132) Discuss the purchasing plan, briefly describing each of the five key elements of the plan.
Answer: Purchasing involves the acquisition of needed materials, supplies, services, and
equipment of the right quality, in the proper quantities, for reasonable prices, at the appropriate
time, and from the right vendor. A major objective of purchasing is to acquire enough (but not
too much) stock to ensure smooth, uninterrupted production or sales and to see that the
merchandise is delivered on time. A small company’s purchasing plan should focus on the five
key elements of purchasing: quality, quantity, price, timing, and vendor selection.
Page Ref: 631-658
Topic: Creating a Purchasing Plan
AACSB: Analytic Skills
133) Explain the philosophy of Total Quality Management, naming the ten things a small
business owner should do to successfully implement a TQM program.
Answer: Under the total quality management (TQM) philosophy, companies define a quality
product as one that conforms to predetermined standards that satisfy customers’ demands. That
means getting everything from delivery and invoicing to installation and follow-up right the first
time. Although these companies know that they may never reach their targets of perfect quality,
they never stop striving for perfection, recognizing that even a 99.9 percent level of quality is not
good enough. The ten things a small business owner should do to successfully implement a
TQM programs are:
∙ Employ benchmarking to achieve quality outcomes
∙ Shift from a management-driven culture to a participative, team-based one
∙ Modify the reward system to encourage teamwork and innovation
∙ Train workers constantly to give them the tools they need to produce quality and to upgrade
the company’s knowledge base.
∙ Train employees to measure quality with the tools of statistical process control
∙ Use Pareto’s Law to focus TQM efforts
∙ Share information with everyone in the organization.
∙ Focus quality improvements on astonishing the customer
∙ Don’t rely on inspection to produce quality products and services
∙ Avoid using TQM to place blame on those who make mistakes
∙ Strive for continuous improvement in processes as well as in products and services
Page Ref: 637-639
Topic: Total Quality Management
AACSB: Analytic Skills
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Copyright © 2015 Pearson Education, Inc.
134) Outline Deming’s 14 Points.
Answer:
1. Constantly strive to improve products and services. This requires total dedication to
improving quality, productivity, and service—continuously.
2. Adopt a total quality philosophy. There are no shortcuts to quality improvement; it requires
a completely new way of thinking and managing.
3. Correct defects as they happen, rather than relying on mass inspection of end products.
Real quality comes from improving the process, not from inspecting finished products and
services. At that point, it’s too late. Statistical process control charts can help workers detect
when a process is producing poor-quality goods or services. Then they can stop it, make
corrections, and get the process back on target.
4. Don’t award business on price alone. Rather than choosing the lowest-cost vendor,
businesses should work toward establishing close relationships with the vendors who offer the
highest quality.
5. Constantly improve the system of production and service. Managers must focus the entire
company on customer satisfaction, measure results, and make adjustments as necessary.
6. Institute training. Workers cannot improve quality and lower costs without proper training
to erase old ways of doing things.
7. Institute leadership. The supervisor’s job is not to boss workers around; it is to lead. The
nature of the work is more like coaching than controlling.
8. Drive out fear. People often are afraid to point out problems because they fear the
repercussions. Managers must encourage and reward employee suggestions.
9. Break down barriers among staff areas. Departments within organizations often erect
needless barriers to protect their own turf. Total quality requires a spirit of teamwork and
cooperation across the entire organization.
10. Eliminate superficial slogans and goals. These only offend employees because they imply
that workers could do a better job if only they would try.
11. Eliminate standard quotas. They emphasize quantity over quality. Not everyone can move
at the same rate and still produce quality.
12. Remove barriers to pride of workmanship. Most workers want to do quality work.
Eliminating “de-motivators” frees them to achieve quality results.
13. Institute vigorous education and retraining. Managers must teach employees the new
methods of continuous improvement, including statistical process control techniques.
14. Take demonstrated management action to achieve the transformation. Although success
requires involvement of all levels of the organization, the impetus for change must come.
Topic: Deming’s 14 Points: Table 19.3
AACSB: Analytic Skills
29
135) Discuss the concept of the economic order quantity. What is its value to the small business
owner and what are the three principal elements needed to calculate it?
138) Identify and briefly describe the types of discounts a small business might receive from a
manufacturer.
Answer: Vendors typically offer three types of discounts: trade discounts, quantity discounts,
and cash discounts.
∙Trade discounts are established on a graduated scale and depend on a small firm’s position
in the channel of distribution. In other words, trade discounts recognize the fact that
manufacturers, wholesalers, and retailers perform a variety of vital functions at various stages in
the channel of distribution and compensate them for providing these needed activities.
∙Quantity discounts are designed to encourage businesses to order large quantities of
merchandise and supplies. Vendors are able to offer lower prices on bulk purchases because the
cost per unit is lower than for handling small orders. Quantity discounts normally exist in two
forms: non-cumulative and cumulative. Non-cumulative quantity discounts are granted only if a
certain volume of merchandise is purchased in a single order.
∙Cash discounts are offered to customers as an incentive to pay for merchandise promptly.
