Eagle Home Products: Controlling Purchases and Materials Usage - Essay Example

? Planning and Controlling Purchases and Materials Usage Table of contents Introduction 2 Importance of study 2 Analysis 5 Conclusion 7 References 9 Planning and Controlling Purchases and Materials Usage Introduction “Eagle Home Products” is a medium sized company engaged in manufacturing of home appliances of various types and sizes for local market and exports. Materials management activities related to purchasing, storing and providing goods and services for production are headed by the Purchase Manager and Stores Manager respectively. The quality, quantity, place and time for supply of materials are predetermined for smooth flow of production in the organization. Budgeting is an important tool adopted by the company for planning and controlling purchases and materials usage. Sales forecast is the basis for planning and budgeting after carefully considering various factors such as capacity available and product mix. Since inventory involves significant investment, keeping it at an optimum level is very important for controlling cost. Material requirement planning is carried out in line with the production schedule for the year. Importance of study Home appliances market is very competitive. The company’s products face stiff competition from the products imported from China and Japan. The company is under tremendous pressure to ensure quality of its products and make improvements to maintain its market share. The company focuses on ‘planning and controlling purchases and materials usage’ with a view to bring down the cost of production to make its products more competitive in the market. The main objective of inventory planning is to keep the investment low for reducing the interest cost. The inventory can be classified into three categories. 1. Raw materials 2. Components purchased for assembly 3. Finished products Purchase and production departments along with stores are responsible for planning and controlling of inventory of raw materials and components and the production department is responsible for planning and controlling of material usage. There are varieties of household appliances manufactured and marketed by the company. Since most of the appliances are electrically operated, quality of materials purchased is very important, keeping in view the safety of the customers. Timely supply of raw materials and components avoid disruptions in production schedule usually. Order size is decided based on factors such as price, usage and lead time required for supply of materials. The materials should be purchased without compromising quality of materials at the cheapest cost in line with the purchase policy of the organization. This requires product knowledge and negotiating skills on the part of purchase manager. Planning and control of purchases is closely relating to storing of raw materials and component part before issue to various production or assembly units of the organization. Inventory planning is therefore is an important aspect in planning and control of purchases in the organization. According to Michalski (2008) “The basic financial inventory management aim is holding the inventory to a minimally acceptable level in relation to its costs. Holding inventory means using capital to finance inventory and links with inventory storage, insurance, transport, obsolescence, wasting and spoilage costs.” Planning and control of usage of materials in production department depends upon the regular supply of materials by the stores department, efficiency in production by the workers and keeping generation of scrap at minimum level. At the same time, requirements as per the production schedule and changes thereof for a week need to be informed in advance to the stores for closely monitoring the stock levels of various raw materials and components for making necessary requisition to purchase department for initiating purchase process. Though reorder levels are fixed for various materials, uncertainties in lead time and sudden demand for appliances should be informed to the purchase and stores departments for taking actions taken in advance on time to avoid disruptions in production. Sometimes the suppliers are not in a position to execute the orders placed on them on time in respect of some components. These should be categorized as ‘critical components’ for monitoring on a continuous basis till the production problems are resolved at the suppliers’ end. Various stages in work-in-progress or components or sub-assemblies lying in production department for regular use are also very crucial in estimating the requirements by production department. At present, periodical review of work-in-progress is not undertaken. There are several semi-finished appliances lying in shop floors for a longer period. Therefore, a system for review of work-in-progress should be established in the company. In view of interdependency, close coordination among purchase, stores and production departments is very important to deliver the budgeted output. Axsater (2006, p.1) stated “Inventories cannot be decoupled from other functions, for example purchasing, production, and marketing. As a matter of fact, the objective of inventory control is often to balance conflicting goals.” Usage of materials in production department is governed by several factors. Of which design and development of the components, standardization of the components and outsourcing are considered important in view of scope for cost reduction, improvement in quality and increasing order quantity. Increase in order quantity will be result in cost reduction due to discounts. Also, ABC analysis of the components will ensure adequate monitoring from investment and control angle. Since inventory cost in this industry is very significant, attention in planning and control of inventory cost is necessary for improving the bottom line. Analysis Budget analysis has been useful in ascertaining the difference between actual results and budget estimates and the causes for differences between actual and budgeted output levels, variable costs and fixed costs relating to purchases and materials usage. The causes underlining positive materials price variance may be due to decrease in price, skilful negotiations on the part of purchase manager, quantity discounts due to larger lot sizes or inferior