
conducts these investigations. A review of financial statements and credit ratings can
reveal whether a supplier is clearly incapable of performing satisfactorily. Financial
stability is essential for suppliers to assure continuity of supply and reliability of product
quality. Imagine the difficulty of getting
i) A financially weak supplier to maintain quality;
 ii) A supplier who does not have sufficient working capital to settle an expensive
claim; or
iii) A financially unsound supplier to work overtime to meet a promised delivery date.

In addition to informing a buyer or the sourcing team about a supplier’s capability to

perform a contract, financial information can be useful in other ways as well.
Financially, strong firms are usually managerially strong. Hence they generally make
good suppliers. An analysis of a firms balance sheet and operating statement is helpful in
numerous ways i.e. on discovering that a firm’s financial conditions has started to
deteriorate a buyer should tighter quality monitoring and consider either searching for a
new supplier or reducing the size of the orders given to the distressed firms.
3. Quality capability
A critical factor to examine is the firm’s quality capability. IF the prospective supplier’s
process capability is less than the buying firm’s incoming quality requirements, the
suppliers typically is not worthy of further investigation. An obvious exception is the
case in which no supplier possesses the required capability.

i) Specifications are most detailed methods of describing requirements. Various types of

design specifications are the detailed descriptions of the materials, parts and
components to be used in making the product. They are verbal and written
description that tell the seller exactly what the buyer wants to purchase.

In a manufacturing firm, when specification is fixed, the final design of a product is also fixed.
Then the products competitiveness and its profit potential is also fixed.

Specification is very important because the cost of materials clearly dictates that their selection is
an important consideration during product design. The costs of many materials are identified
through specifications during the design stage. This is the first and sometime the only point at
which numerous costs can be reduced. It is at the time of the original designing that the greatest
cost saving obtained from both specification and standardization.

Since specifications imports the activities of engineering operations, purchasing and quality,
optimum specification mainly influence the contribution made by all these departments to the
firm’s success. A good specification is to satisfy the procurement consideration of clear, concise
and unambiguous communication. To meet the needs of all departments, a specification must
satisfy many requirement – Design and marketing requirements for functional characteristics
chemical properties, dimensions, appearance etc.

ii) Standardization is the process of establishing agreement on uniform identifications for definite
characteristics of quality, design, performance, quantity service and so on. Standards reduce
varieties and create consistencies. Standards are usually essential in exchange of parts. The
use of standards permits a firm to purchase fewer items in large quantities and lower price.
This reduces purchasing, receiving, inspection and payment costs. Stocking fewer items
makes controlling inventories easier and less costly. Consequently, the purchase of
standardized materials saves money in four ways

4. Plant visit
By visiting a supplier’s plant or distribution facility, the sourcing team can obtain firsthand
information concerning the adequacy of the firm’s technological capabilities, manufacturing or
distribution capabilities and its management’s technical know-how and orientation. Depending
on the importance of the visit, the company may send representatives from only purchasing and
engineering or it may also include some combination of representation from finance, operations,
quality assurance, marketing and industrial relations.

In planning plant visits only a few outstanding potentials suppliers plants should be chosen for
observation due to the time and costs involved. The buying firm wants suppliers whose
management is committed to excellence. To make such a determination properly requires an
overall appraisal.

Among the factors to be addressed are:-

i) Attitude and stability of the top and middle management teams

ii) Research and Development capability
iii) Appropriateness of equipment
iv) Effective of the production control, quality assurance and cost control systems
v) Competence of the technical and managerial staffs.

Other important factors include

i) Morale of personnel at all levels
 ii) Industrial relations
iii) Willingness of the potential supplier to work with the buying firm
iv) Quantity of back orders
v) Effectiveness of purchasing and supply management and materials management
operations

And past performance

i) Past major customers
ii) General reputation
iii) Letters of reference

The plant visit should be planned carefully to provide the required level of knowledge and
insight into the potential supplier’s operations, capacity and orientation. The efficiency with
which the plant visit is planned and conducted reflects on the buying organization.

The prospective supplier usually is requested to provide additional information on the company’s
history, current customers, sales volume and financial stability. In the quality area, the buyer and
his or her sourcing teammates should attempt to understand.

