Question

Subject - Purchasing

Includes a correct and succinct description three purchasing ratios. Purchasing ratio selections and content are supported with examples and/or valid references/facts.

Answer 1

Purchasing ratios:

Measuring purchasing performance helps in optimization of supply chain. Purchasing ratios are also indicators of organizational wellbeing. In order to measure purchasing performance of an organization, three important purchasing ratios are discussed with their importance as follows:

Accounts Payable Turnover:

Accounts Payable Turnover = Credit Purchases/Average Payable

It reveals that how many times in a year pay back is given to the suppliers. Organizations set standards at the beginning of every financial year. If the accounts payable turnover is above or below the set ratio this means that purchasing decisions were diverted from what they were accepted to at the beginning. Analysts than analyse reasons for diversion and take necessary steps to ensure the profitable financial performance of an organization.

Example:

A payable turnover of 7 indicates that the business pays back its purchases seven times through the year. It can also be converted into payable in days. 365/7= 52 days. Therefore, every 52 days all the credit purchases are paid back to suppliers.

Inventory Turnover Ratio:

Inventory Turnover Ratio = CoGS/Average inventory

It helps in measuring purchasing effectiveness. It effectively measures the number of time the inventory is used during a particular period. As price of an item is not considered a good element to measure purchasing effectiveness due to fluctuations, inventory turnover ratio is considered as an important measure to analyse purchasing effectiveness.

Example:

If CoGS for $80K and average inventory for $8K, then inventory turnover will be 10 (80/8)

Purchase component defect rate:

Purchase component defect rate = Number of rejected components/Total number of components received

It is important to keep a track of defected items that were received from a supplier. To return or exchange defective item takes time. This time consumed by defective items can be long and costly. It can also interfere with the productivity of the organization therefore, it is important to keep a track of such defects. The increase in rate of defected component also questions supplier’s performance.

Example:

Suppose, the purchase component defect rate for a particular supplier is visible increasing every quarter. Then, the purchasing staff can consider another supplier for the said items.