quality of materials. Dewan and Sudarshan (1996 p. 2) observed “Through the procurement function the organization operates as a customer. Accordingly, it is susceptible to the marketing strategies of the vendors from whom it obtains the materials that are required for its operations.” Direct materials efficiency variances are relating to usage of materials and the production manager is responsible for usage variances. Various functions are interdependent. For example, usage variance may also arise due to poor quality of materials purchased. Lack of planning for contingencies and the absence of risk management procedure in the system should be rectified through proper planning based on budget estimates with changes in the external and internal environment properly factored in for scheduling of production. Continuously introducing new products and improving the functionalities of an existing product is important for retaining and improving market share. Computer Aided Design (CAD) has come to the rescue of the company to a phenomenal level. However, development and testing of the products for marketing is an arduous task. This is because apart from functionalities, the product should be competitive in the market in relation to its competitors’ products. Therefore, controlling cost is very important for making the product profitable in marketing. The company needs to explore possibilities for cost reduction in areas like use of substitute material and control of wastage through standardization. Establishing standards is a key area where there is scope for improvement and cost reduction. This will avoid discretions in defining the needs. There are various types of standards. For example, there are specifications relating to factors such as quality, size, colour code and hardness of the materials or components. There are number of appliances with many components commonly used in more than one product. Under the concept of standardization the standards of the components are accepted by the industries and users of the products. For instance bolts nuts of various types have been standardized and accepted by the industries. This standardization results in mass production of these components. Such products will be cheaper in the market. Standardization leads to interchange of components in manufacturing. Reduction in number components is possible when the same component could be used in several products made by the company. This will also reduce inventory cost to a greater extent since these components are readily available in the market or lead time in these cases is shorter. Purchase of these components will be easy. Increase in the number of commonly used or interchangeable components reduces wastages in manufacturing, if they are produced internally. This will increase productivity and efficiency in materials usage. Outsourcing is an important area with greater scope for cost reduction. There are many small scale units with lesser overheads compared to this organization undertaking sub-contract jobs. Outsourcing jobs to these units on contract basis, for example, sending raw materials for machining or threading specifying allowance for wastage will reduce cost of production considerably. Alternatively, subcontracting for supply of components including material could be arranged. This will be more beneficial if the price is acceptable since cost of transportation by the company is avoided. Saxena, R. S. (2009 p. 106) stated “ABC analysis is the basis for materials management processes and helps define how stock is managed. It can form the basis of various activity including leading plans on alternative stock arrangements (consignment stock), reorder calculations…” ABC analysis categorizes materials and components purchased and stored into broadly three categories, Category A with stricter control, Category B with lesser controls and Category C with minimal controls. About 10% of the items fall under A Category constituting 70% in terms of total inventory cost. 60% of the items falling under C Category constitute only 10% of inventory value, and Category B falling in between. The management will be in a position to closely monitor stock levels in the case of A Category items, so that inventory can be kept at low levels and timely action for replenishment of stock could be taken. All purchase orders are presently finalised by the Purchase Manager after negotiations with the suppliers. However, approval system for purchasing based on order value should be introduced in the company. Approval for purchase of A Category items may be entrusted to the Director for ensuring stricter control over purchases. This will also ensure timely intervention by him, wherever necessary, to avoid interruptions in production. The components and output is not linked properly under the system. At least, issue of A Category items should be made traceable to the final product through proper codification. This will be useful in dealing with the sales returns for tracing back the supplier of the component, if the component is defective. This will also be useful in fixing up responsibility on operators and quality control inspectors to avoid such mistakes in future. Conclusion There is good scope for reduction of cost of production through planning and controlling purchases and materials Usage. The company is following budgetary control method for planning. But, systems like graded approval for purchases should be introduced to ensure stricter control. The changes in the external and internal environment should be continuously monitored and factored in production schedule without loss of time. The company has to concentrate on designs and standardization to improve materials usage. Introduction of ABC analysis, review of work-in-progress and codification will improve materials usage and lead to cost reduction. The possibilities of outsourcing could be explored by the company to reduce overall cost. References Axsater, S. (2006). InventoryControl. (2nd Ed.). New York. Springer. Dewan, J. M. and Sudarshan, K. N. (1996) Purchasing and Materials Management. New Delhi: Discovery publishing House. Michalski, G. (2008). Value-Based Inventory Management. Romanian Journal of Economic Forecasting – 1/2008 82-90 Saxena, R. S. (2009). Inventory Management: Controlling in a Fluctuating Demand Environment. New Delhi: Global India Publications. Read More