Purchase order process for startups? Yes, you read it right.
We are talking about why a startup should think about setting up a purchase order/purchasing process and how it can help startup’s with cost control and spend visibility when you need it the most.
We live in an era when you can start certain types of businesses without any capital investment, for example, Software as a Service(SaaS). You just need an idea and ninja coding skills and you are off to the races.
However, brick and mortar businesses or any other business which is based on the exchange of physical goods as value delivered needs capital to get started.
As the business grows, so does your spend with external vendors and headcount.
In this blog post, we help you think through a purchasing process for your organization.
• You would learn how a purchasing process can provide better visibility into your spend and extend your burn rate.
The purchasing process is defined as the set of coordinated activities which any organization use to purchase good and services.
Depending upon the maturity of your organization, you might have a single uniform process for all purchases or different set of processes based on the product or service you are purchasing.
For example, an employee purchase office supplies by logging on to Amazon.com, and the amount is charged to the individual card.
However, for larger purchases, the employee needs to get a pre-authorization and then place the order.
The purchasing process has the following sub-activities
1. Request process
This step is to request the authorization for purchasing an item. This might or might not be required as we saw in the examples above. For example, you want to purchase a new purchase order automation software for the company.
2. Approval process
This activity includes approval of a request before the order can be placed.
This could vary depending on the method of purchase and type of purchase.
For example, for small purchases directly purchased on credit cards – there is no way to pre-authorize the purchase because of the effort required to approve everything.
3. Order placement process
This activity is placing an order with the supplier or agreeing to purchase a product or service. A common example of this placing an order on a website. The other example is signing an order form for purchase.
A purchase order is a commercial document which is issued by the buyer to the supplier. It is an official offer made by the buyer to the seller to purchase a product or service.
The seller or supplier accepts the offer by acknowledging the order.
After the purchase order has been accepted by the supplier, the buyer is obligated to purchase the product and pay the supplier for the product or services. The supplier issues a request for payment by issuing an invoice against that purchase order.
Following is an example of a purchase order
A purchase order would have the following sections
The purchase order is a unique number issued for every purchase within your company. This number is referred across the entire purchasing lifecycle.
1. Your company information
This section provides details about your company and your billing address. This information is referred by the suppliers while submitting the invoice/s against the purchase order. If you have a purchase order process, then the Accounts Payable (A/P) team can easily match invoices against purchase orders.
2. Supplier information
The section covers the details of the supplier. It specifies the name of the supplier, order contact and the address of the supplier.
3. Delivery information
This section identifies the location where the supplier needs to deliver the order. In the case of drop shipments to your customers, this section is really important.
4. Items you are purchasing
This section list the details of the items you are purchasing, which includes supplier part number, the description of the item and price agreed with the supplier.
5. Taxes and Shipping
If you are paying taxes and shipping cost, this cost gets added up here.
6. Purchasing terms
This section is very important as this list your standard terms and conditions. In case of any conflict, this section provides guidelines on how to resolve a conflict.
In the beginning – It’s all about survival and innovation
Startups by nature are chaotic, you are trying to get to the escape velocity so that you can build the next billion dollar unicorn.
And it is justified to have all your resources aligned towards acquiring new customers and servicing the existing customers.
However, while you are taking your startup to the next level, you are burning fuel which is Cash.
It is even more critical to keep a close eye on your burn rate so that you can accurately forecast your working capital requirements.
Having an accurate forecast helps you to plan around cash flow requirements and plan around the next round of funding.
The purchasing process at any startup could vary based on the nature of the product or services they are selling. Let’s take a few examples
Let say Acme Software sells time management software to enterprise companies. Since it is a software company, the majority of the spend is around human resources and not on physical products the company might be purchasing.
So at Acme software, the purchasing process might look something like this based on the two broad categories of spend
Office Supplies and other supplies
In our experience, office supplies and other supplies are purchased by either the office manager or individual employees.
Most of this spend is going on credit cards anyways. So an office manager might place the monthly order of supplies.
With Amazon.com, every employee can place their own orders with a wide selection of product availability. It is of course very convenient for the employees.
What we are seeing more and more is that employees are using their personal accounts for placing an order for their office supplies or any other product from sites like Amazon.com.
With that happening, each individual has visibility into their expenses but it is difficult to consolidate the spend at the company level.
Software and hardware purchases
The good part of starting a software company is that you don’t have to purchase physical hardware to host your software. Everything is available as a platform as a service.
So most of the spend is controlled by the software engineering team.
The spend is divided between Software as a Service vendor and Infrastructure as a service.