Once a supplier has been selected, the purchasing department prepares and issues a serially
numbered purchase order. In most cases the purchase order becomes a legal contract document.
For this reason, the buyer should take great care in preparing and wording the order. Quality
specifications must be described precisely. If engineering drawings or other related documents
are to be considered an integral part of the order they should be incorporated clearly by
reference. Quality requirements, price and delivery and shipping requirements must be specified
accurately. In the event of that statistical process control or sampling inspection is to be used,
conditions of acceptance should be stated or referenced on the order.

Similarly, any other important factor affecting the acceptability of the product should be stated
precisely. In short, the order should include all data required to ensure a satisfactory contract and
it should be worded in a manner, which leaves little room for misinterpretation by either party.
 Purchase Order
XYZ CO.
ADDRESS
To: ABC Co.
Address:

Ref: Our Tender NO XYZ/ 10/ 04 Dtd

: Your quotation No. ABC / 01/ 04 Dtd

Dear Sir,
We kindly request you to supply the following items as per the following terms and conditions:

SR NO. Item code Item description Unit of Unit price Total Remark
measurement price

Thank you,
Yours faithfully,
Terms and conditions
Summary of information contained in purchase order
I. Buying firms and document identification i. Shipping instructions
ii. Internal identification ii. Summary totals
iii. Purchase order identification iii. Purchase order item number
iv. Supplier identification iv. Item identification number
v. Specific shipping destination v. Item description
vi. Internal information vi. Delivery quantity
vii. Accounting change vii. Shipping / delivery dates
viii. Payment terms viii. Unit price and measures
ix. Additional contract inclusions ix. Extended price x quantity
x. Point of title transfer x. Buyer identification and date

4.2.3 Acknowledgement and follow-up of the order

In most cases, the original copy of the purchase order, which is sent to the supplier constitutes a
legal “often” to buy. No purchase “Contract” exists, however, until the seller “Accepts” the
buyer’s offer. The seller’s acceptance can take one of the two forms.

i) Performance of the contract or

ii) Formal notification that the offer is accepted.

The purpose of sending the supplier an acknowledgement form along with the purchase order is
two fold. First, it is a form that can be completed conveniently and returned to the buyer,
acknowledging acceptance of the order. At the same time, the supplier can indicate whether or
not it is able to meet the desired delivery date. If a supplier ships the ordered item immediately
from stock, it frequently disregards the acknowledgement form.

Regardless of the specific system used, follow-up communication with the supplier usually takes
one of the two forms. A fax or a telephone call is typically used for most critical orders. Mailing
or faxing a preprinted enquiry to the supplier usually accomplishes routine follow-up for the less
critical orders.

In some firms, the buyer handling the order conducts follow-up procedures. In others, a separate
expediting group conducts follow-up activities. Although relatively few in number, some firms
maintain a force of follow-up personnel in the field such firms typically purchase a great deal of
critical material or major equipment on very tight schedules. To ensure that all material is
available when needed, these firms track critical purchases by having traveling follow-up
representatives personally visits suppliers’ plants. In some situations these field personnel have
the additional responsibility of attempting to speed up (expedite) or even delay (de-expedite)
delivery as the buyer’s timing requirement undergo unexpected changes.

4.2.4 Receipt and Inspection

The next step in the traditional purchasing cycle is receipt and inspection of the order. When a
supplier ships material, it includes in the shipping container a packing ship, which itemizes and
describes the contents of the shipment. The receiving clerk uses this packing slip 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. In some cases, the report is prepared on separate
receiving department forms. However, the trend in most companies today is to reduce the
clerical work by using an online computer based system, coupled with bar code order
identification or by preparing a receiving report form during the same typing or printing
operation that prepares the purchase order.

ABC COMPANY LTD.

