Chapter-4

Material Management
✓Basics of Material Management,
✓Purchasing and
✓Inventory control
 Definition of Materials
• Materials refer to inputs into the production
process, most of which are embodied in the
finished goods being manufactured
• It may be raw materials, work-in-progress,
finished goods, spare parts and components,
operating supplies such as lubricating oil,
cleaning materials, and others, required for
maintenance and repairs
 Introduction to Materials Management
• Materials management is defined as “the function
responsible for the coordination of planning, sourcing,
purchasing, moving, storing and controlling materials in
an optimum manner so as to provide a pre-decided service
to the customer at a minimum cost”.
• Materials Management is that aspect of management
function, which is primarily concerned with the acquisition,
control, and use of materials needed and flow of goods and
services connected with the production process having
some predetermined objectives in view.
 Objects of materials management
1. Minimization of materials costs
2. To reduce inventory for use in production process and
to develop high inventory turnover ratios
3. To procure materials of desired quality when required,
at lowest possible overall cost of the country
4. To reduce paper work procedure in order to minimize
delays in procuring materials.
5. To note changes in market conditions and other
factors affecting the production
6. The purchase, receive, transport, store materials efficiently
 Cont…
7. To reduce cost, through simplification, standardization,
value analysis etc.

8. To conduct studies in new areas e.g., equality consumption and

cost of materials so as to minimize cost of production.
 Purchasing
✓Purchasing: implies procurement of raw materials
machinery, service etc. which are needed for
production and maintenance of the concern

✓This includes selection of sources of supply finalization

in terms of purchase, placement of purchase orders,
follow-up, maintenance of smooth relations with
suppliers, approval of payments to suppliers,
evaluating and rating suppliers.
 Purchasing
Objectives of purchasing
1. To avail the materials, suppliers and equipment's at
the minimum possible costs
2. To ensure the continuous flow of production
3. To increase the asset turnover
4. To develop an alternative source of supply
5. To establish and maintain the good relations with
the suppliers
6. To achieve maximum integration with other
department of the company
7. To train and develop the personnel
8. Efficient record keeping and management reporting
 Parameters of Purchasing
Ten ‘r’s’ of the art of efficient purchasing
1. Right price
2. Right quality
3. Right time
4. Right source
5. Right quantity
6. Right attitude
7. Right contracts
8. Right material
9. Right transportation
10.Right place of delivery
 Purchasing process
The following are the logical steps in the purchasing
process:
1. Requisitioning purchases
2. Exploring sources of supply
3. Issuing of tenders and obtaining quotations
4. Opening of tenders and quotations and preparation
of comparative statement
5. Negotiating over the purchase price and terms of supply
6. Placing purchase order
7. Receiving of materials along with the invoice
8. Checking inward invoice
9. Inspecting and testing materials
10. Forwarding the materials to stores
11. Checking invoice and passing of bills for payments
 Inventory definition
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.
The interval between receiving the purchased parts and
transforming them into final products varies from industries
to industries depending upon the cycle time of manufacture.
It is, therefore, necessary to hold inventories of various kinds
to act as a buffer between supply and demand for efficient
operation of the system.
Thus, an effective control on inventory is a must for smooth
and efficient running of the production cycle with least
interruptions.
11
 Reasons for Keeping Inventories

1. To stabilize production
2. To take advantage of price discounts
3. To meet the demand during the
replenishment period
4. To prevent loss of orders (sales)
5. To keep pace with changing market
conditions
12
 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).

13
 Objectives of Inventory Control
1. To ensure adequate supply of products to customer and avoid
shortages as far as possible.
2. To make sure that the financial investment in inventories is
minimum (i.e., to see that the working capital is blocked to the
minimum possible extent).
3. Efficient purchasing, storing, consumption and accounting for
materials is an important objective.
4. To maintain timely record of inventories of all the items and to
maintain the stock within the desired limits
5. To ensure timely action for replenishment.
6. To provide a reserve stock for variations in lead times of
delivery of materials.
7. To provide a scientific base for both short-term and long-term
planning of materials.
14
 Benefits of Inventory Control

