by martieLast Updated : Jun-27-2023
Are the departments staying within the allocated budgets?
Do you always know whether any department will go over budget before purchasing?
Or you might be a not-for-profit and worried if you have sufficient grant funding to do what you do.
Do you have to wait for the month-end to see if you are over or under budget?
As a CFO, these are the last things you should worry about, assuming you have proper controls.
If you are dealing with any of the above issues, you probably don’t have a purchase order approval process that aligns with your budget management process.
Or you don’t have purchase approval steps or a procurement process.
In this article, we will cover
Why is budget management a challenge for many companies?
Here are some challenges based on our experience working with many small to midsize companies.
A common challenge is missing proactive cost controls.
Proactive cost controls include measures to review the cost before the purchase happens.
The idea is to control what is purchased instead of reacting to surprise spending.
You have a purchase request process for employees and managers with a proactive control process.
With a requisition approval process, you have control over the spending. This is very helpful for large purchases.
Why Is This A Problem?
Generally, this is how companies have evolved.
If there were no purchasing process initially, employees would be used to using the most convenient method for purchase.
First, you should set up a purchasing policy so that employees have a clear direction on the purchasing process.
Your purchasing policy should answer the following questions for your employees:
The second issue we see with companies is using credit cards for most company purchases.
We already mentioned this, but I feel it is worth repeating it.
Even though credit cards are easier to maintain and you don’t have to worry about paying the vendors, you lack cost control.
Since employees purchase without written approval, you could have small or large cost overruns.
And that could lead to you going over budget.
Since you don’t have visibility into budgets while using credit cards, you won’t know if you are under or over budget until all employees submit their expense reports.
So Should You Stop Using Credit Cards?
Well, stop it if you can. However, if you are a small business, you might not get a line of credit from the vendor.
In that case, you have to pay using a credit card.
We recommend the following:
Set up a requisition process to authorize the purchase; if you have to use a credit card,
For example, Let’s say you are paying for online storage (Dropbox or something else), and your average monthly bill is $100.
You can still create a blanket purchase order and approve the annual cost.
This allows you to ensure that the budget owners have the opportunity to review the cost.
You can also use this process to allocate costs to the correct budget.
Most companies have visibility into the total spending.
Pulling a spending report by the chart of accounts or spending by the vendor is not difficult.
But most companies lack the granularity on the line item level visibility.
For example – we spent $100,000 on Advertising.
We spent $100,000 on advertising. Out of that, $10,000 was spent on online ads, and $90,000 was spent on direct advertising channels.
The granular visibility lets you ask better questions to understand how budgets are spent.
The finance teams can use this granular data to understand the ROI for these items, which helps you establish a baseline for the budget.
Most companies used last year’s actuals to build next year’s forecast.
There is nothing wrong with that!
But a data-based approach lets you set up accurate budgets.
In our experience, companies have two types of budgets.
The type of budget varies from industry to industry too.
We could go with a broader classification of capital expenses and operating expenses.
For example – if you are a manufacturing company, then you have COGS budgets, Opex Budget, and Capex budget for improving capital assets, for example, replacing old machinery,
On the other hand, if you are a services company – A marketing agency, you probably would rely more on a project-based budget so that the project’s cost doesn’t exceed the agreed-upon cost with the customer.
So the first step in the budget control process is to decide on the type of budget.
Here are some examples of budgets:
Here is how you would set up a typical budget and schedule for operating expenses:
For example, you are purchasing office supplies.
In this example, there is a budget hierarchy. So for example
In this case, the budget controls should also be monthly to check the monthly budget for consumption.
In some instances, you can let the purchase go over budget.
You can set it up to route the approvals to the budget owners for those exceptions.
That way, you have complete flexibility and control.
The second type of budget is for capital projects, where you might spread out the cost over a couple of months or a couple of quarters.
Following is an example of the capital budget for building repairs:
In this example
In this case, the budget control process should check the purchases against the annual budget, and till the time it is under the annual budget, employees can make purchases.
In some cases, you need project-specific budgets. This type of budget is suitable for cases where you need to track different expenditures within a budget.
Let’s explain with the help of the following example:
In the example above, this is a budget for a marketing agency working on behalf of their client.
The agency wants to track project costs because they would be hiring contractors for content or something else.
So, in this case, you create a project and then individual lines for cost control.
When the user tries to purchase against this project, you can control cost at the line item level.
These types of projects are prevalent in construction projects.
Once the budgets are defined, let’s look at the cost controls you need to put in place so that the purchases are always within the budget.
To do so, you must ensure all purchases are tied to a budget for approval. Let’s take a few examples to show how purchases can be linked to budgets.
Here is an example of how the purchase can be tied to budgets to ensure that you don’t go over budget:
In this example, the system continuously checks for the available budget when the user tries to create a purchase order.
As you can see in the example below, the office supplies budget is ~90% consumed.
Since the purchase amount is under the available amount, the user can purchase of product or service.
Here is another example of project-based purchases:
In the screenshot above, as you can see, the individual line items are tied to the budget line from the project.
If you choose to have project-based budgets, you should tie the purchases to the individual budget lines within the project.
Even though we recommend that all purchases have a purchase order, it is not always practical to have a purchase order.
For example, you might not have a purchase order for every project for legal services:
In that case, the legal firm might invoice you for the services rendered in a given timeframe.
Now, if you have a budget for legal services, how do you ensure you don’t exceed the budget?
