Bonus Material: Purchase Approval Process Template
Are you struggling with setting up an effective Purchase Order approval process?
Maybe you have read through multiple articles that tell you that it should only take 5 minutes to set up a purchase approval process but you still don’t know where to start?
Or you already have a purchase approval process that is not working for you anymore.
In this article, we will cover 4 common templates you can leverage to set up an effective purchase approval process. Download the purchase approval process template and then as you read along, customize it to your company needs.
Many companies struggle to set up an efficient approval process, the result…
You have a long bureaucratic process and every employee in the company hates it!
If you have set up the process right, your purchase order approval cycle times should look like this:
That means 80% of the requests are approved under an hour and the rest of them are over an hour.
If the current cycle doesn’t look this way, don’t worry…
We will cover everything you need to know about the purchase order approval process. Specifically
• We will cover the basics of the steps of the purchase cycle. Feel free to skip it if you are already a purchasing pro!
• How to set up a purchase approval process of maximum efficiency.
• Pitfalls to avoid and how to measure the efficiency of the purchase order approval process.
• Common purchase order workflow templates.
Before we move forward, download the purchase order process template by clicking on the button below
then follow along to see what approval process template best suit your needs.
The challenge with setting up workflow is that it is not just a once process fits all types of purchase within the organization.
For example, an IT purchase needs a different setup of the approval process whereas office supplies purchase needs a different setup of process.
In other words, the former needs a more complex workflow and the later needs a very simple approval process.
Having different purchase categories adds complexity to the purchase order approval process and we will cover that in detail here.
When our customers implement ProcureDesk, we always start with the question – why you need a purchasing approval process?
We hear common answers like
• We need to control our spending and need proper authorization.
• We are getting ready for growth and need a process from a compliance standpoint.
Whatever your desired outcome would be, you should be able to verify that the compliance process is working.
For that, you need to design the process keeping in mind the ease of audit. A well-designed process is simple and should be easy to audit so that you can audit the transactions and ensure that controls put in place are working.
In case you are not familiar with the purchase order process, we will cover a brief overview of the Purchase Order (PO) process here
In case you are familiar with the process, feel free to skip to the next section
The purchase order is a commercial document between a buyer and a seller.
The buyer creates the purchase order and sends it to the seller as a formal offer to the seller for purchasing the goods or services sold by the seller.
The seller then acknowledges the PO and its associated terms or counter the terms with their own terms.
Once the seller accepts the PO, the purchase is a legal binding between with buyer and seller which is governed by the terms of the contract of the terms of the individual PO.
So how does the PO process starts
Please note that we are describing an ideal purchasing process, this might or might not exists in your company, depending upon the maturity of your organization.
For example, if you are a startup, you might not have a PO process at all and all your purchases are on credit cards or you are just directly paying the invoices.
In an ideal scenario, the steps are as follows
Any purchase starts with the identification of the need to purchase. For example, you are fed up with creating purchase orders in an excel template and you are looking for ways to automate the purchasing process.
The need might be driven by increasing productivity or reduce errors in the process.
So in the example above, the need is to find a purchase order system to automate the purchasing process.
In this step, you probably want to document your requirements. In this case key features of a purchasing system.
Let’s continue with the above example – Since you are looking for a system to automate the purchasing process, the next step is to identify the supplier base and who can offer a purchasing automation solution.
You might look at industry reports or just google to start the process of supplier evaluation. The supplier evaluation process could be simple as seeing a few product demos or doing detailed analysis through an RFP (Request for proposal) process.
Once you have identified the supplier, the next step is to get a purchase authorization, also called budget approvals.
Based on the amount of the purchase and other variables, this might need authorization from senior management or a department head.
This step involves creating the purchase order and getting the purchase order approved.
Some companies have already automated their purchasing process, so this is a non-event. However, if you have a manual process, for example, spreadsheets then it takes some time to create a purchase order.
