9/3/2010

“PURCHASE
PROCEDURE”

BY:ASHISH SAWANT
A document by……………………………….ashish sawant

PURCHASE MANAGEMENT

Purchase Management is a function of materials management in a

company. Their basic function is procuring the inputs for
production function. This function encompasses suppliers in the
market external to the organization and several internal to the
organization.
Importance of purchase management: purchase management is
considered to be very important function of materials management
in a company. Its importance is felt even outside the formal scope of
materials management. As the purchase decisions commit a very
large portion of financial resource of the company purchase
function is said to be highly important. Purchase personnel deal with
large number of external agencies while performing their functions.
Hence they represent company’s reputation in the out side world.
As they negotiate and finalize deals worth lot of money for the
company their integrity is of utmost importance for the organization.
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Objectives or goals of purchasing: primary objective or goal of

purchasing function is making inputs available to the conversion
process at minimum cost to the final output of the company. Thus
focus is on system out put rather than on micro level objectives.

The inputs to be made available are raw materials, semi finished

items, bought out items etc. There are certain parameters to be
monitored for fulfilling the system objectives. We can call them
goals of purchasing.

These goals are popularly known as 5Rs of purchase namely:

right price,
right quantity,
right quality,
right place and
right time.

In simple terms, if the above 5Rs are achieved primary objective is

fulfilled.

Right material:
right material is the one chosen as a result of value analysis,
standardization, variety reduction etc.

Right price:
right price is determined by costing the production process of the
supplier.

Right price is determined by allowing reasonable profit for the

supplier and insisting and helping to reduce cost. Tender system
should be used to identify lowest responsible bidder rather than
lowest bidder. Principles normally used to ensure right price are
cost structure and learning curve.
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Right quantity: right quantity of purchase is the one that

ensures no excess and no shortage. High priority items are subjected
to EOQ analysis to determine the right quantity for purchase. This
ensure overall minimum cost for inventory.

Right quality: in an item purchased should ensure adhering to

mutually accepted standard by supplier and customer at the time of
finalizing the purchase order. The accepted standard may be a
drawing, a sample, a grade or a universal standard like DIN, IS, BS
etc.

Right place: is the one where the item is going to enter the value
stream. If the item is not available here, when needed, it is in short
supply for the process.
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Right source: right source meets the QCD expectations of the

customer

Right time: is as decided by production schedule for meeting

customer’s requirements.

Right terms of contracts: terms in a contract are legally enforceable.

In case of dispute between supplier and customer, courts will go by
the terms decide who is wrong. Hence right terms are those, which
protect the interests of the company. At the same time right terms
ensure that neither parties do anything illegal.

Purchase Systems
In an organization all activities are carried out according to systems
and procedures for reducing variations and errors arising out of
individuality. This makes performing the function simple and less
prone to errors. Purchase organization also consists of such systems
established for smooth running of purchasing function. These
systems are pre purchase system, ordering system, post purchase
system.

1. Pre purchase System

This system lays down how purchase activity is initiated. Various

activities controlled by this system are requisitioning, selection of
suppliers and obtaining & evaluating quotations.
Requisitions: Requisition for an item may be made by anyone in the
organization. Pre purchase system prescribes separate requisition
form for capital equipment as this purchase activity is controlled by
a separate system. Requisition for an item shall be made in a
standard format. This format ensures that indenting person
furnishes all relevant information like quantity, specifications etc.
and gets the purchase authorized by competent authority in the
organization. Thereby making purchase activity easier and less time
consuming. This system shall identify the hierarchical level
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competent to authorize the purchase depending on the nature

and value of the item
Traveling requisitions: in an inventory system where an item is made
a stock item to be perpetually maintained at a minimum level,
purchase activity is triggered by stores function based on ROL. The
requisition is a permanent document with specification,
authorization and quantity required permanently marked on it. The
traveling requisition returns to indenting department after purchase
is initiated
Inquiries: Pre-purchasing system prescribes standard formats for
making inquiries in the market for supply of a particular product.
These are standard forms boldly declaring that they are not explicit
or implicit purchase orders
NEGOTIATIONS?

2. Ordering system
Purchase order is the most important element in ordering system.
Purchase manager releases the purchase order after selecting the
supplier and finalizing the price and other conditions of sale. Once
the purchase order is raised and accepted it becomes a legal
document. Contents of the purchase order are

purchase order reference number

description of materials and specifications
quantity required and delivery schedule
price and discounts
shipping instructions
location where the material is to be shipped
signature of the authorized officer
detailed terms and conditions

Several numbers of copies made to be forwarded to various

recipients. Many companies color code the copies making the color
destination specific.
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Original and a copy is sent to the supplier for

acknowledgment of the original order. This acknowledgment is
acceptance of terms and conditions of purchase order.