Many vendors grant cash discounts to avoid being used as an interest-free bank by customers
who purchase merchandise and then fail to pay by the invoice due date. To encourage prompt
payment of invoices, many vendors allow customers to deduct a percentage of the purchase
amount if the customer remits payment within a specified time. Cash discount terms “2/10, net
30″ are common in many industries.
Page Ref: 646-649
Topic: Trade Discounts
AACSB: Analytic Skills
139) What does the small business owner give up if he/she doesn’t take advantage of a vendor’s
discount? Demonstrate by calculating the interest rate on a $12,000 invoice that is 3/10 net 30.
Answer: There is an implicit (opportunity) cost of forgoing a cash discount. By forgoing a cash
discount, a business owner is, in effect, paying an annual interest rate to retain the use of the
discounted amount for the remainder of the credit period.
I = Interest ($) = $360
P = Principle (S) = $11,640
T = Time (number of days/360) = 20/360
R = Rate of Interest (%)
R = 55.67%
Page Ref: 646
Topic: Trade Discounts
AACSB: Analytic Skills
31
140) Timing is a critical element of the purchasing process. Explain the various elements of the
timing of purchases: usage rate, stockouts, safety stock, reorder points, and demand patterns.
Answer: Timing the purchase of merchandise and supplies is also a critical element of a
purchasing plan. Entrepreneurs must schedule delivery dates so that their companies do not lose
customer goodwill from stockouts. In addition, they must concentrate on maintaining proper
control over the firm’s inventory investment without tying up an excessive amount of working
capital. There is a trade-off between the cost of running out of stock and the cost of carrying
additional inventory.
Usage Rate: A business owner must estimate the speed at which the supply of merchandise will
be depleted over a given time. The anticipated usage rate for a product determines how long the
supply will last.
Lead Time: The time gap between placing an order with a vendor and actually receiving the
goods. It may be as little as a few hours or as long as several weeks to process purchase
requisitions and orders, contact the supplier, receive the goods, and add them to the company’s
inventory.
Safety Stock: Business owners must determine the minimum level of stock allowable. If a firm
runs out of a particular item (i.e., incurs stockouts), customers will lose faith in the business and
begin to shop elsewhere. To avoid stockouts, many firms establish a minimum level of inventory
greater than zero. Simply said, they build a cushion, called safety stock.
Reorder Points: When planning delivery schedules for inventory and supplies, owners must
consider the lead time for an order, the time gap between placing an order and receiving it. In
general, business owners cannot expect instantaneous delivery of merchandise. As a result,
managers must plan reorder points for inventory items with lead times in mind.
Page Ref: 649-654
Topic: Timing: When to Order
AACSB: Analytic Skills
141) Compute the reorder point for a small business owner using the following data.
∙ Lead time =7 days
∙ Usage rate=28 units/day
∙ Safety stock=56 units
∙ EOQ=740 units
Answer: Reorder Point = (L x U) + S
Reorder Point = (7 days x 28 units/day) + 56 units
Reorder Point = 252
This business owner should order 750 more units when inventory drops to 252 units.
Page Ref: 653
Topic: Timing: When to Order
AACSB: Analytic Skills
32
142) What is a vendor certification program and why would a small business owner use it?
Answer: When creating a vendor certification program, entrepreneurs should remember the
three Cs: commitment, communication, and control. Commitment to consistently meeting the
company’s quality standards must be paramount. Communication implies trust, and trust creates
working relationships that are long-term and mutually beneficial. A company must make sure
that its vendors and suppliers have in place the controls that enable them to produce quality
results and to achieve continuous improvements in their processes. Creating a vendor
certification program requires entrepreneurs to develop a vendor rating scale that allows them to
evaluate the advantages and disadvantages of each potential vendor. The scale allows
entrepreneurs to score potential vendors on measures of the purchasing criteria that are most
important to their companies’ success.
Page Ref: 657-658
Topic: Vendor Certification
143) It is important to understand transfer of title and the risk of loss when discussing
purchasing. Discuss the three concepts that explain the concept of title, including the rules that
affect the passage of title and risk.
Answer: When small business owners order merchandise and supplies from their vendors, they
should know when the ownership of the merchandise—and the risk associated with it—shifts
from supplier to buyer.
Before the Uniform Commercial Code (UCC) was enacted, the concept of title—the right to
ownership of goods—determined where responsibility for merchandise fell. Today, however, the
UCC has replaced the concept of title with three other concepts: identification, risk of loss, and
insurable interest.
Identification is the first requirement that must be met. Before title can pass to the buyer, the
goods must already be in existence and must be identifiable from all other similar goods.
Risk of loss determines which party incurs the financial risk if the goods are damaged,
destroyed, or lost before they are transferred. Risk of loss does not always pass with title.
Insurable interest ensures the right of either party to the sales contract to obtain insurance to
protect against lost, damaged, or destroyed merchandise as long as that party has “sufficient
interest” in the goods. In general, if goods are identified, the buyer has an insurable interest in
them. The seller has a sufficient interest as long as the seller retains the title to the goods.
However, under certain circumstances both the buyer and the seller have insurable interests even
after title has passed to the buyer.
Page Ref: 662-663
Topic: Legal Issues Affecting Purchasing
AACSB: Analytic Skills
33