With SaaS solutions, you can start for cheap but if the pricing is usage-based, the monthly bill keeps on increasing.
Moreover, the SaaS company offers the convenience of automatically charging your credit card account so you don’t have to worry about paying the bill.
Sweet! But the downside of this is that you are probably not reviewing the need for that service on a regular basis and the bill might keep on going up.
Each silo knows what they are spending, assuming they are keeping track of the total spend but there is no single place to track all your company purchases.
Prudent cash flow management needs a continuous review of expenses. Having a purchasing process forces you to review expenses before they happen
In the next section, we will look at the benefits of having a single purchasing process including the value of spend visibility.
You might be wondering, all this is good but why a startup needs to set up a purchasing process?
In this section, we cover some of the benefits of the purchasing process.
Having a purchasing process simplifies the purchasing activities across your organization.
Employees not only know how to order a product or service but they have less anxiety about whether their purchase would be approved.
Let’s us explain this point with a few examples
Sally just joined the organization and needs to order desk supplies. Due to the lack of a purchasing process, she probably would have to ask around.
Now Sally is all settled in but she needs an ergonomic keyboard.
Now you might say, it is ok for her to ask around and she can figure that out.
Now, imagine, how many such conversations are happening within your organization and how many different answers new employees might be getting?
If you have a purchasing process, then add it in the induction process or the employee welcome kit and you are good to go.
That way, each new employee would know what the process is.
Having a consistent process increases the efficiency of the organization. Once the process is standardized, you are repeating the same activity again and again without thinking about it.
Once you have a basic process setup, the automation of the purchasing process by using a purchasing system can further help in improving the process.
Having a defined process ensures that everyone follows a single consistent process and the other departments like A/P can effectively design their processes around it.
For example, If you have a purchasing process which requires a purchase order for major purchases, then it simplifies the process for Accounts payable team when they receive the invoice from the vendor.
Since the PO is approved, and the invoice refers to the purchase order number, they don’t have to chase people to find out whether this is an approved purchase or not.
The biggest benefit of having a purchasing process is that it is easy to review your spend at one single place.
Imagine a scenario where the CEO of the company goes to the finance team and ask to see the spend for the last 6 months.
The finance team would probably look at the report in the accounting system and provides you a high-level overview of the month by month.
So far so good.
The CEO now wants to drill down on the $1M monthly spend and see who are the individual vendors and what are we paying for.
That is where the fun starts…
Now someone in the finance team has to dig through each and every invoice to identify the line items on the invoice and provide the summary.
This is OK if this is a one-time event but now imagine that the CEO wants this kind of visibility every month.
Let’s look at an alternate reality
Compare this to having a purchasing process – where all major purchases go through a purchase order.
The purchase order captures the detailed line item data and all the purchasing history is available at one single dashboard.
Having that level of visibility not only drives better decision-making process but also helps an organization to better allocate the cash to high value delivering activity.
A common outcome of the purchasing process is that you have a purchase order process for most of the big purchases.
That way, you don’t have to wait for invoices to show up to understand your open liabilities and how much cash you need at any point.
For example, you have signed a long term contract and the payment is monthly. If you just look at the payment history, you would only what you have been paying and then you have to manually review each and every vendor to identify if there are any future payments the company is obligated to.
Now imagine, if you have a purchase order process and you have the ability to review the order history, payment history and easily identify your open liabilities.
Having a purchasing process ensures that all purchases are pre-approved so that later there are no surprises and you can accurately predict your cash flow requirements.
If you are dealing with issues of invoices showing up that were not part of your working capital calculations, then a purchasing process can ensure that you have visibility into what going to come due and when much in advance.
The other benefit of having the visibility is that is it helps you implement a cost control mechanism.
Let’s say you identified that you have a burn rate of $1M which includes the payroll and other purchases the company is making.
Now you only have $3M left in the bank and the next funding round is probably 6 months away.
So before you start letting people go to in order to extend the cash in the bank, use the purchasing data to analyze what you can stop buying immediately and see what that can save you.
So an obvious question you might have at this time is when you should think about setting up the purchasing process.
Here are some guidelines to help you think through this.
Employee count can be used as a variable to determine if you need a purchasing process. As the employee count grows, so does expenses.
The enterprise spend is directly proportional to the number of employees.
Whether it is just IT and office supplies spend or spend around other categories like Software as a Service (Saas) vendors. The spend increases as you grow.
Based on our experience, a purchasing process make sense once you cross the 50, employee count.
The only exception to this is that if you are selling physical products so might need to think about this sooner than later. If you only have a limited set of people ordering the products, you could manage without a formal purchasing process.
