Procurement- The savior Finance needs!

By Chinmay Bhargava
147
  • September 25, 2021

Index

  1. Overview
  2. How do Finance and Procurement think different
    – Cost savings and Cost avoidance
    – Disintegrated data
    – Forecasting & Future Profitability
  3. Challenges with the traditional approach
  4. Adopting an Integrated Approach
    – Optimizing savings
    – Quality Data For Budgeting
    – Better risk management
    – Sourcing Technology
  5. Encouraging Synergy
    – Laying The Foundation Of Trust
    – Aligning objectives
    – Giving Credit where it’s due
    – Data Integration
  6. Leveraging analytics solutions

Overview

Finance and procurement are two unique departments responsible for their distinct functions and goals. It should not be a surprise if they have different perspectives and may have different interpretations of a particular metric or key performance indicator.

We know that finance has an upper hand in an organization and therefore should be responsible for leveraging procurement to create value.

How do Finance and Procurement think differently?

The ERP systems are designed to capture data relevant for accounting, financial reporting, budgeting, inventory management, etc. which is meant for the finance organization. The general ledger entry will relate to business units, cost centers, customers and suppliers. This will get reflected in the ERP systems and accordingly finance will have visibility around it. 

However, the procurement finds this data completely out of place. The first step that procurement will have to undertake is cleansing and categorizing the GL data to make sense for procurement levers of aggregation and consolidation.

On another note, the finance department has cash priorities and works towards discount terms, deferred payments, etc. to efficiently manage the working capital. The procurement organization works towards strategic supplier collaboration and the best pricing framework.

There is a difference in perspectives between finance and procurement in relation to Savings realization as well.

The Aberdeen Group found that “procurement, by its own admission, fails to implement 21 percent of the savings identified through its sourcing efforts” in a poll of CFOs and CPOs (Chief Procurement Officers).  Aberdeen also discovered that 34% of organizations have no clear process in place to measure procurement savings. Less than 10% of procurement departments perform an excellent job of predicting, implementing, and tracking their cost-cutting initiatives, according to CFOs.

Cost Savings & Cost Avoidance

Without a distinction between cost savings and cost avoidance(soft savings), the discussion of cost cutting is incomplete.

Suppose, an organization is paying $15,000 to subscribe to an AI tool for a year. The vendor sends a renewal contract with a 10% increase over the previous year’s contract. The 10% increase in cost can be avoided by negotiating a long-term contract by the Procurement team.

According to The Chartered Institute of Procurement and Supply, “ Cost avoidance is a reduction in cost, resulting in a spend that is lower than would otherwise have been if the cost avoidance exercise had not been undertaken.”

Cost Saving are the hard dollars that can be used for buying. To understand cost savings let us look into the major categories of expenses from a finance perspective –

  • CAPEX:  Any time an organization pays money, uses collateral, or takes on debt to buy new assets, or increase the value of existing assets, it’s considered a capital expenditure, and it’s expected to pay dividends for years to come.As a general rule, this is a below-the-line expense that affects a company’s cash flow, but not its EBITDA for example, purchase of new equipment.
  •  OPEX: A company’s day-to-day operating costs are included in this. As an example, repair/ maintenance, supplies, etc. Also known as above the line expenses, these expenses have a direct impact on EBITDA.

For a better understanding of procurement’s total value, the departments should track both cost savings and cost avoidance

When it comes to EBITDA, procurement develops strategies that maximize savings which are driven to the bottom line P/L and ultimately results in EBITDA improvement. 

Disintegrated Data

Payment information is usually kept in the ERP systems and financial ledgers while other data elements, such as expenditure, POs, prices, vendor performance, and risk data, are kept elsewhere. This causes problems with reconciliation and prohibits the company from enhancing compliance and saving money.

The governance & reporting requirements may be precise and not open to interpretation, thus having well-managed data in compliance with accounting regulations. 

DOWNFALLS OF THE TRADITIONAL APPROACH

Low Spend Visibility

As per Global CPO Survey 2019 conducted in partnership with Deloitte Consulting, it was observed that supply chain transparency is lacking with 65 % of procurement leaders having limited or no insight beyond their top suppliers.

 It was found that cost control and risk management were at the top of procurement and finance chiefs’ priority lists. And for them to achieve these goals, they must have total insight into their complete spend and supply chain.

The Tail Spend Visibility is even a bigger challenge as it is not addressed by Procurement. It is more difficult to track and analyse than the strategic spend especially when purchasing occurs in separate parts of a company. 

Contract Non Compliance

In supplier contracts, conditions and norms include a savings component or a financial incentive built into them. Financing plans and budgets rely on these negotiated savings to meet their goals. Non-compliance with contracts could lead to erratic spending, broken supplier relationships, and put the organization at risk during compliance audits.