In this case, we recommend implementing cost controls at the invoice level.
Here is an example of budget controls implemented at the invoice level:
The goal should be to have budgets tied to all the different purchase mechanisms you have in the company.
I.e., purchase orders, expenses, and invoices.
We strongly recommend that companies move away from non-standard processes like credit card purchases because it is challenging to implement proactive budget controls for credit cards.
You only learn about the Spend when submitting the expense report, which is too late to control Spend.
Implementing an effective approval process for budgeting is crucial to exercise control over expenses within an organization. The subsequent steps outline the process for successfully implementing a budget approval process:
Review Budgetary Constraints: Before implementing the budget approval process, thoroughly review the available budget to ensure that all purchases adhere to the budgetary limits. Determine the approval levels and spending thresholds for each department.
Customized Invoice Approval Forms: Develop personalized forms to gather comprehensive information regarding purchase requests. These forms should include essential details such as vendor information, purchase amount, item description, cost center, and other pertinent data.
Define Approval Workflow: Map out the workflow for invoice approvals, clearly defining the sequence of approvals and ensuring compliance with the organizational hierarchy. For example, a purchase request may require approval from the department head, CFO, and CEO before final approval.
Incorporate Automation Features: Utilize automation features to expedite the approval process and ensure swift processing of all requests. Automation features may encompass email notifications, preconfigured approval templates, approval routing, and approval status tracking.
Organizations can exert better control over expenses by implementing a purchase approval process for budget management and aligning purchases with the available budget. This process entails reviewing the budget, creating customized forms, mapping the workflow, and leveraging automation features to facilitate a streamlined invoicing process.
If you implement the purchase controls tied to the budgets, you can ensure that the purchases stay under the allocated budget.
However, that is not always the case. In some cases, you need to go over budget.
Let’s say you purchase products to service the customers.
You might be allocating an operating budget as a % of the revenue. Let’s say in one year, your sales team breaks all the revenue records.
So as your revenue is growing, you will land up spending more than the planned budget.
In other cases, you might want to keep a close eye on the spending so that you don’t run out of budget.
You can achieve both these cases by implementing these additional budget controls.
One way to ensure you always monitor the budget is to set up a review process during your purchase.
For example, the screenshot above shows a review process for amounts greater than 1,000.
These approvals are over and above your standard approvals for purchase.
In this case, we assume Andrew Warner owns a budget for which the purchase is made.
In summary, set up an approval process so the budget owner can review the purchases to control the Spend if needed.
You should set up the review process so the budget owner approves all large purchases.
Another way to stay under budget is to use proactive consumption alerts.
The budget owner is notified when the budget consumption reaches a certain threshold.
In the example above, the system would notify Alicia when 80% of the budget limit was hit.
This is helpful for the budget owners because now they can take proactive measures to manage the budget.
For example, if the annual budget for office supplies is $50,000 and you have already consumed 80% of the budget in the first three months of the year, that is a cause for concern.
On the other hand, purchasing might purchase certain items in bulk, so the budget usage patterns will differ for that budget.
Another option for budget control is to block the purchase if the purchase order amount exceeds the available budget amount.
For example, the remaining IT budget for the year is $5,000, and the user is typing to purchase an Apple MacBook Pro for $6,000.
In some instances, you probably are ok going over budget, so in those cases, you can set up a tolerance level or allow the user to proceed with a warning.
In the above sections, we discussed setting up adequate budget controls so that you stay under budget.
Having budget controls gives you peace of mind and helps avoid over-budget surprises.
But how do you set up adequate budgets to keep the purchases close to the allocated budgets?
We recommend using Spend data to understand the usage patterns and set up budgets for the next year accordingly.
If you have granular spending data, you will have better visibility into how the allocated budget is spent.
In the chart above, you can see that marketing has the most spending.
This is just an example; we are not suggesting that marketing spends most of the money in a company!
It is a good starting point, but you should go one level deep and understand the usage patterns.
So rather than using the actual Spend as the baseline for the next year’s budget, use the usage patterns to set up next year’s budget.
Let us explain with an example:
The “IT Hardware & Software” category has the most Spend in the case above.
Let’s say this is the total amount spent by the IT department; they had a major IT refresh this year, which is why the Spend is higher in this category.
By understanding the category spend, you can quickly assess whether the spend is recurring or one-time.
We are oversimplifying a bit but better spend data lets you ask better questions.
You can use spending data to set up better budgets, but you can also use this information to reduce total purchasing costs.
With the data in one place, you can quickly check how much you are spending, where you are spending, and at what price point.
You can then use this information to get a better price from your vendors.
For example, you are purchasing IT supplies from three vendors. In the above example – Staples, CDW, and New Age Tech.
A simple approach might be consolidating the purchases to one vendor and getting a better overall price.
If you do that at the beginning of the year, you can adjust the budget based on the negotiated savings.
So if you have better and more granular data, you can use that to drive cost-reduction efforts and reduce the overall budget.
For effective budget control, you need to link the budgets to the point of purchase – for example, the purchase order process.
That allows you to control spending and avoid any over-budget surprises.
The key is not to overcomplicate the entire process but to allow users to see what is available in the budget and how their purchase will impact it.
In the long term, this helps with cost control and building a cost-conscious culture across the company.
What you should do now
Whenever you’re ready… here are 4 ways we can help you scale your purchasing and Accounts payable process.