1. Improvement in customer’s relationship because of

the timely delivery of goods and service.
2. Smooth and uninterrupted production and, hence,
no stock out.
3. Efficient utilization of working capital. Helps in
minimizing loss due to deterioration, obsolescence
damage and pilferage.
4. Economy in purchasing.
5. Eliminates the possibility of duplicate ordering.
15
 ABC analysis system
• An important aspect of inventory management is
that items held in inventory are not of equal
importance in terms of dollar invested, profit
potential, sales or usage volume, or stock out
penalties.
• For instance, a producer of electrical equipment
might have electric generators, coils of wire, and
miscellaneous nuts and bolts among items carried
in inventory. It would be unrealistic to devote
equal attention to each of these items.
• Instead, a more reasonable approach would
allocate control efforts according to the relative
importance of various items in inventory. This
approach is called A-B-C classification approach
16
 ABC Classification System
Classifying inventory according to some measure of
importance and allocating control efforts accordingly.
A - very important
B – moderate important
C - least important

High
A
Annual
$ value B
of items
Low C
Few Many

Number of Items
17
Classificatio Percentag Percentage value
ns e of items of annual usage Remark
Close day
Class A items About 20% About 80% to day
control

Regular
Class B items About 30% About 15%
review

Infrequent
Class C items About 50% About 5%
review

18
• Example
The annual dollar value of 12 items has been calculated based on annual
demand and unit cost. The annual dollar values were then arrayed from highest
to lowest to simplify classification of items. It is reasonable to classify the first
two items as A, the next three items as B and the remainder are C items.
Item number Annual demand Unit cost Dollar value
1 500 200 100,000
2 1000 70 70,000
3 1900 500 950,000
4 1500 100 150,000
5 3900 700 2,730,000
6 1000 915 915,000
7 200 210 42,000
8 1000 4000 4,000,000
9 8000 10 80,000
10 9000 2 18,000
11 2500 330 825,000
12 400 300 120,000
 Solution
Item Annual Unit Dollar Classificatio
DV%
number demand cost value n
8 1000 4000 4,000,000 40.0%
5 3900 700 2,730,000 27.3% A
3 1900 500 950,000 9.5%
21% 76.8%
6 1000 915 915,000 9.2%
11 2500 330 825,000 8.3% B
4 1500 100 150,000 1.5%
27% 18.9%
12 400 300 120,000 1.2%
1 500 200 100,000 1.0%
9 8000 10 80,000 0.8%
C
2 1000 70 70,000 0.7%
7 200 210 42,000 0.4%
10 9000 2 18,000 0.2%
53% 10,000,000 4.3%
 Cycle Counting
• Another application of the A-B-C classification approach is as a
guide to cycle counting, which is a physical count of items in
inventory. The purpose of cycle counting is to reduce
discrepancies between the amounts indicated by inventory records
and the actual quantities of inventory on hand.
• The key questions concerning cycle counting for management are:
• How much accuracy is needed?
• When should cycle counting be performed?
• Who should do it?
N.B. The American Production and Inventory Control
Society (APICS) recommends the following guidelines for
inventory record accuracy: ± 0.2 percent for A items, ± 1
percent for B items, and ± 5 percent for C items.
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 Mathematical Models for Determining Order Quantity (Q)

1. Economic Order Quantity Models

➢The question of how much to order is frequently
determined.
➢EOQ models identify the optimal order quantity by
minimizing the sum of certain annual costs that vary
with order size.
➢Three order size models are described:
• The basic economic order quantity model
• The economic production quantity model
• The quantity discount model
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Economic Order Quantity (EOQ) model

Assumptions of EOQ Model

1. Only one product is involved
2. Annual demand requirements are known
3. Demand is even throughout the year
4. Lead time does not vary
5. Each order is received in a single delivery
6. There are no quantity discounts

23
 EOQ Model inventory cycle
• The inventory cycle begins with receipt of an order of
Q units, which are withdrawn at a constant rate over
time.
• When the quantity on hand is just sufficient to satisfy
demand during lead time, an order for Q units is
submitted to the supplier.
• Because it is assumed that both the usage rate and lead
time don’t vary, the order will be received at the
precise instant that the inventory on hand falls to zero.
• Thus, orders are timed to avoid both excess and stock
outs (i.e., running out of stock).
• The following figure illustrate this idea.
24
 The Inventory Cycle
Profile of Inventory Level Over Time
Q
Usage rate
On hand 50 units
350 units

Reorder
Point
100 units 5 7 12 14

Time (days)
Receive Place Receive Place Receive
order order order order
order
Lead time
2 day
25
 Total Cost
The total annual cost associated with carrying and ordering
inventory when Q units are ordered each time is:

Total Cost = Annual carrying cost + Annual ordering cost

TC = Q + D S
H
2 Q

Where:
Q = quantity to be ordered Note that D and H must be in
the same units, e.g., months,
H= holding cost per unit (carrying
cost per unit) years
D = annual demand
S = ordering (setup cost) per order 26
 Cost Minimization Goal

The Total-Cost Curve is U-Shaped

Q D
TC = H + S
2 Q
Annual Cost

Holding cost

Ordering Costs

QO (optimal order quantity) Order Quantity (Q)

27
 Deriving the EOQ

Using calculus, we take the derivative of the total cost

function and set the derivative (slope) equal to zero and
solve for Q.

