CHAPTER SEVEN

MATERIALS MANAGEMENT

By:

Terefe Z. (PhD)

Rift Valley University

 7.1. Meaning of Materials Management

 Materials management is concerned with

planning, organizing and controlling the flow of
materials from their initial purchase through internal
operations to the service point through distribution.
OR

 Material management is a scientific technique,

concerned with Planning, Organizing &Control of flow
of materials, from their initial purchase to destination.
7.2. Purposes/ Functions of Materials Management

•To gain economy in purchasing

•To satisfy the demand during period of replenishment
•To carry reserve stock to avoid stock out
•To stabilize fluctuations in consumption
•To provide reasonable level of client services
 Four basic needs of material management:
1. To have adequate materials on hand when needed;
2. To pay the lowest possible prices, consistent with
quality and value requirement for purchases
materials;
3. To minimize the inventory investment;
4. To operate efficiently.
Basic principles of material management:
1. 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. Should be simple
6. Must not increase other costs
7. Simple inventory control program
 Elements of material management:
1. Demand estimation
2. Identify the needed items
3. Identifying the trends in Consumption
4. Review with resource constraints
7.3.Inventory/materials Planning

 It means stocking adequate number and kind

of stores, so that the materials are available
whenever required. Scientific inventory control
results in optimal balance.
Functions of inventory control

•To provide maximum supply service, consistent with

maximum efficiency & optimum investment.

•To provide cohesion between forecasted & actual

demand for a material.
 Economic order of quantity

ECONOMIC ORDER OF
QUANTITY(EOQ)

PURCHASING CARRYING
COST COST
• Re-order level: stock level at which fresh order is
placed.

•Average consumption per day x lead time +

buffer stock

•Lead time: Duration time between placing an

order & receipt of material

•Ideal – 2 to 6 weeks.
EOQ Model Assumptions
 Demand is known & constant - no safety
stock is required

 Lead time is known & constant

 No quantity discounts are available

 Ordering (or setup) costs are constant

 All demand is satisfied (no shortages)

 The order quantity arrives in a single

shipment
 EOQ Assumptions
Annual Cost

Total Cost Curve

Holding Cost
Order (Setup) Cost

Order Quantity
 EOQ Assumptions

Number of Orders = D / Q
Ordering costs = Oc x (D / Q)

Average inventory
units = Q / 2
Cost = (Q / 2) x C

Cost to carry
average inventory = (Q / 2) x I x C
= (Q /2) x Cc
I= Carrying /Holding cost (% of Cost per unit of inventory)
Ordering Cost:

 Total ordering cost generally includes:

 The cost of processing order like all record
keeping,
 Transportation cost to get order from the
supplier,
 The cost of unloading the order and placing it in
inventory,
 Salaries of employees involved in the ordering
process,
 All supplies used ordering, including forms,
postage, telephone, and computer time.
Carrying Cost:
 The carrying cost also called the holding cost is the
cost incurred by the store for carrying the items in the
inventory.
The total carrying cost generally includes some or all of the
following items:
 Direct storage cost (rent, heat, lights, maintenance,
security, handling, recordkeeping, labor, etc in the
warehouse
 Deferred profit on investment (items in inventory does
not produce a profit)
 Interest on the investment in inventory
 Product obsolescence
 Depreciation, taxes, insurance, etc.
EOQ Assumptions

TC EOQ = (Q/2) x Cc + (D/Q) x Oc

Inv. Carrying cost Ordering cost

Where:
TC = Annual total cost
D = Annual demand
Q = Quantity to be ordered
Oc = Ordering or set up cost per unit per annual
Cc = Annual inventory carrying/holding cost per unit
EOQ Assumptions

 EOQ can be determined as follows:

Total annual carrying cost = Total Annual ordering cost (at EOQ point)
Q/ 2 x (Cc) = D/Q x (Oc)
Q2 /2 x (Cc) = D x (Oc) ( multiplying both sides by Q)
Q2 x (Cc) = 2D x (Oc) (multiplying both sides by 2)
Q2 = 2D (Oc) ( Dividing both sides by Cc)
Cc
Q2 = 2D (Oc)
Cc
2  D  Oc
EOQ 
Cc
When to Order: The Reorder Point

