3 steps to bridge the gap between procurement & finance
Every organization has its own way of defining savings with processes varying from organization to organization. The process typically involves pulling data from multiple systems and managing the same with excel sheets. The process is not given much importance or is neglected which in turn translates into lack of collaboration between the stakeholders involved in the process. Usually multiple stakeholders are involved in the process viz. Procurement, Finance, Business groups etc. and with a lack of a collaborative platform, arriving at a consensus on critical issues especially pertaining to savings become next to impossible.
Procurement is often found speaking about savings in terms of cost avoidance which indicates the reduction in spend against the normal spend if cost avoidance exercises had not been undertaken. Consider a manufacturer procuring wires. In the case of wire, copper being the key component, it was seen that the prices of copper increased from $4.0/LB in Jan 2010 to $4.5/LB in Jan 2011. The buyer in this case can assume at least 12-13% increase in the cost of the wires (considering nil or negligible price increase in other components like plastic). Now if the sourcing team was successful to restrict the price increase to say 10% then it amounts to a case of cost avoidance of around 2-3%. Typically in this case procurement will speak of the savings it generated through cost avoidance but for finance professional this savings is not visible in the financial statements of the organization raising disputes between the two functionaries.
This article would discuss the 3 steps to bridge the gap between procurement & finance and the role of technology as a means of collaborating between the two functions. Before we discuss the 3 steps let us assess some of the challenges faced by procurement professionals in speaking the language of finance. These are,
- Having a common perception on the savings generated by procurement. The savings calculated by procurement are often not aligned with the accounting principles.
- Project wise tracking of savings generated by procurement and impact on enterprise level savings
- Developing a reporting & monitoring system for procurement & finance professionals
- Balancing the operational continuity objectives of a Chief Procurement Officer (CPO) and working capital strategies of a Chief Financial Officer (CFO) with respect to inventory
- Setting a common goal on credit terms with the suppliers
3 steps to collaboration & role of technology
The challenges mentioned above can be addressed at a technological level and also by means of using innovative processes. The 3 steps to overcome the above challenges and bridge the gap between procurement & finance are,
1. Establish baseline spend details & common savings definition between procurement & finance
2. Track & Manage savings across the enterprise by category, business unit & impact type
3. Demonstrate impact of reported savings on the bottom line
Technology provides a platform to both procurement & finance to arrive on the common definition of savings and set agreed upon baselines to prevent any future disputes. Once the baseline spend has been agreed upon, the next important step is to track the savings being generated enterprise wise across category and business units. It is also important to categorize the savings in terms of its impact on the bottom line. So a savings in say reduction in Cost of goods sold (COGS) can have impact both on the P&L and the balance sheet. However savings generated through process improvement will have its impact only on the P&L (Selling & General Administrative expense) and not the balance sheet. Tracking & Managing savings in this manner not only creates transparency and accountability among the procurement & financial professionals but it also enables procurement to forecast and report savings in the language of finance.
It is essential that there exists a platform for both procurement and finance, where they can set up common agreed upon definition of savings and baseline spend which can be used as the basis of judging procurement performance. Technology provides a means for procurement to demonstrate the impact of its savings on organizations bottom line and finance can use this information obtained from procurement to monitor their performance and to forecast & book savings into department budget & income statement.
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