One copy is sent to the receiving department for making necessary

receiving arrangement
One copy is sent to the indenting department for information
One copy is sent to finance department for organizing payment to
the supplier

3. Post purchase system

This system includes follow up procedures, receipt and checking
invoices.

[a] Follow up procedures: follow up is an expensive activity for an

organization. Hence this should be minimized and made more
effective. A sound procedure for follow up is required to eliminate
duplication and ineffectiveness. After conducting FSN analysis
follow up frequency should be fixed for follow up according to FSN
status so that follow up doesn’t become wasteful.
Follow up responsibility is assigned to buyers responsible for areas
in which suppliers are situated.

[b] Receipt: receipt system should ensure that defects in receipt

process are eliminated proactively. A systematic record of all
receipts, carrier details and descriptions is maintained. This record
is in chronological sequence of arrival of supplies. The system
ensures that inspection of consignments received is arranged in time
and payment to suppliers for accepted consignments is organized. In
many organizations a receipt section handles this activity centrally

[c] Invoice checking

supplier sends his invoice to customer’s finance department for

payment for the goods supplied. Invoice checking system ensures
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that the invoice is checked against the PO terms, reciept

details, quantity received, inspection reports [accepted quantity and
rejected quantity], losses, damages etc. this system helps materials
management to coordinate with finance department for payment to
suppliers.

Special purchasing systems

Forward buying:
when an organization enters into a contract with another company
for buying an item for a period as long as a year or more it is called
forward buying.

Forward buying is a commitment for a long period. This

commitment is made after studying availability of the item, financial
position, EOQ for that item, discounts, staggered deliveries etc.
there is no speculation in this buying.

Tender buying: tender buying is practiced in public sector

companies and in private companies for purchases above specified
limits.
There are two types of tendering systems in practice.
One is called open tendering system that is adopted by public sector
companies. In this case bids are invited by advertisements in papers.
On the day of opening the tenders the lowest bidder is chosen for
awarding the contract of purchase. This method is time consuming
and expensive.

Private companies make a list of well known and serious bidders

known in the market and invite tenders from these bidders. When
the tenders are opened lowest bidder is identified. Care is taken to
ensure that the lowest bidder is also a responsible bidder and
capable of meeting QCD expectation
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Blanket orders: order covers a long period like a year. Price is

fixed. Delivery is as and when customer desires. Supplier to hold
inventory. Benefits are no of orders are less, inventory is passed on
to the supplier.

Zero stock:
Supplier holds the stock for the buyer. Supplier and customer are
close to each other and the inputs flow in a pipe line or on a
conveyer. Obsolescence is minimized. Suppliers production
schedule is as per customers. Dedicated supplier and customer

Rate contract: after finalizing the rates through negotiations for a

definite period, customer shall buy required quantity from the
specified supplier. Railways and other government organizations
practice this method. Price shall not be negotiated once again. Rate
contracts normally do not specify lead time. Hence suppliers
demand higher rates for early delivery.
Reciprocity
Organizations resort to reciprocal buying when they find it difficult
to do business in highly competitive environment. Reciprocal buying
is buying form one’s own customers. If this is done in conditions of
competition, there should not be anything wrong about this. But, in
this situation one tries to take care of the other as each one keeps
changing the role of customer & supplier. This leads to over all
deterioration of product quality and downfall of the pair.

Systems contract
Purchase order is used as a single document during the course of
completing entire transaction. Same document is used as delivery
challan at the time of delivery.
The document is updated at every stage of the process. Reduction in
number of documents and documents preparation is major saving in
administration expenses. This results in cost reduction to the value
chain.
A document by……………………………….ashish sawant

