Module 1 : Purchasing Process. Ch.4 Evaluating Requisitions. Edited by Dr. Seung Hyun Lee (Ph.D., CPM) IEMS Research Center, E-mail : lkangsan@iems.co.kr
Cost/Benefit Analysis. Classification of Costs [TASK 104] Direct Costs. Direct costs that can be directly attributed to a particular job or operation. Direct material(purchased) and direct labor costs are traditionally considered direct costs. Direct costs generally serve as the basis from which suppliers make their allocation of overhead costs. A reduction in the direct costs of a supplier is generally worth more to the purchaser than a major reduction in the supplier's profit percentage, an important factor to be used in the negotiation process. Indirect Costs. Costs that are not directly incurred by a particular job or operation. Certain utility costs, such as plant heating, are often indirect. An indirect cost is typically distributed to the product through the overhead rates. The three basic categories of indirect costs are : fixed, variable, and semi-variable costs. - 1 -
Cost/Benefit Analysis. Classification of Costs (cont). [TASK 104] Fixed Costs. An expenditure that does not vary with the production volume : for example, rent, property tax, and salaries of certain personnel. Variable Costs. An Operating cost that varies directly with a change of one unit in the production volume, e.g., direct materials consumed, sales commissions. Semi variable Costs. Semi-variable costs are those costs that display both fixed and variable characteristics. Examples of semi-variable costs include salaries of supervisors and purchasers, pension plans, utilities, and fuel. - 2 -
Cost/Benefit Analysis. Classification of Costs (cont) [TASK 104] Overhead Costs. The costs incurred in the operation of a business than cannot be directly related to the individual goods or services produced. The costs are grouped in several pools (e.g., department overhead, factory overhead, general overhead) and distributed to units of goods or service by some standard allocation method such as direct labor hours, direct labor dollars, or direct material dollars. Allocation of Overhead Costs. Total plant indirect costs Total plant direct labor dollars = X indirect per direct labor dollar. Total plant indirect costs Total plant direct machine hours = X indirect per machine hours. Total company general & administrative costs Total company sales = X indirect per direct labor dollar. - 3 -
Cost/Benefit Analysis. Classification of Costs (cont) [TASK 104] Standard Costs. The target costs of an operation, process, or product including direct material, direct labor, and overhead charges. Cost Variance Analysis. Analysis for the cost difference between the standard cost and the actual cost. Life-Cycle Costing. The identification, evaluation, tracking, and accumulation of actual costs for each product from its initial research and development through final customer servicing and support in the marketplace. Life-cycle costing considers the purchase price of equipment, plus all operating and usage costs of the items over its life. These costs include maintenance, downtime, scrap or loss, energy, training, installation as well as salvage, and disposal costs. - 4 -
Cost/Benefit Analysis. Classification of Costs (cont) [TASK 104] Opportunity Cost. This cost represents the "lost opportunity" to the organization by spending money or trying up money in one investment opportunity rather than the other. Product Cost. Costs allocated by some method to the products being produced. Job order Costing. A cost accounting system in which costs are assigned to specific jobs. This system can be used with either actual or standard costs in the manufacturing of distinguishable units or lots of products. Process Costing. A cost accounting system in which costs are collected by time period and averaged over all the units produced during the period. - 5 -
Cost/Benefit Analysis. Classification of Costs (cont) [TASK 104] Activity Based Costing (ABC). A cost accounting system that accumulates costs based on activities performed and then uses cost drivers to allocate these costs to products or other bases, such as customer, markets, or projects. It is an attempt to allocate overhead costs on a more realistic basis than direct labor or machine hours. - 6 -
Cost/Benefit Analysis. Financial Tools. [TASK 104] Return on Investment (ROI) ROI = Annual Operating Income or Net Present Value of Cash Flow from Project Total Capital Invested Capital Invested in the Project Return on Assets employed (ROAE). Measure of how the organization is using its assets. ROAE = Net income + Interest Expense after Tax Average Capital Employed Return on Total Asset (ROTA). ROTA = Net Income Total Assets - 7 -
Cost/Benefit Analysis. Financial Tools (cont). [TASK 104] Margin Analysis. Margin analysis represents the profitability of an organization in relation to its sales. This is also known as "net operating margin" Net Operating Margin = Total Operating Income Total Sales - 8 -