Once the purchase order is created, you are going to send it to the supplier. A purchase can be transmitted to the supplier in many ways, the most common being through email. We have also seen some companies still using fax to send the purchase order to the supplier.
The main purpose of the supplier acknowledgment is for the supplier to confirm whether they can meet the requirements of the purchase order.
This step is important because you can avoid any surprises going forward, in terms of nondelivery or price changes if the order is already acknowledged.
Please note that not all purchases need to go through these purchasing steps. For example, for office supplies – you don’t need to identify a supplier.
Let’s now look at how to set up the order approval process. Before you can decide an optimum purchase order approval process, you need to get a better understanding of different variables in the purchasing process.
Understanding your Spend would help you design an optimum and efficient approval process.
What do you need to know before you get started?
One of the biggest mistake companies makes while designing a purchase order workflow is that they consider all purchase categories to follow a similar process.
One size fits all doesn’t work here, we will explain this with few examples. However, you can categorize your workflow in four approval process templates.
However, this is a very critical or underestimated process of the whole purchase order approval process.
By looking at your past purchases, you can get a better handle on what your company is purchasing and what is currently going through a purchase order approval process.
Let’s take an example of a hypothetical manufacturing company, the purchase includes
• Raw materials to manufacture the product company is selling.
• Supplies to run the operations, for example, material supplies.
• IT spend – Hardware and software.
• Common spend like office supplies.
• Other marketing and sales expenses like advertising and sales training.
This is not an all-inclusive list but this should get you started.
We will discuss in the next section on how to use the categories to set up a purchase order workflow.
Average spend amount
When it comes to setting up approval workflows, a common approach is to set up a review process based on the purchase amount of the purchase.
However, how do you decide what amount should be approved at what level in the company?
Most people take an approach where they pick a number out of thin air or so-called best practices.
For example, a manager can approve up to $10,000. That sounds like a good approach but what if your average purchase order amount is greater than $10,000?
In that case, all your purchases need to be approved by senior management and that causes delays in the process.
So to design an approval process based on facts, let’s review the history of purchases across the board for the last year.
Draw a bell curve so that you can understand the distribution of the spend by transaction count. We will use this data in the next section for workflow and design.
Accountability and control
How much accountability and control lower to middle management should have in the company?
Some companies prefer that middle management has more power to make decisions faster.
So if your company culture is enabling the middle managers with more authority so that there is accountability, then the process needs to be designed with that in mind.
However, if senior management likes to have more control over purchases, then that needs to be considered in your process design.
There is no right or wrong answer here, the approval process should reflect the reality on the ground.
We might be stretching here a bit but the approval process really reflects the culture of the company.
Goals of the process – efficient or bureaucratic?
Do you want the process to be efficient or complex and bureaucratic where every purchase needs to be vetted by 4 different groups?
These options are mutually exclusive or in other words, you can either have a process that is efficient or another way around.
Efficient processes are simple by design and not complex.
So you have all the data, let see how you can use this information to design an effective and efficient purchase order flow.
If you haven’t’ done this already, download the approval process template
then use the information from the following sections to optimize the purchase approval process.
From a design standpoint, there are a couple of considerations and we will address them in the following sections.
A very common approach is to design a workflow based on the total amount of the purchase order. This approach makes sense because it takes care of the basic approval or authorization of the Spend before the purchase orders can be sent to the supplier.
In the above section, we looked at the average amount of the purchases over the last 6-12 months, Now we will use that information to design a workflow for the purchase order approval process.
You can use the Pareto principle to understand the distribution of the current purchases and the process flow.
Let’s explain with an example.
Let’s say that your average spend per purchase order is $10,000. So you decide to use $10,000 as the threshold above which approval is required by senior management.
You should not stop there.
Now use this rule and apply this rule to the last 12 months of purchase order transactions. See how many transactions will need senior management approval.
Ideally, that number should be less than 20% of the transactions.
If it is more than that, then adjust the threshold.
