Bonus: Purchase order system checklist
CFOs and controllers of growing companies always struggle with the purchase order management process. If you struggle with cost control and the purchase order process, this article is for you.
This strategy is for the CFO or controller of growing companies who want to implement a tighter Spend control process.
If you are flush with cash and don’t care about Spend management, stop here!
Without purchase order management, you don’t have an efficient procurement process, and you are always playing a catch-up game with your expenses.
Without a proactive cost control measure, the finance team always reacts to what is coming their way.
It could be a surprise invoice or a large unplanned credit card expense.
If you don’t have a purchase order management process, you are probably dealing with the following:
Surprise expenses
Surprise invoices show up without any heads up, and then the finance team needs to have enough working capital to support that.
You probably have tried creating purchase orders to forecast your spending, but keeping track of purchase orders in a spreadsheet is no fun.
Or you have a lower adoption of purchase orders, so not all employees create purchase orders.
Many growing companies rely heavily on credit cards. That makes sense because it is convenient, and you don’t have to worry about setting a separate process for paying vendors using an invoice.
The biggest challenge is waiting for the credit card statement to see your total spending.
With a purchase order management system, you can still have purchase authorized and pay with a credit card.
Poor Cash flow planning
Since you don’t have a way to plan your working capital needs, your team suffers from poor cash flow planning.
If you have unlimited cash in the bank, then not having visibility into Spend might not be a problem. But that is not the case for many growing companies.
By using purchase order software, you can see what you have committed to purchase and then plan your cash flow requirements.
Lower productivity
if you don’t have an established process, it is a productivity drag for the entire organization.
When you don’t have a purchase order process, employees don’t know how to purchase.
You might have a buyer or a procurement team, but without an established process, there is low engagement.
That means employees spend a lot of time asking other employees what to do, or they just do what they want to do.
The result is that the finance team spends a lot of time cleaning up the mess, which is time wasted.
This article will show you a proven strategy to control spending through purchase order management. Specifically, we will cover the following:
- How to implement a purchase order management process.
- How to get management buy-in for implementing a purchase order management software.
- How to track the success of the purchase order management process.
Table of Contents
What is purchase order management?
Purchase order management refers to managing company purchases through a purchase order process.
There are two main components of purchase order management:
Purchase order management process
A purchase order management process refers to a company’s process of purchasing products or services from different vendors to run the operations.
A purchase order management process starts with setting up a purchasing policy that covers the process, approval requirements, etc.
Once you establish the purchasing policy, the next step is to implement the policy and drive the adoption of the purchase order management process across the organization.
If you are a small team (less than five people), you can just inform everyone about the new process, which should do the job.
If you are a large company, you need a system to operationalize the purchase order management process.
Purchase order management system
A purchase order management system is a set of tools that automate your company’s purchasing process.
You can patch together a purchase order management system using spreadsheets and templates, which are prone to human error.
Or you can implement a purchase order system and automate the manual purchase order management process.
A purchase order management system automates the complete process from when a user requests a purchase to automatically dispatching the purchase order to the vendor.
It reduces the effort required to create and approve a purchase order and hence increases the adoption of the purchase order process.
The more purchase orders you have, the better visibility into Spend.
Why is purchase order management important
Here are is what to expect from an effective purchase order management
Tighter Spend control
The biggest benefit you get by implementing purchase order management is that you have tighter control over spending.
Employees create a purchase request before they make the purchase. They then send the purchase request for approval.
The approval process allows a manager to review the spending against the budget and decide if the employee can move forward with the purchase.
It prevents maverick spending and ensures that you stay within the allocated budget.
Moreover, you can establish a review process for the CFO or senior management to approve large purchases. For example – anything over $100,000 should be approved by the CFO of the company.
Better Spend reporting
If you have all your spending in one place, it is easier to report the total spending.
With a purchase order management process, all your purchase requests are in one single place.
Whether you pay using a credit card or an invoice, you have all your purchases in one single place.
With that, you can then track overall Spend with different vendors.
You can accurately track your burn rate and better plan your cash flow requirements with monthly spend trends.
Here is an example of monthly Spend trends:
Increased productivity
It is pretty cumbersome if you are manually implementing a purchase order process.
With a purchase order system, you can significantly improve the entire organization’s productivity and still get better Spend reporting.
Here are the activities that you can automate to increase productivity.
- Employees have to fill in spreadsheets with a manual process to request a purchase. With a purchase order online system, employees can create the request with a few clicks without filling up any forms.
- Employees need to request approval. With email approvals, it is a constant back and forth. Employees need to remember the correct person who needs to approve. You can automate the approval process by setting up a purchasing approval matrix, and then the system figures out the request.