Importance of source

Source is the place from where we procure our inputs. These inputs
may be in the form of raw materials, out sourced components or
semi finished items. Manufacturing companies out source large
number of items as they slim down processes.
As outsourcing is gaining importance in business, importance of
source is becoming high.
Following reasons are considered to be making source an important
element in materials management.
Source of market intelligence: source is a window through which the
buyer organization looks at the world outside. Source provides
access to the real time information about the phenomenon.
Information about current trends and industrial climate is obtained
from the sources.[market conditions, industrial climate, what is
new?]
Crucial for product quality: buyer organizations depend on out
sourced components for producing the product which central to the
objectives business. Reliance on capabilities of supplier to meet
tough quality standards is very high in current business
environment.
Member in the value chain: supply source is an important element
in the value chain. Any cost added to the value chain reaches the
end user as price. Hence effectiveness and efficiency of the source
becomes vital to business.
Import substitution, cost reduction, value improvement: as
indigenization of sub assemblies, components and spare parts is
necessary to reduce the cost of product in competition, buyer
organizations turn to supply sources to develop these items. Several
trials and corrections may be required to finalize the substitute. In
house capacity is generally not available for this kind of trials. A
resourceful supplier is very useful in this process. Same logic holds
good in other exercises for cost reduction and value improvement.
It is quite logical that entire process is not outsourced but isolated
developmental activities are invariably done. It is common
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knowledge that many small scale companies do not have full

fledged tool rooms but rely on sources for all tool room activities.

Searching for source

Trade magazines: Source being such an important element in the
value chain searching for a reliable source assumes importance. A
buyer constantly looks for sources as new requirements keep
cropping up to meet the challenges of business. You will find desks
of purchase managers stacked with national and international trade
magazines. These magazines carry information about who makes
what and where.
Telephone directory: yellow pages in telephone directory is full of
telephone numbers and addresses of manufacturers and service
providers
Trade shows: trade shows are held periodically by industry
organizations and or government to bring sources for various
industrial products on one forum to demonstrate their products for
the benefit of users. Sources set up their stalls and expert know how
is provided at these stalls. Buyer companies get the benefit of
viewing products of competitive sources at one place. Technical and
some times even commercial decisions are facilitated at such places.
Eg. IMTEX at Godrej.
Publications by offices of DGTD [Director General for Technical
Development], DGS&D [Director General for Supply and
Disposal]: these two are central government organizations dealing
with technical development. They publish details of various supply
sources they deal with.
Internet: this is a rich source of information for products and
services.
Inquiries by buyers and request by suppliers: buyers float inquiries
in the market to find potential source, some times formally through
advertisements or direct mailing or informally through friends and
other acquaintances. Responses received to these inquiries and visits
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of sales representatives who come to promote the products of

their companies are sources of information needed by a buyer.
Meetings and or visits subsequently help buyers to identify capable
suppliers.
preliminary screening and selection
sources of supply discussed above are quite large in number. A
buyer short lists supply sources by evaluating them with respect to
some critical factors like physical separation and any other feature.
This would short list the sources to a manageable size. The sources
so selected should visited by buyer’s representatives to conduct a
preliminary screening to further short list them. During this exercise
the buyer rates the supplier on various critical factors on a zero to
ten scale. Various factors generally selected for evaluation are listed
below. A buyer may identify other factors as critical and add them to
the list, or delete some of them if considered superfluous.
general house keeping and maintenance: cleanliness and general
upkeep. Specific, well marked places for all items, general feeling of
orderliness and sleekness. Upkeep of building and equipment.
production and technical competence: technical qualification and
experience of employees.
quality control and inspection facilities: in house facility to check
quality parameters specific to the product buyer has in his mind.
financial resources: general worth of the company, may be in terms
of share value, bonus and other emoluments paid to the employees.
other companies supplied to: an up to date client list, the status of
the clients in the market.
Progressiveness of management: Does the management attach
importance to training? Are there any initiatives to improve total
quality? ISO certification? Inventory reduction? Etc.
Morale of the work force: are the workmen proud of the company?
Ability to meet QCD expectations: evidence of existence of systems
in the company to handle QCD demands of customer.
Cordial relations and courtesy: how are the visitors treated? Same
curtsey to suppliers and customers?
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Individual factors can be awarded weightage as per relative

importance of the selected factors for evaluation. Marks scored on a
0 to 10 scales are to be multiplied by this weightage factor. Total the
scores for all factors. Compare the total scores of all sources visited.
A simple ABC analysis would reveal top 2 or 3.
Negotiations and trial orders
Call the top two or three supply sources and negotiate with them for
a trial order. Terms of delivery, price and quality are negotiated and
finalized. A trial order is placed for a small quantity to gauge mutual
acceptance between supplier and customer.
What strengthens customer supplier relations?
Clear cut need described fully, quantity and technical needs are
clear. A constant source of irritation between supplier and customer
is rejection. Incomplete and ambiguous specification is at the root of
rejection. Nothing should be left to the judgment of supplier in
terms of customer’s QCD expectations.
Personal rapport between buyer & supplier for establishment of
communication.
Vendors’ meet to discuss performance of supplied materials, quality
and technical performance: many good buyers organize an annual
meet for suppliers. A forum is provided where performance of
suppliers product on customers production lines is discussed with
individual supplier. Supplier can easily draw up a list of corrective
and preventive actions to iron out the problems faced by customer.
Supplier also gets a forum to place forward his/her problems with
customers systems.
Vendor rating
Vendor rating is a system generally used for eliminating or
blacklisting a bad supplier. This is also used to apportion buyers’
need of supplies to various suppliers. Vendor rating is allotment of
marks based on QCD performance to suppliers.
How evaluation is done?
As discussed earlier, evaluation is done on QCD performance of
supplier.
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Delivery performance: delivery performance has two aspects,

