What is Material Cost Control?
Material cost control is a set of strategies and practices employed by businesses to manage and optimize the costs associated with acquiring and using materials in their production processes. Materials are essential components used in manufacturing goods and providing services, and their costs can significantly impact a company’s profitability and competitiveness. Effective material cost control aims to minimize wastage, reduce expenses, and enhance overall operational efficiency.
Table of Content
- 1 What is Material Cost Control?
- 2 Functions of Material Control Department
- 3 Features of Material Control Process
- 4 Responsibilities of the Purchase Department
- 5 Materials Issue Process
- 6 Material Control Techniques
- 7 Quantity of Material Procurement
- 8 Material Management at Stores
Functions of Material Control Department
For having an effective control over the materials-related issues, a firm usually has a well-established material control department. Following are the major functions of a material control department in a firm:
- Procurement of raw materials, keeping in view the time to procure the materials, reasonableness of prices, quality of materials and quantity of materials.
- The raw materials are received and inspected to ensure the required quality as per pre-specifications.
- Storage of raw materials and maintaining the records of material received in the store register. It also makes all the required arrangements to prevent loss of materials due to leakage, pilferage, theft, mishandling, etc.
- The raw materials are issued for the use of production on receiving indent from the production department.
- The department also ensures adequate inventory control through maintaining the proper records.
- It is also responsible for timely supply of the required materials and ensuring that the production process does not stop for want of materials.
- The overall responsibility of materials’ price, quantity, inventory control and recording lies with the production department.
Features of Material Control Process
To have a proper monitoring and control on inventory of material and its management, following are the essential features which need to be developed in a firm:
- There has to be a perfect coordination and cooperation among the other major departments, such as production, procurement, warehouse, etc.
- The material control process should be well organized with inbuilt supervision systems. It should be managed by a professional.
- For an effective materials control process, there has to be proper schedules and formats of indent, placing orders and for maintaining other inventory records. There has to be a dual control system to maintain all records both in the soft form, as well as in the physical form.
- An internal mechanism for verification and monitoring needs to be developed for bringing more efficiency.
- Modern and new techniques should be adopted, like bin cards, to have timely monitoring and control over the inventory management.
- The minimum inventory level and reorder level must be maintained.
- The inventory recording system should be online with an inbuilt control mechanism.
- The firm should develop a sound management information system (MIS) for better reporting, evaluation and control on various aspects of inventory control.
- The perfect inventory management system in a firm can help to save the maximum cost if a well-organized system and mechanism are established. This will reduce the cost at different levels.
- The material purchase policy should be more planned and systematic. There should be well-managed logistic systems to ensure that the material is received well in time and at the most effective cost.
Responsibilities of the Purchase Department
The major responsibilities of a purchase department are to ensure timely receipt of materials with required cost effectiveness and minimum material wastage.
Following are the major responsibilities of the purchase department:
- Developing a mechanism for timely receipt of materials requirement indents from all the departments to facilitate timely supply. The department may prepare detailed guidelines and appropriate indent formats.
- Once the indents for materials requirement are received, there should be proper mechanism of recording and follow-up of the indents with predetermined time limits for control at different stages. This can be maintained by allocating appropriate codes and description for different items.
- Empaneling the suppliers for requirements of different types of materials. This is done by inviting tenders and finalizing them based on price, quality, discounts, reputation, etc. This is done very judiciously as the suppliers are not frequently changed.
- All the records of price, terms and conditions, discounts, etc., are recorded in the book for individual suppliers. The agreements and contracts are also properly filed.
- Preparing purchase-order formats, which is contractual agreement, should be prepared incorporating all terms and conditions as per the agreement.
- The orders for the purchase of relevant materials should be placed in time to ensure that the materials are received on time. Once the orders are placed, they should be followed at different levels.
- Receiving materials at the store physically and storing them after due inspection at appropriate places.
- Returning back the defected pieces, if any, to the supplier and followup for replacement or reducing the bill amount.
