This article has been published by Sneha Mahawar.
Table of Contents
Purchases are the lifeblood of business, be it trading, producing, or servicing. Any entity needs to take up the activity of purchasing seriously and sincerely with diligence. It is doubtless to say that timely purchase and purchase of quality material in the right quantity are indicative of the right and efficient management of the business. Purchases in excess of requirements or purchases of less quantity than the need affect the profit of the entity. Both situations are dangerous for regular business transactions. The purchase technique involves some compulsory steps. Purchases should be done in a manner that balances manufacture and sale.
What is purchase technique
This technique refers to the method or strategy used by businesses to acquire inventory or goods for their operations. In simple language, purchase technology means all technology owned by any of the sellers related to or used in connection with the business. It involves the process of sourcing, negotiating and procuring products or services from suppliers or vendors. Purchasing techniques are important as they aid in cost optimisation, supplier relationship management and refined, timely and tuned inventory management. Adoption of a good technique mitigates risk from many fronts, assuring the quality of the next stage of manufacture or/and sale after purchase. The strategy should comply with all requisite ethics needed in line of trade and aligned activities. To plan purchasing at the time of boom, more of the needed quantity is no doubt risky and similarly, a forward contract to procure on a future date at an advance agreed cost may result in profiteering more than the desired level or otherwise. In any case, the adoption of this technique is situational and circumstantial. One can find various types of purchasing, direct or indirect and these can be described as follows.
Types of purchasing
Bulk purchasing refers to the buying of goods or merchandise in large quantities. The primary objective of this type of purchasing is to take advantage of economies of scale, resulting in cost savings and various advantages for businesses. This can only materialise if the need is forecasted with accuracy; otherwise, bulk purchases without immediate usage or consumption in production or trading may result in the blocking of institution funds. Any blockade like this will affect the financial stability and, ultimately, the profitability of the entity. However, bulk purchases are the appropriate means of maintaining cordial supplier relationships, as a supplier gets pleasure when any contract results in a huge sale. Secondly, bulk purchasing may enhance operational efficiency as production will continue with regularity in the huge supply of raw materials and the entity may prefer to work extra hours overtime or otherwise. But on the other hand, this requires greater inventory management, for which the entity may naturally incur some extra expenditure and this should be in mind while planning for bulk procurement.
Multiple businesses or organisations come together to leverage their collective buying capacity, which results in group purchase activity. This may yield a better competitive and economical price, a good earning of a discount and nice, acceptable terms for purchase for both parties or among the parties in the contract. It thus involves forming a group or joining an existing group purchasing organisation (GPO) to pool their purchasing volumes, thereby increasing their bargaining power with suppliers and vendors. Since sales are in bulk, suppliers take keen interest in dealing with all such cases. Business wealth is thus recycled a number of times in a short span, resulting in good earnings. On the other hand, this type of purchasing saves time and effort for many in the line, with easy access to quality suppliers and enhanced networking and collaboration opportunities. By being a member of such a group, a party with low demand may also get scope to procure less quantity at the discounted cost, which would not have been possible with solo purchase activity.
It is a procurement method in which multiple suppliers or vendors submit/furnish their proposals or bids to compete for a contract or project. It involves requesting bids from potential suppliers and comparing their offers based on various criteria, such as price, quality, quantity, delivery time, and terms of supply and payment. The purpose of competitive bidding is to ensure transparency, fairness and value for money in the procurement process. Risk is largely mitigated by resorting to this type of purchase mode. It may be out of place to mention here that government organisations do accept this mode mandatorily. Various government agencies have their own mode of purchase rules, based upon which they do all such activities. Even in many states, general financial rules cover the mode of purchase. Somehow, in the name of transparency, this competitive bidding mode assists some unscrupulous few who are actively engaged in the tender process. The quoted rates they disclose include a huge bribe assisting a particular supplier to supply, from whom they get a huge kickback. This is the dark side of this purchase mode for government organisations. But if applied with genuineness, sincerity and transparency, this process of purchasing may greatly assist in getting a competitive bid at the most economical cost. But non-government organisations get the most out of this mode in terms of competitive rates.
Just-in-Time (JIT) purchase
This purchase mode involves acquiring goods or materials precisely when they are needed in the production process or to fulfil customer’s orders. The goal is to minimise inventory holding costs and reduce the risk of obsolete inventory. By closely connecting and coordinating with suppliers, businesses can ensure timely deliveries and maintain lean inventory levels. This purchase mode is particularly beneficial for businesses with fluctuating demand and limited storage space, with a focus on efficiency and cost reduction. JIT purchasing promotes streamlined processes, reduced lead times and efficient use of resources. By focusing on goods with actual need, this purchasing aids in the usage of funds for the best purpose for which they are needed and thus the blocking of funds is minimised most.
Electronic procurement is the process of purchasing goods, services and supplies using electronic platforms and technologies. It involves the use of digital system and internet based technologies to automate and streamline procurement activities, including requisitioning, sourcing, ordering, processing for payments, etc. This purchasing mode offers organisations a more efficient and cost effective way to manage their procurement operations compared to traditional manual methods. The advantages of this procurement are cost and time savings, enhanced transparency and visibility associated with better supplier management, and improved data analysis and reporting. The Government of India insists on mandatory e-procurement from approved E-market places, popularly called GeM (Government-e-Market). The government has mandated purchases in this mode exceeding a certain limit and in the process, all buyers and sellers have to be registered under this portal. Parties as registered purchasers may send their requisition to this portal and details of sellers available to supply the specified item are brought to the notice of the purchaser then. The purchasing party will then pay through the portal after choosing the selected seller. This type of purchase saves time and money, as no tendering is needed while the purchase is made through this mode. The central government visualises the activities of purchase and sale throughout the country by all government organisations, which helps in economic forecasting.