CFO love tighter Spend controls but hate to have slower processes and lower productivity.
A purchase order management process allows you to get better controls without sacrificing productivity.
Steps for implementing a purchase order management process
This section will talk about how to implement a purchase order management process. We will talk about the processes and technology you need to implement a purchase order process.
Please note that we are using ProcureDesk as an example. You can replace this with the tool of your choice or templates.
Here is the six-step process for implementing a purchase order management process.
Step 1: Assess the opportunity
The first step is to identify the opportunity for improvement if you implement a purchase order management process. In this step, you access the procurement activity and identify improvement areas.
Another way to ask this question is: if you already have implemented a purchase order management process, how it would impact your business operations.
A couple of areas to help you identify the opportunity:
Improvement in productivity
When you implement a purchase order management system, you increase the productivity of your entire team.
The simplest way to quantity is to calculate the average cycle time for a purchase transaction and then figure out the reduction in the cycle time.
When you have an average cycle time, you can quantify the cost of issuing a transaction.
You can calculate your own cost or use benchmarks for a purchase order cost.
Here is an example of sample purchase order costs.
Let’s say that based on the average cycle time, the cost per PO is $60.
This cost includes creating, approving, and issuing the purchase order to the vendor.
Assuming you create 100 POs/month. Here is the simple math.
Current cost of manual process: 100* 60 = $6,000/month
Assume that you can reduce the cycle time by 40% and hence the cost by 40%.
Cost savings per month = $6000 * 40% = $2,400.
Annual cost savings = $28,800.
Improvement in Spend management
With a purchase order management process, you get all your purchases in one single place. That means you can control spending and manage the cash flow better.
In terms of controlling Spend, as per the Spend Matters benchmark, a medium size company can save 2-3% on their annual cost by cost avoidance.
Cost avoidance means purchases you decide not to move forward with because they are not required, or a substitute is available.
For example, an employee wants to purchase a new computer monitor, but the IT department already has this in inventory. Since you don’t need to purchase the item now, it is cost avoidance.
Suppose you have $5M in annual spending with external vendors (excluding payroll, benefits, interest payments, etc.)
Suppose you take an average of 2% cost avoidance. Then that is $100,000 in annual cost avoidance.
The other benefit of the purchase order management process is better working capital planning.
Since all the purchase orders are in one place, you don’t need to worry about surprise invoices and last-minute financing.
You can reduce your overall interest expense by controlling the timing of the Spend.
Cost savings potential
Once your employees are free from spending time processing purchase orders manually, you can focus on reducing the overall spending.
After a detailed spend analysis, you will better understand what you purchase, from whom, and how much.
That allows you to reduce the overall Spend by negotiating better rates.
For example, let’s say you purchase a widget from vendor A and vendor B. By consolidating the purchase to a single vendor, you can get volume discounts and reduce the overall spend.
On average, companies can save anywhere between 5 to 8% on the negotiated Spend.
The negotiated spend is that annual spend you can negotiate in a year.
For example, if you have $1M in negotiable Spend, then with better negotiation, you can achieve $50,000 – $80,000 in annual cost savings.
While you are reviewing overall operational costs, you can also look at improving cashflows through payment terms management.
Hopefully, the above opportunities should give you enough ammo to build a business case for procurement automation.
Step 2: Set Up a purchasing policy
The next step is to set up a purchasing policy so that you can provide guidelines for employees on how to purchase products or services in your company. Purchasing policy defines the standard operating procedure for the purchase process.
If you already have a purchasing policy, you can skip this section.
Here is the purchasing policy template to get you started if you don’t.
With a purchasing policy, you provide guidelines to employees on how to purchase and who needs to approve a purchase.
You can also define when you need to request a purchase vs. just using a credit card for a purchase.
Here are the three key areas to focus on:
Contract signatory authority
You don’t want anybody in your company to sign up for a product or service without a proper review.
We all have been there when you discovered that an employee signed a multi-year agreement for a service you no longer need.
That is why contract signatory authority is important.
You want to ensure that the contracts go through proper review and limited people in your company sign them.
If you are a small company, the owner should sign all contracts.
If you are a medium-sized company, maybe the COO or CFO can sign the contract.
Whatever works for you, document it in the purchasing policy.
Purchase approval authority
The next section is about who can approve a purchase.
You might be wondering that if there is a signed contract, why do I need to approve the purchase?
Approving the purchase allows you to control the cash flow.
Let’s say you are making a large purchase, and you want to match the timing to the cash available in the bank.
The approval process design should ensure that the senior management doesn’t become the bottleneck for approval.
