Introduction

In the earlier years, Materials Management was treated as a Cost Centre, since Purchasing Department was spending money on materials while Stores was holding huge inventory of materials, blocking money and space. However, with the process of liberalization and opening up of global economy, there has been a drastic change in the business environment, resulting in manufacturing organizations exposed to intense competition in the market place. Indian manufacturers have been working out various strategies to face the above challenges and to cut down manufacturing costs to remain competitive. Progressive Management have since recognized that Materials Management can provide opportunities to reduce manufacturing costs and can be treated as a Profit Centre.

On an average, half the Sales income is spent on Materials. Suppose a firm is spending 50% of its volume on materials and the profits are 10% of sales volume. A 2% reduction in materials cost will boost the profits to 11% of sales or the profits will be increased by 10%. To achieve the same increase in profit through sales efforts, a 10% increase in sales volume will be necessary. In other words, compared to sales volume, material cost has five times the average on profits. Organizations earn or loose large sums depending on how effective are their Materials Management.

The cost savings which are possible in Purchasing are as follows:

a) By obtaining materials at lower prices through:
• Development of new sources
• Price negotiations with vendors
• Using modern techniques like cost-price analysis to determine the right or reasonable price for the materials
b) By managing taxes payable
c) By reducing the cost of packaging
d) By optimizing the transportation costs
e) By ensuring the right quality of materials
f) By value analysis
g) By import substitution

Profitability 

Till the last decade, the equation in business could be stated as

Selling Price = Manufacturing Cost + Profit

In view of the current competitive pressures in the market, the equation has changed to:

Selling Price – Manufacturing Cost = Profit

In the current situation, the Selling Price is determined by the market forces and as such, Profit can be ensured only by reducing the Manufacturing Cost. In most of the organizations, materials cost contribute to 60% of manufacturing cost and as such there is a significant importance to Materials Management. Materials Cost is divided into two segments:

a) Unit price of the Materials
b) Consumption for Production

The Purchase Department can control the prices by effective Negotiations. However, the question is, whether Materials Management can control the total cost, including the Consumption? Yes, it is possible, by controlling the issue from the Stores, based on the norms for Production. Now let us see how Materials Management can improve the PROFITABILITY of an organization –

(All figures in Lakhs)

It may be seen from the above table, that just by reducing the material cost by 10%, the Profit has increased by 85%. Similarly, by reducing the materials cost and other expenses, for increased Sales, the profit has increased by 105%.

Inventory Management

The importance of proper management of Materials need hardly be emphasized. In any manufacturing industry, nearly 60% to 70% of the total funds employed are tied up in Current Assets, of which Inventory is the most significant component. In the cost structure of most of the products, materials constitute 50% of the total cost, again pointing to the need for the proper budgeting and control on cost of materials The objective of any commercial organization is to get the best mileage out of every rupee invested in the company. In other words, Management through their policies, decisions, coordination and control mechanisms must maximize the Return On Investment (ROI)

                    Profits
ROI = ————————
Capital Employed

Profits = Sales – Manufacturing Cost
Manf. Cost = Labour (10%) + Materials (70%) + Overheads (20%)
Overheads include Bank Interest Charges of Inventory held.
Capital employed = Fixed Assets + Current Assets
Current Assets = Cash (10%)+ Receivables (20%) + Inventory (70%)

From the above, it is clear that ROI can be maximized either by increasing Profit Margin or by reducing the Capital Employed or by both. In the current market situation, Sales Price cannot be increased (rather there is a demand to reduce it) and as such Profit can be increased only by reducing the Material Costs.

On the other hand, the opportunity to reduce the Overheads and Capital Employed is more by Inventory Reduction. It is thus evident that the ROI can be maximized by either reducing the material cost or reducing the current assets by way of inventory of materials or can be optimized by increasing profits and reducing capital employed.

It is evident that the Materials Manager can make a direct contribution in increasing Profitability in the following ways:

a) By deciding inventory norms rationally and through control systems. Inventory Turnover can be maximized which in turn will maximize current Assets Turnover and ROI

b) By proper planning and control of Spare parts, capacity utilization can be increased which will increase the turnover of Fixed Assets and consequently increase ROI

c) By developing dependable sources and purchasing quality materials at competitive prices, materials cost per rupee of sales can be brought down which will increase Profit Margin and in turn ROI

d) By developing proper systems and control on issue of materials, the consumption can be minimized, resulting in reducing the materials cost, which will increase the Profit Margin and also ROI

Let us now see the financial position of three companies – A, B, C, and how the ROI has improved by controlling the Inventory (all figures in lakhs)

Realizing the effect of materials on the functioning of any organization, all areas connected with receiving, buying, stocking, issue of materials, are being brought under the name of “Materials Management” as one function in the organization. We can define Materials Management 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 predetermined service to the customer at a minimum cost.” Material Planning and Inventory Control is the most important function of Materials Management and it forms the nerve centre in any organization.