• Without safety stock:

R  dL
where R  reorder point in units
d  daily/weekly demand in units
L  lead time in days/weeks

• With safety stock:

R  dL  SS
where SS  safety stock in units
 Expected number of order (N) = D/Q

 Expected Time between orders (T) = Working days per year/N

 Demand per day (d) = Annual demand (D)/ Working days per year
 EOQ Model Example
Kaldis Coffee needs 1000 Kg of coffee per year. The
cost of each Kg of coffee is $78. Ordering cost is $100
per order per year. Carrying cost is 40% of per unit cost
per year. Lead time is 5 days. Kaldis coffee is open for
365 days/yr.

a.What is the optimal order quantity?

b.What is the ROP?
c.What is the ROP if Kaldis coffee plans to hold 15 kg
of safety stock ?
d.Calculate the total annual inventory cost
e.Calculate the number of orders and time between
orders
 EOQ Model Example

Given: 2  D  Oc
D = 1000 EOQ 
Oc = $100
Cc
C = $ 78
I = 40% 2  1000  $100
Cc = C x I
EOQ 
Cc = $31.20
$31.20
EOQ = 80 Kg of coffee
 EOQ Model Example

b). ROP = demand over lead time

= daily demand x lead time (days)
=dxl
D = annual demand = 1000
Days / year = 365
Daily demand = 1000 / 365 = 2.74
Lead time = 5 days
ROP = 2.74 x 5 = 13.7 => 14 Kg

c). ROP with SS = D x l + SS

= 2.74x 5 +15Kg = 29Kg
 EOQ Model Example

d). Total inventory cost = Total carrying cost + Annual ordering cost
= Q/2 (Cc) + D/Q (Oc)
= 80/2 ($31.20) + 1000/80 ( $100)
= $1248 + $1250
= $2498 per year

e. The number of orders (N) = Annual demand (D)/Q

= 1000kg/ 80kg
= 12.5 ~ 13 orders per year
The time between orders (T) = Working days/ Number of orders per year
= 365 days/13 orders
= 28 days between orders
7.5. Purchasing

 Purchasing is an important function of materials

management.

 Purchasing is a process of buying of equipments,

materials, tools, parts etc. required for industry.

 The basic objective of the purchasing function is to

ensure continuity of supply of raw materials, sub-
contracted items and spare parts and to reduce the
ultimate cost of the finished goods.
7.5.1. Basic Principles of Purchasing (5 R’s)

 The basic principles of purchasing regarded as the provision of the

required materials:
i. In the Right Quality: is concerned with determining what is
the required and why it is needed.
ii. In the Right Quantity: implies that the amount of materials
required should be determined.
iii. In the Right Time: implies prior determination of delivery
date and delivery schedule for each type of materials.
iv. At the Right Price: It is the fair and reasonable price
determined through negotiation.
v. From the Right Supplier: is a supplier that can provide
uniform quality materials and that is punctual in delivery time.
7.5.2. Supplier selection
 Appropriate selection procedure encourages competition among
suppliers which has a direct impact on the economic development
of a country.
Evaluation methods such as categorical method, weighted point
method and the cost ratio method are used to select the suppliers.
1.Categorical method: This method makes use of information from
the materials record and the supplier record.
 All the concerned departments are involved in the
evaluation process.
 A list of performance factors which is important to each
department can be prepared for each major supplier.
 After the factors are identified for relative importance, each
supplier is then rated in simple categorical terms, such as
very good, good or unsatisfactory ( highly subjective, but
inexpensive).
 Supplier selection Cont’d

2.The weighted point method: The weighted point method uses

numerical terms and gives a weight for each evaluation factor based
on the relative importance of the factors.
 Based on past experience, the percentage performance point is assigned
to each factor for each supplier. Then the composite weight is calculated
for each supplier.
 Criteria which are the most important for an organization will be
assigned the highest weight and a criterion that is least important is
assigned the least weight.
 The weight assigned to each factor varies from one purchase to another.
 For example: A medium size manufacturing enterprise determined
quality, delivery and price as the best evaluation criteria. Of these three
criteria the enterprise, again, believes that quality has the highest relative
importance and should be weighted the highest point as indicated in the
following table.
Supplier selection Cont’d

An enterprise assigned 50, 25, 25 points for quality, delivery and

price respectively. The last performance of the three suppliers A, B
and C in percentage was as follows.