time and quantity.
a. Adherence to time schedule: Proportion of consignments
reaching the customer on time to total consignments sent during a
specific span of time is a measure generally accepted to assess
delivery performance with respect to time.
b. Adherence to quantity schedule: Proportion of quantity received
by the customer to the quantity demanded the customer during a
specific span of time generally accepts a measure to assess
adherence to quantity schedule.
2. Quality performance: Proportion of consignments meeting
mutually accepted standard of performance on customers
production lines to total consignments sent during a specific span of
time is a measure generally accepted to assess quality performance.
3. Price performance: proportion of price expected by the customer
to the price accepted the supplier during a specific span of time
generally accepts a measure to assess price or cost performance.
Special aspects in source selection
Local sources and outstation sources, merits demerits: local sources
are easily accessible to the customer. The fact that they are
physically close to the customer places them at an advantage over
the suppliers away. A rapport easily develops between these
suppliers and customer. They respond to the customer’s need
promptly. These sources can easily be reached in situations where
the customer needs any help for fulfilling urgent requirements. If
you observe the industrial map of India, you will find that there are
isolated areas that excel in production and supply of specific items,
like Kolhapur for castings, Mumbra for sand, Kokan for mangos,
Punjab for sports goods. If we stick to local suppliers we shall be
deprived of the expertise available elsewhere.
Subcontracting - better utilization of man power, better scheduling
of facility for critical operation
Small suppliers and big suppliers, merits, demerits: small suppliers
are always keen to serve the customer as they are small and would
like to expand their business. They generally do not have many
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customers. They are readily accessible and take extra efforts

to satisfy the customer. Response time to customer is very short. A
big supplier always has number of customers and not very keen to
spare extra efforts for one customer. He is not as keen as a small
supplier to run an extra mile to please a customer. But a big supplier
has better infrastructure, well-organized systems for quality
performance and R&D setup. This makes a big supplier more
competent than a small one to meet QCD expectations.
Make or buy decisions
What do we make? Why & When do we make?
Whatever is crucial to the quality of final out put of the organization
is always made in house. Such operations should be carried out
under direct supervision of manufacturer.
Core competence of the company: Core competence is developed
around the critical operations to the product quality. Operations
falling within the core competence of the organizations are always
done in house.
Propritorial knowledge and confidential design: operations with
respect to these issues are never outsourced but done in house as
these are to be guarded against competition in the interest of
company. Just as weapon design should never reach the enemy.
Special skills and technology: such operations are done in house as
the skills and technology is available only in house.
In house capacity is unutilized: when the capacity in house is
unutilized outsourcing would only add cost to the product.
Fear of monopoly by supplier: if the operation is such that supplier
can hold the buyer to ransom after product development of
product, one should never resort to outsourcing.
Suppliers are unreliable and not transparent: unreliable suppliers
make the customer company vulnerable in the market with respect
to their customer’s QCD expectation. A supplier who is not
transparent also is equally undesirable. In the context of modern
business supplier and customer collectively add value to the supply
chain. Reluctance to be transparent obviously hides cost sources that
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ultimately make the product uninteresting to the price-paying

customer.
Order quantity is small: a small order quantity is not viable
commercially as the supplier would certainly quote high price.
What & why do we out source or buy?
Important but not critical: only such operations that are not critical
but important to the final product are outsourced by an
organization.
Core competence of supplier: if the operation happens to belong to
the area that is in the core competence of the supplier, it is sent out,
as there is advantage of quality.
High overheads of buyer organization make production in house
very expensive. So
Non-critical operations are always made outside.
To balance the production line outsourcing is a known method. In
this case we exploit full potential of production line by balancing.
Planned maintenance programs render the equipment unavailable
for production during maintenance schedule. During this period
one has to plan outsourcing to meet the commitments given to the
customer.
Sudden breakdowns send production schedules haywire and
purchasing department comes under pressure to procure material
from outside until the breakdown is set right.