Procurement Cost Control

Procurement cost control is a key part of the CFO’s responsibilities, especially in economic cycles like a recession.

Growth is all that matters in good times, so who cares about the cost control!

But if you are looking to control procurement costs, this article would cover the framework for controlling spend and immediately reducing the burn rate.

By implementing this strategy, you will be able to extend your cash flow runway without eliminating the headcount (if possible). If you need to cut costs, always consider controlling procurement costs before considering headcount reduction.

Many finance teams struggle with procurement cost control because they don’t have any mechanism to control cost.

The purchase is usually happening using credit cards, or there is no purchase approval process to review the spending before it happens.

You might have a purchase order process, but employees don’t follow the process resulting in surprise invoices that impact your cash flow.

You might have tried Google forms to build a purchase process, but the adoption is low, and you don’t have a single place to see all the company purchases.

This article will cover a step-by-step process to implement procurement cost control in your company.

Note: ProcureDesk is our product, and we have designed it to help CFOs control cost and increase cash flow visibility. Click here to schedule a demo, If you want to see how ProcureDesk can help with procurement cost control; otherwise, read below to build your procurement cost control process.

What is Procurement cost?

Procurement cost covers all the external vendor costs.

It covers all the external vendor expenses, from raw materials to office supplies. It covers everything a company needs to purchase from external vendors to run its operations.  A procurement function is generally responsible for external vendor costs.

Some companies refer to procurement costs as operating expenses or supply chain costs.

Looking at your income statement, this will generally fall in operating expenses or COGS (Cost of Goods Sold).

If you purchase raw materials to manufacture a product, you might refer to procurement costs as direct and Indirect costs.

Direct procurement is all the purchases you make to manufacture the product you are selling. Indirect procurement cost covers all the other expenses required to run the operations.

What is Procurement cost control?

Procurement cost control is controlling spending by implementing tighter Spend controls. Some companies refer to procurement cost control as cost avoidance or soft savings.

Procurement cost control allows managers and senior management to review the spending before the purchase order gets issued to the vendor. When you have ever-changing market conditions, a cost control process ensures that no unauthorized spending is happening in the company.

Procurement cost control is probably the easiest mechanism you can put in place to reduce the overall Spend in a short time.

What is the difference between cost control and cost savings?

A common question is how is cost control different from cost savings?

The difference is in the approach. Cost savings refers to proactively reviewing key supplier spending to identify cost savings opportunities.

A procurement department is responsible for identifying and executing cost-saving opportunities across a specific supplier base or the entire Spend.

Cost control, on the other hand, is a cost avoidance approach. With a cost control process, the managers can decide whether a purchase is required or not.

A purchase control process enables you to reduce spending by cost avoidance.

A cost savings process doesn’t eliminate the Spend but focuses more on getting the best price for the vendor’s product or service. It is done by evaluating all the cost drivers and identifying procurement savings opportunities.

Not purchasing a new computer because the old one works fine is an example of cost control or cost avoidance.

Negotiating the best rate for a new computer is an example of procurement cost savings.

Procurement cost savings is a proactive approach to reducing costs; Procurement cost control is a reactive approach to cost control.

Procurement cost control in 3 steps

In the following sections, we will describe the 3 step process you can implement to start controlling the Spend now!

Please note that we have used ProcureDesk as an example tool, but you can use any tool or build your process using Google forms or any other tool.

Step 1: Set Up a purchasing policy

The first step for procurement cost control is to have a purchasing policy.

A purchasing policy defines the procurement process for your employees.

If you have a procurement department, the purchasing policy covers the procurement department’s role in the purchasing process.

If you don’t have a purchasing policy, you can use ProcureDesk’s purchasing policy template. 

Two main areas that you  should cover in the purchasing policy:

Need for the purchase approval

For effective cost control, you need a purchase approval process.

Every employee should know when purchase approval is required.

There is no rule of thumb here. A company is burning cash fast and needs to control costs and might choose to review everything.

A company setting a proactive cost control approach might want to review spending over a certain dollar amount.

Keep in mind that if you send everything through a purchase approval process, it will take significantly more time to make purchases.

It also hurts productivity because managers now need to approve more purchases.

But if you are struggling for survival, productivity is probably not a top-of-the-mind issue.

Approval matrix

Once you have determined what purchases need approval, the next step is to define who will approve the purchase.

For example, should a manager approve the purchase, or should the finance team make the purchase approval?

Generally, we recommend following the 80-20 rule here.

That is, senior management should approve 20% of the purchase request. The 20% should cover 80% of the Spend. That means you are only sending large purchases to management for approval.

The requester’s immediate manager or the department head should approve the remaining 80% of the purchase requests.

If you are looking for a more strong cost control process, you might want to route everything to finance or senior management for review.

For example, a CFO or controller can review every purchase.

It might not be the best use of the CFO’s time, so try to balance the need for cost control and the impact of purchase approvals on certain individuals.

You want the approval process to run smoother so that no one person becomes the approval bottleneck.

Step 2: Set up a purchase request process

Step two of the purchase cost control process is to set up a purchase request process.

If you already have a purchasing process, all you need to do is to set up a purchase requisition process and make it easy for employees to submit the purchase request.