Supplier Quality % Delivery % Price/un

it %
A 80 75 100
B 90 60 110
C 90 70 115

 The total composite rating is calculated by adding the points

of all factors for each supplier after multiplying the
performance point by the weights
 Supplier selection Cont’d
• Total composite rating is calculating by adding the points of all
factors
Supplier Quality rating Delivery rating Price rating Composite
rating

A 80%x50 = 40 75% x 25 = 18.75 100% x 25 = 25 83.75 : 2nd

B 90% x50= 45 60% x 25= 15 90.9% x 25= 22.73 82.73: 3rd

C 90% x 50 = 45 70 %x25 = 17.50 86.9% x 25=21.74 84.24 : 1st

 Price rating is calculated as: Lowest price/ Actual price x 100

A. 100/100 x 100 = 100%
B. 100/110 x 100 = 90.9 %
C. 100/115 x 100 = 86.9 %
7.6. Inventory Control or Management

 Inventory generally refers to the materials in stock.

 It is also called the idle resource of an enterprise.
 Inventories represent those items which are either stocked for sale
or they are in the process of manufacturing or they are in the form of
materials, which are yet to be utilized.
 It is necessary to hold inventories of various kinds to act as a
buffer between supply and demand for efficient operation of the
system.
 An effective control on inventory is a must for smooth and
efficient running of the production cycle with least interruptions.
7.6. 1. Meaning of Inventory Control

 Inventory control is a planned approach of determining

what to order, when to order and how much to order and
how much to stock so that costs associated with buying
and storing are optimal without interrupting production
and sales.

Inventory control basically deals with two problems:

(i) When should an order be placed? (Order level), and (ii)
How much should be ordered? (Order quantity).
7.6.2. Reasons for Keeping Inventories

 To stabilize production

 To take advantage of price discounts

 To meet the demand during the replenishment period

 To prevent loss of orders (sales)

 To keep pace with changing market conditions

7.6.3. Benefits of Inventory Control

It is an established fact that through the practice of scientific

inventory control, following are the benefits of inventory control:
i. Improvement in customer’s relationship because of the
timely delivery of goods and service;
ii. Smooth and uninterrupted production and, hence, no stock
out.
iii. Efficient utilization of working capital which helps in
minimizing loss due to deterioration, obsolescence, damage
and pilferage;
iv. Economy in purchasing; and
v. Eliminates the possibility of duplicate ordering.
7.6.4. Techniques of Inventory Control

When the number of items in inventory is large and then large

amount of money is needed to create such inventory, it becomes the
concern of the management to have a proper control over its
ordering, procurement, maintenance and consumption.
 The control can be for order quality and order frequency.

The most widely used method of inventory control is known as

ABC analysis.

 In this technique, the total inventory is categorized into three

sub-heads and then proper exercise is exercised for each sub-
heads.
7.6.4. Techniques of Inventory Control

ABC Aanalysis method

(ABC = Always Better Control)
 This is based on cost criteria.
 It helps to exercise selective control when confronted with
large number of items and rationalizes the number of orders,
number of items & reduce the inventory.
oAbout 10 % of materials consume 70 % of resources
oAbout 20 % of materials consume 20 % of resources
oAbout 70 % of materials consume 10 % of resources
 ‘A’ ITEMS
Small in number, but consume large amount of
resources.
Must have:
•Tight control
•Rigid estimate of requirements
•Strict & closer watch
•Low safety stocks
•Managed by top management
 ‘B’ ITEM
Intermediate
Must have:
•Moderate control
•Purchase based on rigid requirements
•Reasonably strict watch & control
•Moderate safety stocks
•Managed by middle level management
 ‘C’ ITEMS
Larger in number, but consume lesser amount of
resources
Must have:
•Ordinary control measures
•Purchase based on usage estimates
•High safety stocks 