This procurement may be facilitated by an assessment. If the cost of building, managing and utilising technology for production on site is less than that of procuring, managing and utilising the technology, then organisations may go for developing/building the technology. Otherwise, technology may be immediately procured. Developing technology on spot naturally enhances the brand value of the company.
Steps involved in purchasing
Next, we may discuss the steps involved in purchasing:
To assess the need for purchasing, it is essential that the total quantity of purchases made in the last quarter or last year be taken into account and based on that and certain other probable activities, an assessment of the purchase in terms of quantity and cost may be made.
After assessment, a market survey is needed. Government organisations undertake the job by calling for quotations from the open market. Called for quotations, they are then recorded and tabulated by a committee meant for the purpose and the lowest tenderer (L-1) is awarded the supply order. Usually, the statement prepared for this purpose is called a comparative statement, which is authenticated by the individual signatories. The supply order may be in the form of a contract.
The supply is then made by the supplying firm. After the materials are delivered, the quality of the material is tested by a team. Next, the materials delivered are taken to stock with certification of stock entry. Payment then follows after being taken to the store.
Concept of Break Even Point (BEP) and the effect of linkage of purchasing mode with BEP
BEP refers to the level of sales or production volume at which a company’s total revenue equals its total costs, resulting in no profit or loss. Thus, while a firm is at BEP, there is no net income or net loss. A break even analysis is a specific technique for studying and presenting the interrelationship between costs, volumes and profits. It is an efficient and effective method of financial reporting and planning.
There are two approaches to determining the BEP, viz., the formula approach and the chart approach. The formula approach stems from very simple logic and is being discussed here in this paper. The equations from the analysis of BEP for the computation of BEP may be given as follows:
- Unit selling price – unit variable cost = unit contribution
- Unit contribution x units sold = total contribution
- Total contribution = total fixed cost + profit = total fixed cost (since at BEP, the profit by definition is zero).
The BEP may be expressed in terms of the number of units sold, in terms of rupees of sale or as a percentage of the total estimated/budgeted sale, depending on the need. We may see that the way we make purchases, stack or consume impacts the BEP. We may take one example to see how BEP is computed.
One company produces and sells product X. The sales price per unit is Rs. 50/ say; the variable cost per unit is Rs. 30/- and the given fixed cost of the operation is Rs. 1,00,000/-. From all this given information, we may calculate the contribution margin per unit, which is the sales price per unit less variable cost per unit, and it is Rs. 20/- here (50 minus 30). Next, we can compute the BEP in units. BEP in Units=Fixed Cost/Contribution Margin per Unit. So BEP in units = 1, 00,000/20= 5,000 units. The company may hence need to sell 5,000 units to break even or reach the break-even point.
For computing BEP in sales revenue, we need the contribution margin ratio, which equals the contribution margin per unit divided by the sales price per unit. In the instant case, the contribution Ratio=20/50=0.4: To calculate BEP in sales revenue, the formula devised is a Cost/Contribution margin ratio. So 1,00,000/0.4= Rs. 2,50,000/- is needed to be generated from sales for the company to break-even. The selling cost of 5000 units equals the amount arrived here.
BEP helps with pricing decisions, cost management and investment decisions. With this knowledge, a firm can go for enhancing the sales level, managing the cost structure or pricing based on profitability. At the start of any financial activity, say the introduction of a new facility in a hospital, it becomes logical and essential to analyse facts and figures to judge whether the venture will be profitable in the near future. However, before the actual profit, one would come to a point of level of operation where there is no profit or no loss. It is definite that beyond that point, any extra sales margin will generate profit.
Importance of BEP
Importance of BEP:
- BEP helps most to make decisions on costing or pricing. The mode of purchasing or cost of purchasing and the stock in hand out of the purchase at the close of the year impact BEP and the resultant sale turnover. Alternatively, profit forecasting and exact profit in account aid management again with the known BEP level to take any sort of investment decision. Thus, knowing BEP in sales revenue aids in forecasting sales beforehand, which is the best management tool for a business to grow vertically.
- BEP helps in analysing scenarios and thus, business at different points horizontally can be thought of as commencing. In turn, one may have easy sensitivity to the study of the target customers to grow further.
Benefits of a break even analysis
The benefits of a breakeven analysis are:
- Breakeven analysis helps uncover unnoticed expenses.
- Breakeven analysis gives us some important points and facts, which makes it easier for us to make a business decision
- This helps in setting goals and achieving them because, with breakeven analysis, we know exactly what goals we need to achieve.
- It also helps us properly price our products from a business standpoint.
Factors that increase a company’s break even point
Factors that increase a company’s break even point are:
- When the demand for a good increases, its supply also increases, in most cases. When the production of such goods is increased, it raises the break even point and helps cover extra expenses.
- The break even point also increases when the cost of goods remains the same but the cost of raw materials increases. This increase in breakeven point is because of additional expenses.
- Equipment failure also leads to an increase in the break even point because the desired number of units are not produced. Equipment failure leads to higher production costs and a higher break even point.
Various modes of purchasing associated with the computed BEP of the immediate prior period can be linked to forecast the quantity to be procured and the quantity to be utilised or consumed. Stock in hand can be minimised to the maximum extent, limiting the same to the next immediate need so that the fund of the unit is not blocked at any point in time. Aiming to maximise the profit with legitimacy is the current point of discussion.
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