- Verifying the invoices and sending them to accounts department for payment to suppliers.
Raw material inputs are most significant in all manufacturing units. It is estimated that nearly 60% of the total cost of production pertain to material acquisition. Therefore, it is all the more important to have an adequate control on the cost of material acquisition. In view of this, the responsibilities of the purchase department assume more significance.
Materials Issue Process
The efficient materials issue process in a firm is very much required to ensure timely availability of materials by the concerned departments. This helps in adequate utilization of resources and non-stoppage of work due to timely availability of the raw materials. This also results in cost minimization. For the effective management of material issue, certain systems are devised. We will discuss some of the important systems in the following sections.
Bill of Materials
Bill of materials is a detailed statement of materials which are required for the different types of jobs. It also contains information about the quantity of materials required and issued to the concerned department. This can be prepared in the format given in Fig.
Material Requisition Slip
The purchase department prepares a specific format for supply of raw material through a material requisition slip. This slip is sent to stores by the different departments requiring the materials, furnishing all details of the quantity. After receiving the requisition, the stores make necessary arrangements to issue the materials. Figure represents the commonly used format for requisition slip.
Material Control Techniques
Following is the mechanism through which adequate control over materials’ movement and right use of materials is ensured:
Material Inspection Report
The materials at store are delivered through a delivery note from the supplier side. The warehouse staff physically checks the quantity and also inspects the quality of materials for each item. A material receipt advice note is prepared to confirm the receipt of materials with the remarks of defects, if any. This report is called material inspection report.
Goods Received Advice
Once the materials are received and inspected, the stores department prepares this advice to inform purchase department, production department and accounts department about the receipt of materials. The accounts department will arrange for payment to the supplier only after the receipt of this advice from the stores department.
Materials Transfer Note
When a department requires certain materials, it issues the material requisition slip. Accordingly, the stores department, while issuing the materials, issues materials transfer note furnishing all the details of materials supplied to the concerned department. It is also used for making necessary accounting entries.
Materials Return Note
Whenever the department has surplus materials or if the material supplied is not according to the quality and specifications, the concerned department returns the material to the store through a transfer note furnishing all the details of the materials being returned to the stores. A copy of this note is sent to the costing department for making necessary accounting adjustments.
Quantity of Material Procurement
There is another important parameter in material control process as how much quantity should be stored at a time to ensure that the production process does not get affected and at the same time excess quantity of materials is avoided. The inventory holding also carries a cost in terms of interest, space, maintenance, spoilage, wastage, etc.; the higher the inventory level, the higher will be the carrying costs.
Therefore, a firm needs to adhere to all the strategies to avoid excess holding of inventory and at the same time maintaining a level of inventory which is adequate to run the production process. Some of the strategies are explained in the following section.
Economic Order Quantity
This is a technique to determine how much should be the quantity to hold which is economic in terms of cost. This helps the purchase department to assess the quantity to be purchased at any one time. This in essence is a measurement of how much quantity is to be ordered at any one point of time. We should understand that there are primarily different costs associated with the ordering quantity apart from the purchase price. There are mainly two types of costs. One is the ordering cost.
The ordering cost can be explained in terms of placing an order for purchase of materials. The other one is the carrying cost which is associated with carrying of inventory including interest. Let us further understand these costs. Ordering cost is the cost of placing an order, a firm has to incur certain costs at the time of placing order for purchase. These costs basically include inviting tenders, staff involved in this process, handling and transportation costs, stationery costs, placing an order, follow-up costs, etc.
Therefore, more the frequency of the order, the more will be the ordering cost. Besides, there are certain costs that are called as carrying costs. The cost of carrying the inventory is the real out-of-pocket cost associated with having inventory on hand, such as warehouse charges, insurance, lighting, losses due to handling, spoilage, breakage, etc.; and another important component of carrying cost is the amount of interest on holding the inventory. Obviously, higher the level of quantity of material in the inventory, more will be the cost of holding it.