INSPECTION NOTE

Supplier Name: _________________________________ No.____________________

Invoice No.: _________________________________ Date:___________________
P.O. No. ________________
SR. Item Unit of Quantity
No. No. Description Measure Received Rejected Reasons

Distribution:-
Distribution:-
Original - General Accounts
1st copy - Costs & stock Accounts
2nd copy - Purchasing
3rd copy - Stores recording and control
4th copy - Storekeeper
5th copy – Pad
 ABC COMPANY LTD.
GOODS RECEIVING NOTE

Supplier ____________________________________ No.____________________

Classification of Goods Date:___________________
Consumable __________ Spare parts ____________ P.R. No. ________________
Fixed assets _________________________________ P.O. No. ________________
Supplier Inv.No__________

SR. Item Unit of Quantity Unit Total

No. No. Description Measure Ordered Received Price Price Remark

Prepared by __________ Checked & Received by_________ Approved by ___________

Distribution:-
Distribution:-
Original - General Accounts (white) 1st copy - Costs & stock Accounts (Yellow)

Red - Purchasing Pink - Stores recording and control

Blue - Storekeeper Green - pad

The necessity and advantages of a goods received note are:-

i) It provides a complete records of all materials received.
ii) It informs the storekeeper or other interested departments of the quality of goods received.
iii) It provides a means of checking the supplier's invoices.

4.2.5 The invoice audit and completion of the order

Occasionally, a supplier’s billing department makes an error in preparing an invoice or its
shipping department makes an incorrect or incomplete shipment. To ensure that the purchased
makes proper payment for the materials actually received, sound accounting practice dictates that
some types of review procedure precede payment to the supplier.

4.3 PURCHASING DEPARTMENT RECORDS

The files of a purchasing department contain an endless flow of operating data. Despite its huge
volume, much of this information can be useless in daily operations unless it is organized in a
manner, which makes it readily accessible. The following basic records are essential for the
effective operation of most purchasing departments.

 A record of open order

 A record of Closed orders
 Purchase log –
 Commodity record
 Supplier record
 Contract record
 Special tool record

4.3.1 Record of Open Orders

All buyers need immediate access to information concerning the status of their outstanding
orders. The record system can be maintained on a computer, in hard copy form, or as a
combination of the two.

4.3.2 Record of Closed Orders

The closed order file provides a historical record of all completed purchases. It frequently serves
as a useful reference when questions arise concerning past orders and when certain historical
data are needed to guide future decisions.

4.3.3 Purchase Log

Every purchasing department should maintain an ongoing record, in numerical sequence, of all
purchase orders issued. The record not be elaborate, but it should contain the purchase order
number, the status of the order, the supplier’s name, a brief description of the material purchased
and the total value of the order. Such a record summarizes the commitments for, which the
purchasing executive is responsible. In the event that the working copy of an order is lost, basic
data concerning the purchase can be found in the log. The log further serves as a convenient
record from which summary administrative data can be extracted concerning such matters as the
number of small orders, rush orders, and total orders issued. The volume of purchases from
various suppliers the value of outstanding commitments; and so forth.

4.3.4 Commodity Records

The file of commodity records constitutes a vast reservoir of materials data that makes efficient
“mass production purchasing” possible. A commodity record card or computer file should be
maintained for each major material and service that is purchased repetitively. Typically included
in the record is a complete description of the material or service, with full reference to necessary
engineering drawings and specification, which might be filled elsewhere. Also included should
be a list of approved suppliers and their price schedules. Competitive quotations may be
included in the file, although it is more common to summarize bid data in the record, note a cross
reference to the original quotation and place all quotations in a separate file.

4.3.5 Supplier Record

To provide quick access to information about suppliers, most companies centralize such
information in a single record file. A separate card or computer record is maintained for each
major supplier. In this record is recorded the address, telephone number and the names of
personnel to contact on a specific matters of inquiry. Selling terms and routing instructions for
shipping purposes also usually are included. Although the practice varies, many firms
additionally summarize in this record the suppliers delivery and quality performance, as well as
the annual volume of materials purchased from the supplier.

4.3.6 Contract Record

Today most firms are purchasing an increasing number of items on a long-term contractual basis.
In such cases, it is usually convenient to consolidate all contracts in a separate file. In addition to
providing immediate access to all contract documents, the file also apprises all buying personnel
of the materials that are purchased in this manner. If the number of contracts is large, it is
desirable also to list them in summary form to provide a bird’s eye view of all contract purchases
and their expiration dates.

4.3.7 Special Tool Record

Many companies have no need for this record. However, such a record is essential to those firms
that purchase many items requiring special tooling for their manufacture. On some orders the
purchaser buys the required dies, figs, fixtures, and patterns. On others the supplier owns them.
By maintaining a record of special tools, the buyer can summarize for quick reference the special
tools owned, the age and location of each and the essential mounting and operating
characteristics of each.

