Purchasing objectives may be both general and specific. The overall purchasing task or the general objective is to obtain materials of the right quality in the right quantity, from the right source, delivered to the right place at the right source both before and after sale in the right price. All the rights must be reconcilable and integrated to assure survival, profitability, competitiveness, supplies continuity, cost reduction to the organisation.
The quantity of items required will depend on immediacy or otherwise of needs, notified requirements based on known or estimated usage of items required. Two types of situations are discussed in relation to the right quantity, they include situations of immediate needs and continuous needs. What constitute the right quantity here will depend on the following factors:
1. The overall quantities used in a given period
2. The pattern of usage of the items
3. The availability of the items in relations to the needs.
4. The frequency of changes in the end product, either through seasonal or design changes.
5. The effect of quantity on the costs of purchasing.
6. The extent to which items are likely to deteriorate prior to their being required.
7. The extent to which the organisation can afford to finance quantities in excess of immediate needs.
8. The extent to which the company can store quantities in excess of immediate needs
9. The willingness of suppliers to co-operate in supplying the quantities called. for
10. The pattern of supply sources available
11. The cost of holding and ordering items, (economic order quantity, EOQ)
Quantity And Buying Policies
What constitutes a “right” quantity frequently determines the Buying policy applicable in each case.
(a). Purchase against a specific requirement normally applied to satisfy the “Special requirements such as capital purchases, items for special projects, items for jobbing production and intermittent departmental needs.
(b) Purchase to maintain stock: This means buying at short pre-determined periods ahead of production, and applied to items required in-line with the production programme where a small stand-by stock is necessary to equate supply need.
(c) Ordinary Forward Buying: This policy involves purchasing quantities in excess of minimum based on normal usage and average delivery, and is applied to all items which are held in stock against level in excess of minimum.
Quantity And Ordering Methods
Different ordering methods may be adopted to give economic advantage to the buyer, namely:
(i) Individual orders – Each for an economic quantity and no further commitment.
(ii) Long term contracts Covering estimated requirements with call-off orders as required.
(iii) Bulk Orders Firms orders for known requirement’s deliveries being made to a pre-determined schedule.
Economic Order Quantity (EOQ)
Consideration has just been given to all of the factors which are likely to affect what might be considered the “right” quantity. These include, usage, availability, possible deterioration and co-operation of suppliers, as well as the financial/cost . considerations involved. We shall now m consider the costs aspects in more details.
Where all other considerations can be met satisfactorily, the ultimate choice of what represents the “right” quantity, from an economic point of view, can be determined by combining the costs of ordering materials with the costs incurred in holding or carrying stocks. Whichever quantity results in minimum total costs is regarded as the “right” quantity (Economic Order Quantity)
Factors Affecting EOQ:
(a) Ordering Costs
The cost of ordering include:
1. The clerical and administrative costs associated with the purchasing, accounting and goods received department.
2. Transport costs expended on goods m and personnel e.g loading and off-loading costs.
3. Where goods are manufactured internally, the set up and tooling cost connected with each production run.
(b) Stockholding costs:
Also called carrying costs. It is the cost of financing and maintaining an order. They include: interest tied up in stock, storage charge (rent, lighting, heating, refrigeration, air conditioning, etc) Handling costs, stores staffing, equipment maintenance and running costs, audit.
Stocking or perpetual inventory cost, insurance and security, losses due to deterioration, obsolescence, wastage and pilling, pilferage, vermin damage, etc. clerical costs of stocking.
(c) Stockout Costs
These are the costs associated with running out of stock. The avoidance of these costs is the basic reason why stocks are held in the first instance.
The costs include the following:
1. Lost contribution through lost sales caused by the stockout.
2. Loss of future sales because customers go elsewhere.
3. Loss of customers goodwill.
4. Cost of production stoppages caused by stockout of”work-in progress or raw-material”
5. Labour frustration over stoppage
6. Extra costs associated with urgent, often small quantity replenishment purchases
Economic Ordering Quantity (EOQ) Models
A model is an imitation of reality. The EOQ is only a model representing what could operate in real life situation. It is also a mathematical formula used by many organisations to establish the most economic amount to order for any item held in stock.
Basic EOQ Assumption
For the model to be accurate, the following assumptions need be recognised:
(i) Uniformity of demand
(ii) Absence of any limitation imposed by stores capacity.
(iii) Cost of acquisition and holding costs for unit of material are independent of order quantity.
(iv) Order and delivery quantities are equal
(v) The prices of raw materials or components are stable.
(vi) There will be no loss in value, other than allowed for in calculating holding costs arising from deterioration and obsolescence.
Based on these assumption, two of the typical EOQ models that can be derived are:
1. The basic EOQ model
2. The quantity discount model
However, only the first model is relevant for our purpose here.
The basic EOQ model: This assumes that the entire quantity order is to be received at one time.
Problems involved in using EOQ formulae
As already expected, formulae do not take into account many other factors which are difficult to quantify such as:
(i) Unforeseen fluctuations in demand
(ii) Possible difficulties in supply
(iii) The extent to which items are subject to deterioration
(iv) How far suppliers are prepared to accept the quantities considered economic by the buyer.
(v) How far other controls in the company may over-ride the application of EOQ.
In any event, the costs themselves are always difficult to determine and are subject to constant change. This formula tries to balance out in mathematical terms the advantages of low stocks and high stocks and low ordering costs, and the costs of storage affected accordingly. In situation where bulk discounts are available, stock control must take these possible savings into account in their EOQ calculations.
Objectives of Economic Order Quantity
The main objective is the optimization level of stock and it includes the following:
(a) Minimising total cost i.e (Purchase price cost, ordering cost, carrying/holding cost and stockout cost
(b) The quantity that should be ordered anytime an order is placed in order to minimize the total cost.
(c) When to order.
Problems associated with EOQ based system.
There are a number of problems that the stock controller must bear in mind when employing the EOQ method of stock control. These are as follows:
(a) Accurately establishing the “true” cost of ordering and setting a standard to cover every type of order.
(b) Establishing ‘true’ storage costs, given that many organisations have a very wide range of stock, each requiring different forms of handling and storage.
(c) How to cope with unexpected alterations in the pattern of demand for stock.
(d) How to cope with variations in lead time even though deliveries may be set at regular intervals, delays can still occur.