Specifications Some Concepts for Specifications. [TASK 106] Specifications define what constitutes an acceptable product or service. They are required before a purchase takes place to ensure that both purchaser and supplier have the same understanding of what is being bought. Specifications are a description of the technical requirements for a material, product, or service that indicates the criteria for determining whether these requirements are met. A specification may describe the performance parameters that a supplier has to meet, or it may provide a complete design disclosure of the work or job to be done. Specifications for service contracts normally take the form of a statement of work (SOW). - 9 -
Specifications Internal Input for Specifications. [TASK 106] Formal. In general, manufacturing companies have formalized procedures for specification generation. Technical experts such as research and development or the quality control group often generate specifications for technical products. Organizations that have many specifications on file may have a department, often called "document control" or "configuration control", assigned the sole function to maintain specifications. Informal. If there is no formal process for generating specifications, then the obligation rests with the requisitioner to clearly define what they want. Purchasing has the responsibility to see that the requisitioner does this before solicitation take place. - 10 -
Specifications External Input for Specifications. [TASK 106] Suppliers. If the supplier is already working with the purchasing organization in a trusted relationship, then their input to the specification can be very valuable. Suppliers. If the expertise needed to properly define specifications does not exist within the organization, consultants who posses such expertise may be hired to assist in generating the specification. Industrial standards, handbook, and guides. Industrial standards exist for many commodities. If applicable, they can be used as specifications. - 11 -
Specifications External Input for Specifications (cont). [TASK 106] Peers/Professional Purchasing Organizations. If consistency across organizations is useful, then peers in different organizations may collectively define standards. Competitors. Standardization within an industry can lead to the use of a competitor's specification for a "standard" item. - 12 -
Specifications Two Components of Specifications. [TASK 106] What the product must look like or do. Blues prints, material specifications, performance specifications, and SOW. Quality Measures. Parts-per-million or parts-per-billion for electronic components, MTBF for equipment, C pk for custom-production, or allowable frequency of defaults in performance of a service. - 13 -
Specifications Acceptance Criteria. [TASK 106] Some Considerations. For tangible goods, these include the measurements of an incoming inspection process and the allowable results. For equipment, these include the level of performance at which the equipment must operate and for how long it must operate at that level before it is deemed acceptable For service, these include the definition of the finished "deliverable" which may be a result, a look, a report, a product, or the performance of equipment. - 14 -
Specifications Acceptance Criteria : Considerations. [TASK 106] Performance Specifications. They are used to define the acceptability of capital equipment and many types of services. The details of how the performance will be achieved are not specified and rest with the supplier. When performance specifications are used, the supplier has maximum latitude to determine how to go about satisfying the requirement and also assumes the risk for proper performance of the end product. Internal vs. External Specifications. If internal and external specifications are not the same, the product will usually cost more. Correlating quality measurements between purchaser and supplier so that both organizations not only know what is wanted, but also are in agreement about how it will be measured is wise. - 15 -
Specifications Acceptance Criteria : Considerations. [TASK 106] Building quality into the manufacturing process. Quality is best achieved by preventing defects from occurring rather than attempting to detect them later. Detection methods include inspection processes that occur anywhere other than at the point of manufacture. Prevention methods involve controls at the point of manufacture. This include automated controls, point-of-manufacture inspection with immediate correction, and Statistical Process Control Supplier Samples. A physical sample can be used as a specification. - 16 -