With a purchase request process, you will be able to achieve the following:

1. Employees get a standardized process on when and how to request a purchase. There is no confusion on how to create a purchase request.
2. Reduce the purchase order cycle time because all the requisitions are in a single place, and everyone has visibility into purchases.
3. The approvers can review the budget before approving the purchase so that they can approve with confidence.

You can use a word template for purchase requests or implement a tool like ProcureDesk that automates the purchasing request process.

Here is an example of an automated purchase request generated in ProcureDesk:

The system remembers the user defaults so that the employees don’t have to reenter the redundant information like their default department and ship to information.

The employee can see the budget before submitting the purchase request. The budgets combined with the purchase requisition system provide a proactive cost control process.

With Budgets, you can create a process in which an employee can’t create a purchase request if a budget is not available.

Here is an example of how easily an employee can select the required budget:

You can also further streamline the purchasing process by setting up vendor catalogs.

You can integrate ProcureDesk with vendors like Amazon.com so that it is easy for employees to select the items they want to purchase and submit for approval.

Here is an example of how a vendor catalog can enhance purchasing experience:

You can also create internal catalogs that enhance the purchasing experience. Here is an example of an internal catalog:

Step 3: Set up an automated  purchase approval process

Once you have a purchasing policy and a purchase requisition process, it is time to set up an automated purchase approval process.

If you have a manual purchase approval process, your employees are going to struggle with the following:

1. They don’t know who needs to approve the purchase without referring to the purchasing matrix all the time.
2. The purchasing approval is slow because you have to manage the back and forth related to the approval in an email.
3. Purchase request approval emails get lost, and the employees have to start over.

You can overcome all these challenges by leveraging an automated purchase approval process.

Here is how to automate the purchase approval process:

If you haven’t already done that, define an approval matrix so that you know who can approve the purchase request.

Next, configure that in the system:

Here is how to configure a multi-step approval workflow that dynamically adjusts the workflow based on the amount.

The first approval is from the manager, and the system automatically identifies and sends to the CFO if the amount is more than $500,000.

Instead of defining every step for different amounts, you can set up the approval limits for each user.

Now the system can automatically identify the relevant people on their approval limit.

For example, The system sends the requests to the immediate manager and their manager because the immediate manager doesn’t have the appropriate approval authority.

The system also keeps track of the complete audit trail so that you don’t have to worry about compliance.

Here is an example of a complete approval audit trail:

The approvers also can approve the request in the way it works best for them. ProcureDesk system supports approval through a web application, mobile app, and directly via email without logging in to the application.

Here is an example of how you can easily approve using the mobile app.

FAQs – Procurement Cost control

This section will answer frequently asked questions about procurement cost control.

What cost is included in the Procurement cost?

The procurement cost includes the cost of the product or service you are purchasing. Some companies also consider the cost of the purchasing process in the procurement cost.

Generally, the procurement cost has one or more components:

1. Cost of the product or service.
2. Purchase order cost covers the cost of creating, approving, and issuing a purchase order to the vendor. The cost could vary from $60 to $500 depending upon the complexity of the purchasing process.

What is cost control?

Cost control defines the process that enables management to review the spending before it happens.

By having the ability to approve a purchase request, the approving manager can decide whether the company can or can’t avoid the cost. If you can avoid a certain purchase, it is called cost avoidance. Hence the term cost control.

What is the difference between cost control and cost reduction?

Cost control focuses on the process of purchasing and controlling unwanted expenses.

On the other hand, companies can achieve cost reduction by eliminating the need for purchase or purchasing from alternate resources.

For example, let’s say you need a new laptop. You can purchase a Mac or a Windows laptop. Let’s say the Mac costs $1300 and Windows costs $600.

Purchasing a Windows laptop instead of an Apple Mac is an example of cost reduction.

Alternatively, you can decide to continue using the old laptop for some more time. It is an example of cost control.

What are cost reduction strategies?

There are many purchasing cost reduction techniques that you can implement. The technique you implement depends upon your maturity as an organization and the resources dedicated to the procurement department.

The top 2 techniques that companies use to reduce costs are:

Consolidate vendors: By consolidating vendors across a category, you can increase overall Spend with a vendor and get better discounts due to increased volume.

Standardize the products: This strategy includes standardizing different variations to a single product. You can increase your purchasing volume for the standardized part and reduce your overall cost.

You can read more here about Procurement cost savings strategies. 

What is cost control in the procurement process?

Cost control refers to the purchase approvals in the procurement process. By approving the purchase request, the managers can control costs.

Now your turn!

Are you ready to get started with your procurement cost control process?

Here is what to do next:

1. Create a purchasing policy and the approval matrix.
2. Set up a purchase request process so that employees know how to submit a purchase request.
3. Track the cycle time for the purchase request process and tweak the process based on the employee’s feedback.

You can do all this using Microsoft word templates, emails for approvals, and trial and error.

Or you can use ProcureDesk to set up a procurement cost control process. ProcureDesk helps finance teams in implementing a purchase control process.

To see if ProcureDesk is a good fit for you, click the button below and schedule a demo with one of our product specialists.