ABC analysis does not stress on items

those are less costly but may be vital .
 ANNUAL COST CUMMULATIVE
ITEM % ITEM COST %
ABC [Rs.] COST [Rs.]
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500
9 2750 191250
S
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
SHEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
 7.7. Stores Management
 Stores play a vital role in the operations of company.

 It is in direct touch with the user departments in its

day-to-day activities.

 The most important purpose served by the stores is

to provide uninterrupted service to the manufacturing
divisions.
 7.7.1. Functions of Stores
 The functions of stores can be classified as follows:
1. To receive raw materials, components, tools, equipment’s and other items
and account for them.
2. To provide adequate and proper storage and preservation to the various
items.
3. To meet the demands of the consuming departments by proper issues and
account for the consumption.
4. To minimize obsolescence, surplus and scrap through proper codification,
preservation and handling.
5. To highlight stock accumulation, discrepancies and abnormal consumption
and effect control measures.
6. To ensure good house keeping so that material handling, material
preservation, stocking, receipt and issue can be done adequately.
7. To assist in verification and provide supporting information for effective
purchase action.
 7.7.2. Codification
 Codification is one of the functions of stores management.
 It is a process of representing each item by a number, the
digit of which indicates the group, the sub-group, the type
and the dimension of the item.
 Whatever may be the basis, each code should uniquely
represent one item.
 It should be simple and capable of being understood by all.
 Codification should be compact, concise, consistent and
flexible enough to accommodate new items.
 The groupings should be logical, holding similar parts near to
one another.
 Each digit must be significant enough to represent some
characteristic of the item.
7.7.3. Inventory Record Accuracy
 Inaccurate inventory records can cause:
o Lost sales
o Disrupted operations
o Poor customer service
o Lower productivity
o Planning errors and expediting
 Two methods are available for checking record
accuracy
• Periodic counting-physical inventory
• Cycle counting-daily counting of pre-specified items
provides the following advantages:
o Timely detection and correction of inaccurate records
o Elimination of lost production time due to unexpected
stock outs
o Structured approach using employees trained in cycle
counting
 7.8. Standardization
 Standardization means producing maximum variety of products
from the minimum variety of materials, parts, tools and
processes.
 It is the process of establishing standards or units of measure
by which extent, quality, quantity, value, performance etc., may
be compared and measured.

 Advantages of standardization:
o Work study section is benefited with efficient break down of
operations and effective work measurement.
o Costing can obtain better control by installing standard costing.
o More time is available to the supervisors to make useful records and
preserve statistics.
o Reduced wastage and scrap.
o Helps supervisors to run his department efficiently and effectively.
 7.9. Just-in-Time (JIT) Manufacturing
Just-in-Time (JIT) Manufacturing is a philosophy rather
than a technique.
By eliminating all waste and seeking continuous
improvement, it aims at creating manufacturing system that is
response to the market needs.
JIT is viewed as a “production methodology which aims to
improve overall productivity through elimination of waste and
which leads to improved quality”.
JIT provides an efficient production in an organization and
delivery of only the necessary parts in the right quantity, at the
right time and place while using the minimum facilities”.
 7.9. 1. Benefits of JIT
 The most significant benefit is to improve the responsiveness
of the firm to the changes in the market place thus providing
an advantage in competition.
 Following are the benefits of JIT:
i. Product cost—is greatly reduced due to reduction of
manufacturing cycle time, reduction of waste and inventories
and elimination of non-value added operation.
ii. Quality—is improved because of continuous quality
improvement programs.
iii. Design—Due to fast response to engineering change,
alternative designs can be quickly brought on the shop floor.
iv. Productivity improvement
v. Higher production system flexibility
vi.Administrative and ease and simplicity