2DS 2(Annual Demand )(Order or Setup Cost )

Q OPT = =
H Annual Holding Cost

Number of order per year= D/Q0

Length of order cycle = Q0/ D
Where Q0 = QOPT
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 EOQ
• Example
A local distributor for a national tire company expects to
sell approximately 9600 steel-belted radial tires of a
certain size and tread design next year. Annual carrying
cost is $16 per tire, and ordering cost is $75. the
distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ is ordered?

29
Solution
𝐷 = 9600 𝑡𝑖𝑟𝑒𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
𝐻 = $16 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
D. TC = Carrying cost +
𝑆 = $75 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
Ordering cost
A. Q0 = 2 DS 2(9600)75
= = 300 ✓ 𝑇𝐶 = (𝑄0/2) 𝐻 + (𝐷/𝑄0) 𝑆
H 16
300
B. Number of order per year: = 16
2
D/Q0 = 9600/300 = 32 order +(9600/300) 75

C. Length of order cycle: LCO = = 2400 + 2400

= $4800
(𝑄 ∗ 𝑂𝑝𝑒𝑟𝑎𝑡𝑒 𝑑𝑎𝑦𝑠)/

300∗288
𝐷= =9 workdays
9600
Economic Production Quantity (EPQ)

• Production done in batches or lots

• Capacity to produce a part exceeds the part’s

usage or demand rate

• Assumptions of EPQ are similar to EOQ except

orders are received incrementally during
production

31
 Economic Production Quantity Assumptions

• Only one item is involved

• Annual demand is known
• Usage rate is constant
• Usage occurs continually, but production
occurs periodically
• Production rate is constant
• Lead time does not vary
• No quantity discounts
32
Economic Run Size
The run size can be determined by using the following formula:

2DS p
Q0 =
H p− u
Where:
P = production or delivery rate
U = usage rate
33
 Economic run size (cont.)
The minimum total cost is determined as follows:

TC min = carrying cost + setup cost =  I max   D

  H +   S
 2   Q0 

Q0
I max = ( P − u) = Maximum inventory
P

Q0
cycle = = Cycle length
u

Q0
Run = = Run length
P
 Example
A toy manufacturer uses 48000 rubber wheels per year for
its popular dump truck series. The firm makes its own
wheels, which it can produce at rate of 800 per day. The toy
trucks are assembled uniformly over the entire year.
Carrying cost is $1 per wheel a year. Setup cost for a
production run of wheels is $45. the firm operates 240 days
per year. Determine the:
a. Optimal run size
b. Minimum total annual cost for carrying and setup
c. Run time 35
Solution
D = 48000 wheels per year
S = $45
H = $1 per wheel per year
P = 800 wheels per day
U = 48000 wheels per 240 days, or 200 wheels per day

2 DS P 2(48000)45 800
a. Q0 = = = 2400
H P−u 1 800 − 200

 I max   D
a. TC min = carrying cost + setup cost =   H +   S
 2   Q0 
 Solution (cont.)

Q0 2400
I max = ( P − u) = (800 − 200) = 1800
P 800
1800 48000
TC =  $1 +  $45 = $900 + $900 = $1800
2 2400
Q0 2400
cycle = = = 12days
u 200
Q0 2400
Run = = = 3days
P 800
 Quantity discount model
• Quantity discounts are price reductions for large orders
offered to customers to induce them to buy in large
quantities.
• In these buyer must weigh the potential benefits of
reduced purchase price and fewer orders that will
result from buying in large quantities against the
increase in carrying cost caused by higher average
inventories.
• The buyer’s goal with quantity discounts is to select the
order quantity that will minimize the total cost, where
the total cost is the sum of carrying cost, ordering
cost, and purchasing (i.e., product) cost.
38
 Total Costs with Purchasing Cost
Annual Annual Purchasing
TC = carrying + ordering + cost
cost cost

Q + DS + PD
TC = H
2 Q
Where P is the unit price.