For example, you don’t want to send every purchase order request to the company’s CEO. They have better things to do than approving purchase order requests all day.
A simple rule is that management should not approve more than 20% of the purchase requests. This 20% should cover up to 80% of the total Spend.
We have covered the approval process in detail here.
Purchasing process
A purchasing process provides the process employees can follow to purchase a product or service.
For example – Create a purchase request for every purchase.
Or, for purchases under $200, you can use your corporate credit card for the purchase, and for anything over $200, you must create a purchase request.
The next step is to provide step-by-step directions on creating a purchase request.
You can use a simple form that the employees can fill in, but implementing a more efficient purchase requisition process is a better way.
Step 3: Setup a requisition process
A purchase requisition process allows employees to request a product or service purchase.
When it comes to improving the productivity of the whole organization, the requisition process is the most important.
Many companies start by setting up a manual form for purchase requisition. Usually, it is a Google form or word template.
Though the process is simple, it is cumbersome to support and scale.
Employees always make mistakes in entering the data, and then there are countless hours spent on printing requisition forms and then emailing them for approval.
That is why we recommend an electronic requisition process.
With an electronic requisition process, employees don’t need to worry about filling up forms and remembering the accounting codes.
Here is how an electronic requisition process can help reduce the time spent on processing requests.
Automated defaults
An electronic purchase requisition software like ProcureDesk automatically defaults the basic user data like department, cost codes, cost center, etc.
All the user has to do is enter the description of the item they want to purchase and submit it for approval if needed.
Catalogs
Any good purchase requisition automation software provides the ability for catalogs.
With catalogs, employees don’t have to worry about typing in all the data they need for purchasing.
You can simply select what you want to purchase, and the system automatically adds that to the employee’s purchase request.
Here is an example of the Amazon.com catalog integration with ProcureDesk.
After the user clicks on “Send for Approval,” the shopping cart data is automatically added to the purchase request.
Here is an example of that:
Step 4: Automate the approval process
A typical approval process would start with sending an email to the manager for approval.
The manager might forget about approving the request, and then you need to remind the manager multiple times for approval.
That is why you need to automate the approval process.
There are three items to consider for approval process automation.
Workflow engine
A workflow engine allows you to configure the workflow conditions upfront.
For example, you can specify when you need approval and who needs to approve.
The system sends the request to the manager in the screenshot below.
If the request is more than $100,000, the CFO also approves the request.
Automated workflows
With automated workflows, the system generates the workflow for the employees.
The person creating the request doesn’t need to worry about identifying the appropriate person for approval.
That reduces the manual intervention and increases compliance with your purchasing policy.
Here is how ProcureDesk generates the workflow for a purchase request.
Please note that the user didn’t select who should be approving the request. The system does that for the user.
Omnichannel approval
Let your users approve the way they want to approve the purchases.
Some approvers prefer to approve over email, and some prefer to log in to the tool to see all details before approving.
If the approvers are on the road a lot, they prefer a mobile app for approvals.
That is why ProcureDesk supports the Omnichannel approval process.
Approvers can approve the purchase in whatever method that works for them- ProcureDesk support approval over email, web application, and mobile app.
Here is an example of the mobile app for purchase approvals.
Step 5: Automate the purchase order dispatch
Once the purchase order request is approved, you might have to send a purchase order document to the vendor.
Some vendors might not ship you the product unless they receive a purchase order. Hence it is important to have a process to issue the purchase order to the vendor.
If you are using QuickBooks, the accounting team needs to create the purchase order in the system.
It leads to delays because you might have an Accounting team of 1, and they have more important things to do like processing bills, paying vendors, and closing the books.
That is why you need to automate the process of purchase order creation and then send the purchase order to the vendor.
If you have a buyer, you might want them to review the purchase order details before issuing the purchase order.
The additional review ensures that the requester correctly populates the chart of accounts and other fields.
Here is an example of a purchase order generated by the system:
After the system generates the purchase order, it can also dispatch the PO to the vendor.
Here is an example of an automated email that the system sends to the vendor:
For repeat purchases, you can create blanket purchase orders to reduce the burden of purchase order process management.
Step 6: Track purchase orders
Effective tracking of purchase orders allows your buyers to stay informed about the delivery schedule for different suppliers.
There are different options for purchase order tracking. We have covered these options in detail here.
You can use a spreadsheet to track purchasing orders, or you can use a purchase order system to track the lifecycle of a purchase order.
Here are a few things that you need to track for a purchase order:
Order Acknowledgement
In the current supply chain situation, vendors often don’t have the product, or it is severely back-ordered.
Having an order acknowledgment process enables suppliers to confirm the schedule of the delivery as well as the quantity they can ship.