The above two costs, the carrying costs and the ordering costs, are variable costs, but their behavior is opposite of each other in the sense that with more frequent orders, cost will go on increasing but as the material ordered will be lesser in quantity, the carrying costs will decrease. While on the other hand, if the number of orders are minimized, the quantity per order will decrease but the carrying cost will increase.
Remember, the ordering cost will decrease on account of the reduced number of orders. In addition to the above costs, there are other considerations, like capacity and availability of storage facility, price fluctuations of the materials in the market, type of material in terms material life, etc., which affect the materials’ holding level at a time. Therefore, a firm has to arrive at the decision to order the most desirable quantity which could be ordered. The optimum quantity could be the quantity at which both the ordering costs and the carrying costs will be optimum.
This quantity is known as “economic order quantity (EOQ).” The EOQ can be calculated with the help of the following formula:
Economic order quantity (EOQ) = ————
where A is annual demand/annual consumption in terms of units, O is cost of placing an order and C is inventory carrying cost per unit per annum. The above equation indicates the efficient quantity of units per order. We also come to know that we can calculate the number of orders to be placed during the period through the following equation:
Numbers of orders to be placed = ————
The EOQ is an important technique as it provides a fairly accurate level of quantity to be purchased at one time or in one lot/batch. This concept is based on the following assumptions:
- The materials in question will be available all the time without any barriers or restrictions.
- The price of the materials, discount, credit period, transportation costs, etc., will remain constant.
- Ordering cost and carrying costs are variable and remain constant.
- The impact of discount on quantity will be negligible.
The other important aspect of material procurement is to purchase the optimum level, that is, not in excess or not too little that it hampers the production process. At the same time, the timing of the purchase of materials also assumes significance. The following technique helps a firm to decide both the level and the timings of the order.
There is a concept of maximum level which is the highest level of materials procurement beyond which the inventory of materials should not be allowed. This will help a firm to avoid overstocking of the materials. This level can be fixed considering the consumption of materials and the time of reorder period.
Maximum level = Reorder level + Reorder quantity − (Minimum consumption − Minimum reorder period)
Like maximum level of inventory, we may also fix minimum level of inventory. This level is fixed to avoid shortage of material so that the production process is not held up. Therefore, the minimum level is fixed. A firm should ensure that the minimum quantity of stock holding does not fall below the minimum level at any time.
The minimum level is fixed in the following manner:
Minimum level = Ordering level − (Average material consumption rate − Reorder period)
We can also fix the reorder level to ascertain that the next order is placed much before the inventory becomes out of stock to have continuity in the production process. Reorder level is fixed for deciding the time for placing the order. In case the stock of materials reaches this level, fresh order is placed to ensure that material is procured well within the time before the level of the material falls to the minimum level. The reorder level can be fixed as follows:
Reorder level = Maximum usage of materials for specific period − Maximum reorder period
The firm can also fix the average level of material holding based on the average of the maximum and minimum level. This can be computed as follows:
Average level of material holding = Maximum level of materials + Minimum level of materials 2
Material Management at Stores
The materials purchased by the purchase department are stored in a safe and secured place known as the warehouse. From the stores, the materials are issued to the production department. The storage of the raw materials is an intermediate step in the material control. However, if a firm follows “just-in-time” inventory system; there is no need for storing the materials.
In all other cases, the firm should make all the arrangement that takes care of the safe and secure storage of the material inputs that are optimally used. Generally, in practice this function is performed by the storekeeper in the stores department.
In general, the following functions are undertaken by the storekeeper as regard to efficient management of materials:
- Maintaining a buffer in case of emergency and ensuring timely availability of materials.
- Providing safety and security of the materials.
- Maintaining just sufficient quantity to avoid over/under stocking of the materials.
- Designing and developing a proper system for ensuring control over usage, with proper recording system of issues and receipts of material inputs.
- Minimizing material losses on account of mishandling, wastage, evaporation, breakage, etc.
- Proper upkeeping of records and documentation for recording the receipts and issues.