Recall that in the basic EOQ model, determination of order size

doesn’t involve the purchasing cost. The inclusion of the unit price
in the total cost computation merely increase the total cost by the
amount P times the demand (D). See the following graph.
39
 Total Costs with PD

Cost

Adding Purchasing cost TC with PD

doesn’t change EOQ

TC without PD

PD

0 EOQ Quantity
40
 Total cost with purchasing cost
• When quantity discounts are offered, there is a separate
U-shaped total-cost curve for each unit price.
• Because the unit prices are all different, each curve is
raised by a different amount: smaller unit price will
raise the total cost curve less than larger unit price.
• No one curve applies to the entire range of quantities;
each curve applies to only a portion of the curve.
• Each total cost curve has its own minimum.
❑There are two general cases of the quantity discount
model:
1. The carrying cost is constant
2. The carrying cost is a percentage of the purchase
price.
41
 EOQ when carrying cost is constant
• For carrying costs that are constant, the procedure is
as follows:
1. Compute the common minimum point by using the
basic economic order quantity model.
2. Only one of the unit prices will have the minimum
point in its feasible range since the ranges do not
overlap. Identify that range:
a. If the feasible minimum point is on the lowest price
range, that is the optimal order quantity.
b. If the feasible minimum point is any other range,
compute the total cost for the minimum point and for
the price breaks of all lower unit cost. Compare the
total costs; the quantity that yields the lowest cost is
the optimal order quantity.
42
Example

➢ The maintenance department of a large hospital uses

about 816 cases of liquid cleanser annually. Ordering
costs are $12, carrying costs are $4 per case a year, and
the new price schedule indicates that orders of less than
50 cases will cost $20 per case, 50 to 79 cases will cost
$18 per case, 80 to 99 cases will cost $17 per case. And
larger orders will cost $16 per case.

a. Determine the optimal order quantity and the total cost.

43
Solution
Range Price
• D = 816 cases per year, S = $12 1 to 49 $20
H= $4 per case per year. 50 to 79 18
• The price schedule is:
80 to 99 17
1. Compute the common EOQ
100 and more 16
2 DS 2(816)12
EOQ = = = 69.97  70
H 4

2. The 70 cases can be bought at $18 per case because 70 falls in the
range of 50 to 79 cases. Therefore the total cost to purchase 816
cases a year, at the rate of 70 cases per order, will be:
TC70 = carrying cost + ordering cost + purchasing cost
= (Q0/2)H + (D/Q0) S + PD
= (70/2)4 + (816/70) 12 + 18 (816) = $14,968
Solution (cont.)
• Because lower cost ranges exist, each must be checked
against the minimum total cost generated by 70 cases
at $18 each. In order to buy at $17 per case, at least 80
cases must be purchased. The total cost at 80 cases
will be:
TC80 = (80/2) 4 + (816/80)12 + 17(816) = $14,154
• To obtain a cost of $16 per case, at least 100 cases per
order are required and the total cost at that price break
point will be:
TC100 = (100/2)4 + (816/100) 12 + 16(816) = $13,354
Therefore, because 100 cases per order yield the lowest
cost, 100 cases is the overall optimal order quantity.
45
 EOQ when carrying cost is a percentage of the unit price

When carrying cost are expressed as a percentage of price, determine

the best purchase quantity with the following procedure:

1. Beginning with the lowest unit price, compute the minimum points for
each price range until you find a feasible minimum point (i.e., until a
minimum point falls in the quantity range of its price).

2. If the minimum point for the lowest unit price is feasible, it is the
optimal order quantity. If the minimum point is not feasible in the
lowest price range, compare the total cost at the price break for all lower
prices with the total cost of the feasible minimum point. The quantity
which yield the lowest total cost is the optimum
46
 Example

• Surge Electric uses 4000 toggle Switches a year.

Switches are priced as follows: 1 to 499, 90 cents each;
500 to 999, 85 cents each; and 1000 or more, 80 cents
each. It costs approximately $30 to prepare an order and
receive it, and carrying costs are 40 percent of purchase
price per unit on an annual basis.

a. Determine the optimal order quantity and the total

annual cost
47
Solution
• D = 4000 switches per year, S = $30 H = 0.4 P
• Find the minimum point for each price, starting with the lowest
price, until you locate a feasible minimum point.