The goal is not to have senior management approves all purchase orders.
From a spending perspective, it should be reversed.
So using Pareto, senior management should only approve up to 20% of transactions which contributes to 80% or more of spend.
The second approach to workflow design is to set up a workflow based on the category of the purchase.
Generally companies setup only one workflow for all categories.
So whether you are purchasing office supplies or whether you are purchasing a million dollar capital equipment, the approval process is the same.
Granted that approvals for capital investments are already done offline and approval through the system is just a formality.
However different categories have different needs and you should set up an approval process accordingly
Let’s explain with the help of an example
For office supplies, there is no additional approval required unless you maintain an inventory of common office supplies products.
If that is the case, you might need the final approver to be the office manager so that they can decide whether the item can be fulfilled from the existing inventory or it needs to be ordered from a supplier.
Most of the strategic sourcing teams are organized by categories, so if you want procurement to review non-standard purchases, then it is a good idea to route the requisitions based on the category of the purchase.
Another example could be IT purchases.
The IT department might want to review purchases to ensure that they meet the IT standards. For example, if your IT team only supports the Windows operating system, you don’t want employees to purchase a Mac.
Above are some examples where a category-based approval workflow makes sense.
You should review your purchase history and approval history to decide whether such approvals are required or not.
Another common approach is to have a budget owner review purchases before it is sent to the supplier.
The first question to ask is who is the budget owner?
Is it the person responsible for the department or is it someone in the finance department who oversees budgets and planning?
In our view, it should be the person responsible for the operation of the department. After all, they are responsible for the end results.
Once you have determined who is the budget owner, you need to then determine when they need to approve a purchase?
For example, should they approve everything or should they approve purchases above a certain threshold?
In the end, you need to balance the need for control to the efficiency of the process.
Ideally, budget owners should review items above a threshold and finance should be involved in case the purchase is over budget.
So far, we have discussed the need for different types of workflows. In this section, we will cover some common purchase order approval process templates.
You can combine one or many of these templates together to get to your ideal workflow.
The most common template used for purchase order approval is the approval of the manager or the next person in the reporting hierarchy.
The process works as follows
1. Every purchase needs at least one approver. No matter what the amount is. The idea is to have a basic control in place to ensure that a second person is always reviewing the purchase.
2. The second aspect of this workflow is the threshold of approval. So for example, a senior manager can only approve up to $100,000. Then anything above that should be sent to the next person in the reporting hierarchy.
So to summarize, there are two aspects of the HR manager approval process
1. Approval by the manager of the person creating the purchase order.
2. An approval threshold to decide how many people in the hierarchy should approve the purchase.
The category-based template is generally used in combination with the HR manager process flow described above.
The purpose of a category-based workflow is to have an additional review of the purchase based on the category of the purchase.
We will look at some common examples where category based approval process is used in combination with the HR manager approval
IT hardware is a good example of a category-based workflow.
For example, an individual in the company wants to purchase a new computer monitor.
Your IT team has a specific standard for monitors.
So by having a category-based workflow, any IT hardware purchase can be reviewed by the IT department to ensure compliance with the standard.
Another example is Software, the IT department might have enterprise licenses for productivity software like Microsoft Office. A pre-purchase review can help identify any rogue purchase.
As the name suggests, this approval workflow is based on the budget owner.
The budget owner could be the person who leads the department or the owner could be the finance team lead assigned to that department.
The first and foremost goal of the budget owner is to ensure that before the purchase happens, you have vetted that you have enough budget assigned for that purchase.
Now, do you need to do it for every purchase?
The answer is No, for example – you don’t want a printing paper purchase to be approved by the budget owner.
However, you want large purchases approved by the budget owner.
We recommend the following template
1. Set up a threshold for budget owner approval
2. Set up categories for budget owner approvals, not all purchases need to go for approval.
3. Additionally, you can think of exceptions – for example, if the budget remaining is less than the purchase order amount, then the budget owner should review that.
