Some Procurement Managers think for purchasing more materials than needed for budgeted production when the market rate is favorable to the purchasing company. But it is not always safe and sometimes turn into a peril in the seed. Here are some risky grounds which are to be thought before purchasing excess materials than needed:
1. Risk of Obsolescence: All materials have a specific shelf life and supposed to be expired within 2 to 5 years. Materials purchased in excess of production or sales plan may have to be written off from the stock which ultimately generates loss to the company.
2. Shift of Consumer Preference: Most consumers assess the utility of the product before making a buy. The preference or choice of products depends on the fashion, trends and other external factors which are probable to shift from time to time. So, there is a risk for the excess materials to remain un-utilized forever, which would become chronic to the company’s operational results (profit).
3. Space Occupation: Excess materials which will never be used, of course have occupied some excess space in the warehouse, which certainly had an opportunity cost, if was rented. Had there no excess stock, other available stocks could have better warehousing.
4. Finance Costs: Most companies purchase by means of loans from banks or other financial institutions. Every financing institutes charges interests on loans from day 1 ( some may have grace period). Finance costs for excess stocks may not have been incurred if optimum level purchase was done.
5. Materials Management Expenses: Holding costs i.e. insurance, inspection, freight, unloading charges, interest etc. and other administrative expenses were incurred for excess materials procured. How can we ignore them now? Should we forget the warehouse rent for excess materials?
6. Influencing Product Cost and Profit: This is very obscured impact of excess materials than budgeted requirement, where an explanation required. It will be visible when a company uses absorption costing system along with standard costs. For example, a company has 1000 units of production plan, so purchased excess materials 100 kg of materials @$10 actual in place of @$12 standard. As a result of this purchase it earned $200 favorable variance. So, this $200 was adjusted with COGS and increased Net Profit by the same amount $200, in the current year. Cost of Products has absorbed the entire favorable variance $200 and reduced the COGS by ($200/1000) =0.20 per unit, current year. (Could be vice-versa)
Now, say, out of 100 kg, only 50 kg was used in operations and the rest 50 kg is kept for future use or for some other reasons. Say, in the next year the rest 50 kg is decided to write-off. Now again, $100 is charged against P&L, in the next year. So for excess materials, $100 was overstated in the earlier year but adjusted in the next year. Even though, no impact on performance if we consider 2 years at a time. But the company is supposed to pay Government Taxes on net profit shown for excess purchase of materials. Future is always uncertain, so I cannot say what will happen for materials more than required quantity.
7. Performance Appraisal: More dispositions or write-offs from stock will call for purchasing performance. Generally, when a company’s Sales, Procurement and Production Departments are asynchronous or unskilled in nature, and forgets the accountability; more material are
8. Unproductive Labor hours: Who did Manage these excess stocks? Somebody in the company, of course! Sometimes excess materials required extra manpower, extra documentation, extra stationary, extra quality inspection or other extra expenses. Excess labor hours of efforts from all related bodies were unnecessarily used for nothing!
So, Buyer Be Aware! Do NOT buy excess materials over the Production Plan!