Range Unit price H Quantity Remark

1 to 499 $0.90 0.40(0.90) = 816 Not in range
0.36 Switches
500 to 0.85 0.40(0.85) = 840 In ranges
999 0.34 Switches
1000 and 0.80 0.40(0.80) = 866 Not in range
more 0.32 Switches

This is a feasible point; it falls in the $0.85 per

switch range of 500 to 999
 Cont…

• Now compute the total cost for 840, and compare it to

the total cost of the minimum quantity necessary to
obtain a price of $0.80 per switch
TC = carrying cost + ordering cost + purchasing cost
= (Q/2) H + (D/Q)S + PD
TC840 = (840/2) (0.34) + (4000/840) (30) + 0.85(4000) =
$3,686
TC1000 = (1000/2) (0.32) + (4000/1000) (30) +
0.80(4000) = $3,480
Thus, the minimum-cost order size is 1000 switches

49
 Issue and Replenishment
• Reorder Point - When the quantity on hand of an item
drops to this amount, the item is reordered

• Safety Stock - Stock that is held in excess of expected

demand due to variable demand rate and/or lead time.

• Service Level - Probability that demand will not exceed

supply during lead time.

SL= 100-stock out risk

50
 Determinants of the Reorder Point
• The rate of demand (usually based on a forecast)
• The lead time
• Demand and/or lead time variability
• Stock out risk (safety stock)
If the demand and lead time are both constant, the
reorder point is simply:
ROP = d × LT
Where:
d = demand rate (units per day or week)
LT = lead time in days or weeks
Note that demand and lead time must be expressed
in the same time units.
51
 When to reorder (cont.)
• When variability is present in demand or lead time, it
creates the possibility that actual demand will exceed
expected demand. Consequently, it becomes necessary
to carry additional inventory, called “safety stock”, to
reduce the risk of running out of stock during lead time.
The reorder point then increases by the amount of the
safety stock:
ROP = Expected Demand During Lead Time + Safety Stock
The following graph shows how safety stock can reduce
the risk of stock out during lead time

52
 Safety Stock

Quantity

Maximum probable demand

during lead time

Expected demand
during lead time

ROP

Safety stock
LT Time
Safety stock reduces risk of
stock out during lead time 53
54
 Safety stock (cont.)
• Because it cost money to hold safety stock, a manager must
carefully weigh the cost of carrying safety stock against the
reduction in stock out risk it provides.
• The customer service level increases as the risk of stock out
decreases.
• The order cycle “service level” can be defined as the
probability that demand will not exceed supply during lead
time. This means a service level 95% implies a probability of
95% that demand will not exceed supply during lead time.
• The “risk of stock out” is the complement of “service level”
• The amount of safety stock depends on:
1. The average demand rate and average lead time
2. Demand and lead time variability
3. The desired service level
55
 Reorder point models
❑ There are many models that can be used in cases when variability
is present. These models are:
1. The expected demand during lead time and its standard
deviation are available. In this case the formula is:
ROP = expected demand during lead time + ZdLT
Where:
Z = number of standard deviations
dLT = the standard deviation of lead time demand
Safety Stock = ZdLT
• This model assume that any variability in demand rate or lead time
can be adequately described by a normal distribution, this is not a
strict requirements; the model provide approximate reorder points
even where actual distributions depart from a normal distribution.
56
Reorder Point

The ROP based on a normal

Distribution of lead time demand
Service level
Risk of
a stock out
Probability of
no stock out

Quantity
Expected ROP
demand Safety
stock
0 z z-scale

57
 Example
• Suppose the manager of a construction supply house
determined from historical records that demand for
sand during lead time averages 50 tones. In addition,
suppose the manager determined that demand during
lead time could be described by a normal distribution
that has a mean of 50 tons and standard deviation of 5
tons and manager assuming stock out risk of no more
than 3 percent will be accepted.
a. What value of Z is appropriate?
b. How much safety stock should be held?
c. What reorder point should be used?
58
 Solution
The expected lead time demand = 50 tons
dLT= 5 tons
Risk = 3 percent
Service level = 1- risk = 0.97
a. From z tables, using a service level 0.97, you
obtain a value of Z = + 1.88
b. Safety stock = Z dLT= 1.88(5) = 9.4 tons
c. ROP = Expected Demand During Lead Time
+ Safety Stock
= 50 + 9.4 = 59.4 tons 59
 THANK YOU !!!
Wish you all the best!!!

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