4.4 HANDLING EMERGENCY/ RUSH ORDERS

Every department executive tries to develop an orderly and systematic pattern of operation that
efficiently utilizes the resources of that department. In a well run purchasing department
systematic analysis and processing of most orders is completed in two to four days after the
purchase request is received.

How should purchasing handle the emergency needs that inevitably arise in any business
operation? Clearly, a special procedure for processing rush requisition is needed. The key
elements of such a procedure are discussed in the following paragraphs.

Even in the case of emergencies, it is unwise to accept oral requisitions – in person or over the
telephone. Too much chance for erroneous interpretation of the requirement exists. The
requisitioned should state the need in writing and preferably, deliver to the buyer in person. For
purposes of identification, emergency requisitions can be printed on paper of a different color or
they can be identified with a visible emergency sticker. Typically, the buyer should process
these requisitions and telephone emergency orders to the supplier. In no case, however, should
an order be placed without assigning it a purchase order number. For most purchases, a
confirming purchase order subsequently should be mailed to the supplier. In cases where the
emergency is less urgent, the buyer may process such requisitions at appointed times twice daily
(say at 10:30 am and 2:30 pm).

Rush orders always cost more than if they were handled through the normal purchasing system.
Higher prices frequently are paid because rush purchases are not investigated as thoroughly as
those handled in the normal routine and of a buyer’s scheduled work by the emergency request
invariably produce inefficiency in normal purchasing department activity.

Consequently, steps should be taken to discourage all rush orders that arise because of poor
planning in the using departments. In practice, three approaches have proved successful. The
first involves a concerted effort to coordinate the activities of the using group of production
scheduling and purchasing. Some companies require that realistic order points for inventory
materials be established jointly by production scheduling and purchasing is required to issue
periodic lead time reports to users for all major classes of materials. A second approach,
designed to reduce unjustifiable requests, requires the requisitioned to obtain approval from a
general management executive for all emergency requisitions. A modification of this approach
requires an after-the fact review of all rush orders by top management. Still another approach
assesses the requisitioning department a predetermined service charge for each emergency
requisition processed.

4.5 THE SMALL ORDER PROBLEM

Small orders are a serious problem in every organization. Examination of a typical company’s
purchase order file reveals that a sizable percentage (sometimes up to 80 percent) of its
purchases involve in an expenditure of less that 250.

In total, however, these purchase constitute a small percentage (seldom more than 10 percent) of
the firm’s annual dollar expenditure.

Clearly no manager wants to devote more buying and clerical effort to the expenditure of less
than 10 percent of his or her funds than to the expenditure of the other 90 percent.

The very nature of business requires the purchase of many low-value items. Nevertheless, small
orders are costly to buyer and seller alike.
The various methods used by purchasing manager to deviate the small order problem can be as
illustrated below.

4.5.1. Centralized Store System

A stores system is the first approach typically used to reduce the volume of small-order
purchasing activity. When expenditure shows that the same supply items are ordered in small
quantities time after time, the logical solution is to order these items in larger quantities and
place them in a centralized inventory for withdraws as needed. An analysis of repetitively used
production materials leads to the same action for the multitude of low-value items. If usage of an
item is reasonably stable, an optimum order quantity can be computed using a basic economic
order quantity approach.

4.5.2. Blanket Order System

A store system solves the small-order problem only for items that are used repetitively. A blanket
order system helps solve the problem for the thousands of items a firm cannot carry is inventory,
as well as some that it does carry.

Briefly, the general procedure used for this type of purchase is as follows. On the basis of an
analysis of past purchases, the buyer determines which materials should be handled in this
manner. After bidding or negotiation, the buyer selects a supplier for each item, or family of
items, and issues a blanket order to each supplier. The order includes a description of each item,
a unit price for each item when possible, and the other customary contract provisions. However,
no specific order quantities are noted. The blanket order typically indicates only an estimated
usage during the period of coverage (usually one to three years). It also states that all
requirements are to be delivered up on receipt of a release from the buyer or other authorized
person. On receiving a requisition for one of the materials, the buyer merely sends a brief release
form to the supplier. On the release form are noted the blanket order number, the item number,
and the quantity to be delivered. Receiving reports are filed with the original order, and at the
end of the month are checked against the suppliers monthly invoice. At the end of the period, the
order may be reviewed or placed with another firm, depending on the suppliers performance
record.
The blanket order system offers six important benefits:
1. It requires many fewer purchase orders and reduces clerical work in purchasing,
accounting and receiving.
2. It releases buyers from routine work, giving them more time to concentrate on major
problems.
3. It permits volume pricing by consolidating and grouping requirements.
4. It can improve the flow of feedback information, because of the grouping of materials
and suppliers.
5. Because of some suppliers will stock material for prompt delivery, this system may
reduce the buyer’s lead times and inventory levels.
6. It develops longer-term and improved buyer supplier relationships.