If a product is unavailable to ship, the supplier can use this process to inform the buyers about the potential delays and ship dates.
Shipping details
Once the vendor ships the products, you need to track the product’s status while it is in transit.
Vendors can provide ASN (Advance Shipping notice) with the tracking information, and the buyers can track the product.
Tracking purchase orders becomes a cumbersome process if you have hundreds of orders every month.
Having a tool like ProcureDesk can enable automatic ASNs from suppliers. The system can also track the status and inform the respective buyers of any status changes.
Confirming the receipt
Once you receive the purchase order, you must confirm that the quantity is what you ordered and the product is not defective.
That is where the receipt process can help buyers or the warehouse team provide details about the shipment.
If the product is defective, then the invoice needs to be adjusted. You can also run a 3-way match process to match the purchase order with the receipt and invoice.
Best practices for implementing a purchase order management process
So far, we have talked about how to implement a purchase order management process.
Now let’s look at some best practices that you can follow to get the most out of your purchase order management process.
Implement catalogs
Many companies implement purchase order management without catalogs. Essentially, they take their manual form and put that in an electronic format.
If you only do that, you solve the management need to review all purchase requests.
However, it is still cumbersome for employees to enter all the data they need on a purchase order request.
That is where catalogs can help increase the adoption of the process and make the rollout of the new purchase order process frictionless.
Review your top 10-12 vendors that have heavy purchase order volume.
Implement a punchout catalog or internal catalog and provide your employees with a better purchasing experience.
Define clear purchase order guidelines
When you roll out a purchase order management process, you need to ensure that your employees know when to issue a purchase order.
Otherwise, you would have compliance issues because your employees don’t follow the process.
Here are some questions that you should answer to figure out clear guidelines:
- Do you need purchase orders for small purchases? For example, office supplies under $50.
- Do you need purchase orders for website orders? For example, purchases from Costco, Walmart, and so on.
- Do you require a purchase order for services?
These are some examples.
The best way to approach this is to review all your purchases and decide when you do and don’t need a purchase order.
Share Spend information
You have all your Spend in one system when you have a purchase order process.
You get detailed spend visibility that helps you make better purchasing decisions.
Here is an example of a Spend dashboard:
If you want to build a Cost Conscious Culture (CCC), you need to share this information.
At the bare minimum, all department heads should have access to this information.
They can see how their teams are spending money and what they are purchasing.
They can review the Spend and decide whether those purchases are in the company’s best interest.
Having complete spend visibility allows you to avoid surprises while reviewing budgets with different stakeholders.
Key purchase order management metrics
So far, we have learned how to implement the purchase order management process and best practices for purchase order management.
Now let’s look at some KPIs that you should track to measure the efficiency of your purchase order process.
Requisition approval cycle time
What is it?
Requisition approval cycle time measures the average time for a purchase requisition from the time of request to the time it is approved.
Why is it important?
It measures the efficiency of your approval process.
How to measure it?
Keep track of the total time it takes for each requisition, from when the requisition was created to when it was approved.
Average cycle time = Total time/ Number of requisitions
PO cycle time
What is it?
PO cycle time measures the time it takes to issue and dispatch a purchase order to the vendor.
The PO process follows a purchase requisition, or you can directly create a purchase order.
Why is it important?
The PO cycle time measures the efficiency of the purchase order process.
The lower the cycle time, the better it is. Tracking the PO cycle time allows you to identify and eliminate process inefficiencies.
How to measure it?
Track the total PO cycle time for each purchase order.
It is the total time from the time an employee creates the purchase order to when it is approved.
Average PO cycle time = Total time for all purchase orders/ Total purchase orders.
PO adoption rate
What is it?
The PO adoption rate helps you track the adoption of the purchase order process across the organization,
The higher the adoption, the higher the number of purchase orders.
Why is it important?
A key benefit of a purchase order management process is that it allows you to control spending through proactive approvals.
If PO adoption is low, you have limited control over your Spend.
How to measure it?
A simple way to measure PO adoption is by keeping track of whether an invoice has an associated purchase order with it or not.
PO adoption rate = Invoices with purchase order number/ Total invoices.
You should target an 80-85% PO adoption rate.
Your Turn!
A purchase order management process done right can deliver the following benefits for your company:
- Reduce annual costs by 2-3% due to better Spend controls.
- Reduce purchase order cycle time by at least 40%
- Eliminate surprise invoices so that you are not struggling with cash flow management.
You can get these results by following the process outlined above or using ProcureDesk to set up a purchase order process in no time. We have helped 100;s of companies set up an effective purchase management process using our tool.
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