The purchasing review applies only when you have a purchasing team.
This workflow could be used in combination with the HR approval process. Ideally purchasing should be the first step in the approval hierarchy.
First of all, this is a review process and not an approval process.
The approval for purchase always comes from the department whose budget is being consumed.
The purpose of the purchasing review is to ensure that the purchase is with the preferred vendor and we have received competitive pricing for the purchase.
If you are just starting with purchasing automation and setting up the approval process, we recommend not adding a purchasing review on day one. It will make the process long and some stakeholders might complain about too much oversight.
Having said that, if you want to set up a purchasing review process, here are the guidelines.
1. No purchasing review for catalog items
If you already have catalogs with preferred pricing, then there is no need for purchasing to review the requisitions again.
2. Set up a threshold for purchasing review
Not every purchase has to be reviewed by purchasing. So first and foremost, it is important to define why you need purchasing to review the purchases.
It could be that you want the purchasing team to negotiate a price for any non-standard purchase or items for which you don’t have preferred pricing.
It could be that you want Purchasing to review the orders for completion of the data.
Ideally, you should have a purchasing system driving most of the compliance – both data compliance as well as purchase order approval process.
if you don’t have a purchasing system, then set up a threshold for approval and have everything reviewed by purchasing.
What is the difference between purchasing review and purchasing approval?
A review is done to ensure that the order is complete, and the only time you reject the order when the order data is not complete.
Approvals, on the other hand, serve as a control to ensure that the purchase is routed to preferred vendors with preferred pricing.
In case you are wondering what are the benefits of a purchase order approval, let’s touch upon some of the key benefits of the approval process.
The obvious benefit is cost control.
Since you are authorizing all the purchases before the PO is sent to the supplier, you control whether the spend should happen or not.
With effective cost control, you can avoid certain spend because either the purchase is unnecessary or it can be fulfilled through other means.
For example, you are ordering an item that is already in inventory because the person ordering is not aware of the items in the inventory.
Visibility into working capital requirements
One of the challenges with non-PO based purchases is that though the process is fast, you don’t know about the spend and related obligations till you get the credit card statement or the supplier invoice shows up.
This is a major headache If you are responsible for the treasury function or controller of the company.
So how does an approval process remedy this?
It provides instant visibility into the spend and related obligations.
Not only you know what has been approved for purchase but also what is in the process of being approved.
Since you have one process for all purchases, you can easily figure out what is processed and what is in the process of being ordered.
You can also see Purchase orders which are still being created and not entered in the process.
More importantly, over time you can easily forecast trends based on the purchase history and linking your purchases with contracts.
Faster month-end close for A/P
One of the challenges for A/P team is to reconcile the invoices with purchase orders.
Even if you have a purchase order process which is manual, it is possible that all purchase orders are not at one single place.
With a purchase order approval process, you are ensuring that all PO’s are going through one common process and it is easy to find all purchase orders at one single place.
You could modify the HR-based Approval template (Click below to download) to add an additional finance layer.
Once you have the PO approval process is in place, you also have to ensure that the suppliers are mentioning the purchase order on the invoice.
That way when A/P teams receive the invoice, they know the PO against which they need to index it.
This process can be further optimized by leveraging one system for procure to pay process.
When designing the purchasing process, go with the assumption that the process is not going to be perfect on day one.
You should continuously seek feedback and work on improving the process.
Having said that, here are some best practices or common pitfalls to avoid while setting up the process.
While designing the process for the first time, try to keep it minimal and simple.
Over a period of time, you can add more steps to make the process more comprehensive.
In the above section, we talked about different types of workflows (HR, category, purchasing) you can leverage while designing an optimum workflow.
We don’t recommend adding all those steps on day one.
Your purchase approval process must evolve over time along with the maturity of the procurement function as well the adoption of procurement within the organization.