Generally, the finance department is not notified of changes in supplier remittance information after a purchase contract is signed. It is also difficult for finance to track suppliers in terms of pricing, discounts, and delivery. 

Supply Chain Risks

The Supply Chain risks arise due to political developments, environmental factors and economic constraints.

Increasingly, organizations are recognising the necessity for a constant risk analysis of their supplier base – not just when a vendor is established, but during the vendor’s entire lifecycle. Procurement and finance play a large role in firms’ supplier visibility initiatives.

ADOPTING AN INTEGRATED APPROACH- The key to success

The traditional approach creates acute tension between the two departments. The key to efficiency lies in bridging the gap. Procurement and finance departments’ essential functions are evolving into a new, more integrated approach.

Optimizing Savings

Close collaboration helps to find and investigate the most appropriate savings options, as well as realize the negotiated savings. Savings optimization includes-

SPEND MANAGEMENT

Organizations have little insight of their spend when procurement and finance function in isolation, making spend analysis and control difficult. The method of working in silos, also leads to a proliferation of vendors across the organization, inadequate vendor management, and hampered sourcing effectiveness

TAIL SPEND VISIBILITY

Tail-end spend management, which accounts for 20% of a company’s spend but 80% of its suppliers, can benefit greatly from procurement and finance alignment. It comprises the bulk of transactions in a company, yet it is not categorized. Many firms don’t manage their tail spending with the same rigor they do their core spending. There are ‘maverick’ high-cost purchases that ideally should have gone through a more strategic purchasing process.Unmanaged tail spend makes company’s susceptible to risks.

COMPLIANCE

Uncoordinated purchasing behavior throughout an enterprise has a detrimental influence on measures like PO penetration. It also makes it more difficult to negotiate with suppliers, and it reduces spend visibility and spend control.

Adding a savings tracking module to existing procurement technology such as spend analysis tools is possible. The benefit of using a tool is that the team will have a seamless experience from saving opportunity identification to saving opportunity implementation.

Integrated automated systems make it simple to share information like supplier order history and category spend data, giving procurement more leverage in negotiations. As a result, the finance department can keep track of procurement contributions, consequently, build trust and optimize performance.

Quality Data For Budgeting

This is where predictive analytics comes into play. Data management has been enhanced with predictive analytics to aid in the forecasting process. A wide range of current and historical data sources are used to develop strategies for expenditures. The factors affecting the it include,

  •       Market Intelligence-consumer behavior, demand pattern, supply chain disruptions, government policies, etc
  •       Economic factors such as exchange rates, currency valuation, etc.
  •       Drivers of costs include materials used, production labor, and transportation, in addition to indirect costs such as administration and research and development (R&D)

To ensure that reports deliver real-time information that people can act on with confidence, a collaborative approach to employing technology to integrate and speed up processes is required.

For instance, the procurement department can help if finance has a policy of deliberately defer payments. This means that teams should focus on implementing integrated finance/procurement tech solutions that will prevent problems like missing PO numbers and inaccurate master data.

According to a Harvard Business Review study, 26% of the executives cited that transparent finance and procurement process would lead to 11-20% cost reduction.

Better Risk Management

While finance and procurement have different risk management priorities, they both care about things like new supplier due diligence, continuing compliance updates, internal controls, and the financial implications of a supply chain breakdown. Collaboration on requirements, systems, and procedures will help widen risk understanding and improve risk management strategies.

Organizations can utilize analytics to execute order processing, purchasing, and other business-critical processes using filters like value benchmarks and data completeness requirements. These reports serve as a warning mechanism for potential company hazards and regulatory noncompliance, lowering the chance of significant financial loss.

Sourcing Technology

Savings from procurement activities can be measured and tracked using supply chain management technology, sometimes known as “sourcing technology.” And if the measurement method identifies what should be handled and how, savings can be realized fast.

Procurement can help finance by providing insights into the vendor landscape, as well as their knowledge of CSR.

The jewelry business Tiffany considers transparent sourcing to be vital to their brand. Consumers, particularly younger ones, seek proof that the stones were not made with child labour or used to fund terrorism. As a result, Tiffany is now disclosing the country from which the diamond was mined, and will shortly begin disclosing where each diamond was cut, polished, and set. This builds brand value and raises profits.

ENCOURAGING SYNERGY

The procurement team’s goal is to save money for the company, and the finance team determines the procurement’s budget. Paying for everything that the procurement team orders and receives is another responsibility of finance. Determining whether or not what the finance team paid for was actually delivered is the responsibility of the procurement team.