Specifications Statements of Work (SOW). [TASK 106] Roles of SOW. A statement of work(sow) is used in the purchase of services to define exactly what work is being contracted. A simple SOW defines the work to be done, the boundaries of that work including the time frame, the expected end result, and criteria for evaluating performance and quality. All important attributes should be defined. As the service become more complex, so does the statement of work. For lengthy and/or very expensive projects, a properly detailed SOW provides the mechanism to manage the project throughout its duration. - 17 -
Specifications Statements of Work (SOW). [TASK 106] Work Breakdown Structure. For a lengthy or complicated project, the SOW may include a description of the work divided into segments. Hold Points/Milestones. When the SOW is divided into segments, it may be advisable to condition continuation upon the successful completion of each segment. Performance Evaluation Factors. Every SOW should clearly state all performance and quality criteria, and how they will be measured. - 18 -
Performance Check. 1. Consider the following equation : X = Price paid - Budget price. In this equation, X is considered the A. Target price B. Forecast price C. Purchase Price Variance. D. Producer price index. 2. Which of the following types of costs changes in direct proportion to changes in the level of operational activity? A. Fixed. B. Variable. C. Standard. D. Direct. - 19 -
Performance Check. 3. Which of the following is (are) TRUE with regard to standard costs? Ⅰ. They are defined in terms of manufacturing items. Ⅱ. They are defined in terms of units of service. A. l only B. ll only C. Both l and ll D. Neither l nor ll 4. Which of the following attempts to estimate the total cost of ownership of a capital asset, include acquisition, installation, use, maintenance, removal and disposal? A. Life-cycle costing. B. Fixed costs. C. Purchase price variance. D. Activity-based costing. - 20 -
Performance Check. 5. All of the following are elements considered in a cost analysis EXCEPT. A. Direct labor. B. Liability C. Material D. Profit. 6. Major elements of policies for the handling of supplier samples include all of the following EXCEPT A. Criteria for whether payment is to be made for samples. B. The treatment of trade secrets for supplier proprietary information. C. Guidelines for sample evaluation and availability for reports to the supplier. D. Methods of distribution of reports within the organization. 7. After testing product sample or parts submitted by supplier, it is MOST important to A. Pay for the samples. B. Destroy them to protect confidentiality. C. Report the results to the supplier. D. Request additional samples for a second test. - 21 -
Performance Check. 8. With regard to information on supplier sample, a prudent buyer should be sensitive to the confidentiality of which of the following.? Ⅰ. Computer software. Ⅱ. Profit information. Ⅲ. Wage and salary scales. Ⅳ. Asset information. A. l only B. lll only C. l and lll only D. All of the above. 9. A supplier assume most of the product risk in a purchasing agreement that contains? A. Design specification. B. Performance specification. C. Physical specification. D. Chemical specification. - 22 -
Performance Check. 10. Which of the following communications specific product requirements to anyone familar with a particular industry? A. Brand-name or equivalent. B. Grade designation. C. Performance specification. D. Design specification. 11. A well-written Statement of Work (SOW) for a service purchase should include all of the following EXCEPT. A. The prescribed method of payment. B. Verifiable performance and acceptance criteria. C. A description of the work to be performed. D. Post-award administrative guidance to the supplier. - 23 -
Performance Check. 12. Which of the following represents a specification that allows multiple sourcing, and is generally the least expensive alternative? A. Brand name. B. Manufacturer's standard. C. Engineer's drawing. D. Industry standard. 13-15 refer to the following types of specifications : (A) Manufacturing Process. (B) Performance. (C) Design. (D) Engineering Drawings. From the types of specifications above, choose the one that is referred to in each of the following situations. A choice may be used following situations. A choice may be used once, more than once, or not at all. - 24 -
Performance Check. 13. A buyer tells a paint manufacturer the detailed specifications of the paint wanted; the buyer thereby assumes responsibility for the paint's performance. 14. The U.S. Army instructs a supplier about the precise procedures and testing necessary to produce a technologically complex components for a weapons system. 15. The U.S. Navy instructs a manufacturer about the designated accuracy of a guidance mechanism it wants produced. - 25 -
Performance Check. Solutions. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 C B C A B D C D B B A D C A B - 26 -