If you are just setting up the purchasing approval process, here are some recommendations
1. Setup a minimal workflow – for example, all purchases must be approved by at least one person.
2. Have clear guidelines for the end-users. For example, all purchases above $10,000 need to be approved by the Director of the department.
Once you have the basic process working, you can always add more steps to it.
Look at automating the purchase approval process so that users don’t have to remember who needs to approve the purchase.
Along with a complex purchase approval process, the next common mistake we see is a series of management approval.
The question you should ask is what is the purpose of management approval?
• Is it to control spend by ensuring that all purchases are reviewed by senior management?
• Is it to ensure that management is aware of all the major purchases so that later there are no surprises?
These are the most common goals of setting up a management workflow.
Whatever your goal is, the challenge with management approval is that it takes time.
CXO’s of companies are busy growing the business and not sitting around waiting for the purchase orders to show up for approval.
Most of the time the approvals are anyways delegated to executive admins, so we don’t think it is effective anyway.
If you want to set up management approvals, set up a higher threshold for management approvals.
You can easily figure out the threshold based on the purchase history, focus on 20% (or less) of transactions which contributes to 80% of spend.
That is just a guideline but the idea here is to ensure that only minimum and most important purchase orders are approved by management.
Yes, we are overemphasizing this point but to make sure that the purchase approval process is serving its purpose, you have to continuously look at the efficiency of the purchase process.
We recommend a quarterly review of the process to measure the effectiveness and then adjust accordingly.
An objective way to measure the effectiveness of purchasing workflow is to calculate and report on the end to end cycle time for a purchase order.
PO cycle time = [Date & time when PO is sent to the supplier] – [Date & time when the requisition was created]
When measuring the cycle time, divide data by spend buckets. Purchase orders with large amount might take more time because of the management approval.
A qualitative or subjective way to measure the effectiveness of workflow is to ask the end-users.
For example, you can ask some power users – how is the approval process?
Is it simple or it is overwhelming?
Based on quantitative and qualitative feedback, accordingly, adjust the workflow.
Do you have an internal audit department? Or do you engage external auditors to review the key controls?
If you answered Yes to any question, then you need to design the approval process with the auditor’s requirements in mind.
If the answer is No, It is still a good practice to design the process which is easy to audit, so that at a later time when you have to provide data to auditors, it is readily available
The following are some key items which the auditors look for
The basic premise for any audit exercise is to determine whether the controls are working as designed.
So needless to say that your purchasing approval process should be well documented.
Your purchasing policy should be the single place where the controls should be documented.
If you currently don’t have a purchasing policy, you should put that together before implementing any such approval controls.
Auditors ask for a sample of data so that they can audit the transactions and ensure that the controls are working as designed.
From an implementation standpoint, you should ensure the approval history of each purchase order is well documented.
Auditors would need a sample of the data along with the audit history of the documents so that they can compare that with the documented controls and identify discrepancies if any.
If your purchase approval process is not automated then this could be an issue because the auditors would request approval email etc as evidence of the documented controls.
Any good purchasing system would have a documented audit history that can be easily made available to the auditors for review.
No matter how good your purchasing process is, you would always have exceptions to the process.
It is normal to have those exceptions, but auditors always look for those boundary conditions where the workflow didn’t work.
Ideally, you should document the following
• The reason for the exception in the workflow.
• How the exception was handled.
• What is being done to manage the exception going forward?
Here are some examples of exceptions
For example – The approval needs to be routed to someone else because the person is out of office. In case you have an automated purchasing system, this can be easily be managed through delegations.
This is just one example of a very common use case around exceptions
When it comes to designing an effective purchase order approval process, follow these guidelines
• Analyze the purchase history to understand your purchasing trends.
• Use the purchase history to drive your approval process design.
• Keep it simple and then improvise based on user feedback.
• Keep senior management approval to a minimum.
• Keep other needs into consideration, for example, need for the audit department.
Now your turn!
Download the approval process template and get started with designing the optimum purchase approval process. If you have questions, leave a comment below.