So how does one enable collaboration?

Laying The Foundation Of Trust

  • The accounts payable staff, the purchasing or procurement departments, and senior management should work together to build a top-down working capital culture that permeates the organization, rather than just a stopgap measure to guarantee bills are processed swiftly.
  • For the finance and procurement teams to function successfully together, and for each team’s responsibilities to be well understood, it’s essential that they communicate effectively and openly. It is critical for the growth of the organization for the two teams to trust each other.

Aligning Objectives

  • Procurement and finance have traditionally tracked various measures and KPIs, resulting in separate governance and assessments.
  • Finance focuses on efficiency measures such as payment cycle time, days payable outstanding (DPO), operational cost and working capital, while procurement may try to minimize costs through early payment discounts and supplier leverage.
  • These goals are frequently out of sync. Aligning objectives requires establishing a common governance rhythm. This can be accomplished by establishing a governance board with  representation from both sides, which will track and analyze the relative merits of discounting and DPO.
  • To get the most out of their collaboration, both parties should decide on KPIs and KPCs. Businesses can connect procurement and finance in a variety of ways, enabling them to work together more effectively and efficiently.

Giving Credit Where It’s Due

  • The framework for measuring cost savings should clearly define the types of savings. Those in charge of finance must understand and accept the fact that all cost savings cannot be measured using a standard formula.
  • Projects undertaken are frequently cross-functional collaborations with interdisciplinary   teams. Hence, accountability for realizing savings does not always fall to procurement. The procurement team should be recognised and applauded for the efforts put in by them.

Data Integration

  • Budgets are created by combining the efforts of procurement and finance teams in a cooperative manner. For example, finance is in charge of determining the budget, while procurement is in charge of adhering to those budgets and making sure that the products purchased have been received and paid for by finance.
  • An integrated approach based on actual invoice data and linking it to spend development increases the credibility of savings. For the stakeholders, it is more important to see the total net impact on costs rather than just savings.

As a result of this shift in their relationship, both sides will need to improve their awareness of each other’s priorities and KPIs. The integration of finance and procurement is made easier by investing in business data analytics technologies.

LEVERAGING ANALYTICS SOLUTIONS

Procurement Analytics generates cross-functional information that other departments can use to assess their own spending and financial performance. According to a McKinsey & Company expert interview, automated source-to-pay process can reduce spend by 3.5%.

When applied across a real-time collaborative logistics platform, analytics can help companies by pointing out opportunities for improvement in the following ways:

As a result, the chances of financial losses and out-of-stock issues are reduced.

Furthermore, analytics-driven insights assist supply chain leaders in intervening when issues or changes arise, such as the need to collaborate with a carrier that offers speedier delivery at a greater cost.

Implementation of AI results in increased payment and spend visibility by leveraging procurement analytics to give finance and procurement teams with customizable data and dashboards on transactions and key performance indicators (KPIs) including PO correctness and invoice payment on time.

Not only can having visibility into spend, process KPIs, and supplier data helps increase revenue, but it also provides more control over financial operations.  The interactive data filtering allows you to customize the data in any way, such as by spend volume, organization unit, cost center, project, or other relevant dimension

Businesses can continue to use their existing ERP systems while extending the strategic value of their investment thanks to cloud-based procurement tools that sync with and complement existing ERP systems and get insights of tail spend.

Automation helps optimize procurement operations and provides firms with data-driven procurement insights that reduce costs and improve overall financial health.

In conclusion, using a collaborative shared environment, members of the team can improve productivity while decreasing errors by adopting universal norms and practices. When it comes to complex procurement activities, such as lease, purchasing decisions, outsourcing, lean activities, vendor-managed inventory programmes, finance’s experience and buy-in is invaluable. While financing can be better informed about sourcing decisions and procurement targets, generating greater cross-functional learning and collaboration opportunities.

These teams can give better data for overall planning, especially to support yearly planning cycles, if they collaborate more. Finance teams can obtain a better understanding of organizational spend and make better cash flow decisions if procurement receives specific spend data. Finance and procurement teams can also find areas for enhancing processing efficiencies and cost reductions by working in sync.

Proacure is a procurement technology & data-science organization based in the San Francisco Bay Area. Our ‘Koreografy’ model leverages multiple frameworks like congruence of different data sets, fusion of digital, analytics and business processes, and synchronous collaboration between various stakeholders. The model enables 100% Spend Visibility with prescriptive actionable insights to transform Strategic Sourcing and help realize untapped value in the Supplier and Tail Spend. Proacure’s deliverables include cost savings of 7-30%, a 20%+ increase in EBITDA, cash flow optimization, and reduced supply-chain disruption.

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