To function effectively in the long run, however, any blankets order systems must provide
adequate internal control. Absence of the control element encourages petty fraud and poor
supplier performance.

4.5.3. Systems Contracting

Systems contracting is simply an extinction and more sophisticated development of the blanket
order purchasing concept. Some firms call it “stockless” purchasing.

As its name implies, systems contracting involves the development of a corporate wide
agreement, often a one-to five year requirements contract, with a supplier to purchase a large
group or “family” of related materials. The items to be purchased are usually described in detail
is a “catalog” that belongs part of the contract. Estimated usage usually is included, a long with a
fixed price for each item and an agreement by the supplier to carry a stock of each item adequate
to meet the buyer’s needs. Various types of supplies and commonly used operating items,
typically purchased from distributors, are the materials most often covered by these types of
agreement.

4.5.4. Telephone/Fax Order Systems

Most companies now use a telephone or fax ordering system to reduce the paperwork associated
with small-order purchasing. Under this system, when the purchasing department receives a
requisition, it does not prepare a formal purchase order. Instead, the order is placed by telephone
or fax, and the requisition is used in the receiving procedure.

4.5.5. Petty Cash and C.O.D

Most firms today use a petty cash fund for making small one-time purchases. For this purpose,
many firms define “small” as under $ 100. it is often less expensive for an individual user to buy
minor items personally and pay for them from a petty cash fund than it is to buy them through
the conventional purchasing system.

Some firms also find it economical to make small one-time purchase on a C.O.D basis. Material
can be ordered by telephone and paid for an arrival. Payment can be made using petty cash or a
departmental check written on an account set up for such purchases.

4.5.6. Supplier Stores/Consignment System

It a purchaser buys a large enough volume of certain materials from a single supplier, the
supplier sometimes can afford to start a small “store” at the purchaser’s plant and operate it on a
consignment basis. Users then simply go to the store and sign for their purchases. At the end of
the month the company is billed for its purchases just as if the user had “gone downtown” to buy
the material.

This system clearly is not a short-term arrangement. The purchaser, therefore, must take great
care is selecting the supplier and in negotiating the terms of the agreement.

4.5.7. Supplier Delivery System

The supplier delivery system is somewhat similar to a supplier stores system, but it is more
feasible for firms with a smaller volume of purchases. Many suppliers who are not willing to set
up a store at the buyer’s plant are willing to stock numerous miscellaneous materials and make
daily or semiweekly deliveries. The buyer typically reviews and accumulates purchase
requisitions for such materials. The suppliers delivery person them pecks them up on the
specified day, and at the same time delivers the material ordered on the preceding batch of
requisitions.

Check Your Progress

1. Identify and explain in detail the purchasing procedure
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2. What is a purchase register? Explain
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3. Discuss in detail the various records maintained by the purchasing departments
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4. Discuss at least 4 methods used to curb the problem of small-order problem
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4.6 SUMMARY

Every business units develops a series of procedures to assist operating personnel in carrying out
the polices and plans of the unit. In total these procedures establish the ground rules for the daily
activities of the department.

The specific procedures employed by each firm should be designed to meet the unique needs of
that firm. Generally speaking properly designed procedures should accomplish four objectives:
1. Accomplish each task satisfactorily with a minimum of time, effort and paperwork
2. Effectively communicate and coordinate the efforts of one work group with another.
3. Minimizing overlapping efforts and group conflicts by clearly designating responsibility
for each step of the procedure.
 4. Permit effective management by exception.

It is important too, to consider the external dimension of the procedures issue. The nature of the
procedural interface that is established units a supplier is defined by the form of relationship that
is developed with the firm.

This area is undergoing a rapid evolutionary change as acquisition needs of purchasing firms
become more dynamic.