The type of purchases also dictates when you need to set up a purchasing process.
Let’s say you are a software company and other than payroll – you probably are spending money on IT Hardware as other office supplies.
If you are only a few employees and the purchases are not that frequent, then one person might be responsible for purchasing and that is the purchasing process.
Now consider that same scenario with a startup which sells physical products, let’s say next-generation robots.
Now since the company is manufacturing these robots, the chances are that the purchases are complicated and they need to actively track their purchase orders so that they can continue their production process.
That would require a purchasing process to ensure that they can keep a complete track of all purchases including what is on order and what has been received.
If you are purchasing small-ticket items, for example, coffee and office supplies and most of the big tickets are purchased by a single department then maybe you don’t need a purchasing process.
However as the amount of individual purchase grow, you probably would need a purchasing process.
Let’s consider the impact of frequency and amount of purchases with the help of an example.
Assume that you a small company with less than 50 employees. Most of the big purchases are approved by the CEO of the company but all other purchases are left to the office manager.
The office manager consolidates all the requests from the team and then places an order, maybe once a month.
So far so good.
Now the team grows to 100 in the next 3 months, now all of a sudden the volume of purchase has gone up and so does the purchase frequency and individual requests to the office manager.
If you are dealing with such a situation, then maybe you should think about setting up a purchasing process.
Instead of sending their requests to the office manager, the employees can directly place the order with the supplier. That will increase the efficiency and productivity of the staff.
We talked a lot about the benefits of the purchasing process, now let’s talk about how to set up your purchasing process.
Your goal should be to set up a minimal purchasing process and then iterate it based on the feedback.
The goal should be set up a process which is not a burden for the team implementing it as well as employees who are going to use the process to purchase product and services
Let’s borrow a concept of MVP (Minimal viable product) from software development and apply that to a purchasing process.
Eric Ries defined MVP as that version of a new product which allows a team to collect the maximum amount of validated learning about customers with the least effort.
Going with the above definition, your MVPP (Minimum Viable Purchasing Process) should be focused on your current situation and not necessarily on the best practices.
Set a simple purchasing process, see how employees adopt it and then make changes to improve the process.
The goal of the process is to get visibility into expenses or in other words to understand the purchasing habits of your employees.
Here are some suggested guidelines on how to go about setting up your purchasing process
Yes, you have heard that many times but how often that leads into a simpler outcome?
So how you can define a simple process?
The basic outcome of the purchasing process is as follows
1. Tell employees what they can purchase on their own and from where. For example, it is OK to purchase office supplies from Amazon or Staples.
2. What to do when it is something else?
For example – how do I order a new monitor? In this case, if you have preferred configuration available on Staples or Amazon – you can let your employees, directly purchase it.
Otherwise, they can always send a request to the IT department for all IT related purchases.
3. When you need approval?
This is a common question – what employees can purchase on their own without prior approval and what needs approval.
A simple way to determine this is to look at past purchase history. For example, your average order is $100, so maybe that is the threshold and any amount greater than that need prior authorization
4. Who can approve?
The next question is obviously who can approve the purchase if it needs approval. The goal should be to keep the approvals to a minimum so that it is not burdensome for employees.
The question to ask is what is the purpose of the approval?
Yes, the answer is obvious that purchasing authorization is required, but why that is required?
• Do you want managers to be aware of what their team is purchasing?
• Do you want finance to ensure that they have the correct budget before a purchase is authorized?
• Do you want the CEO or the owner of the company to review all big purchases?
Answer to the above questions would help determine the appropriate workflow.
So to summarize, here is what the purchasing process should cover at a bare minimum
1. What employees can purchase on their own and from where. The where is the set of preferred vendors with preferred pricing.
2. How to pay for the purchases, whether they can use a personal card or company have a consolidated billing arrangement with suppliers.
3. Process for non-supplies purchase, for example – Hardware and Software.
4. When an approval is required before purchase.
5. Who should be approving based on the different type of products purchased or the amount of purchase?
Yes, you read it right and here is the reason why we suggest to ignore the best practices.
Best practices are always designed with some underlying assumptions and til the time assumptions hold true, best practices don’t make sense.
Let’s take an example
A very common purchasing best practice is to have a three-bid and buy program – what that means is that for every purchase you should get bids from three different suppliers.
Make sense? Absolutely it does – the more competition you have, the better the price you will receive.
However, that requires an infrastructure where you have a purchasing team who is handling this on behalf of your company.
When are just starting up, you probably don’t have a purchasing team.
So just implementing the best practice without understanding the prerequisite infrastructure is a sure short recipe for failed procurement influence.
Again, we are not saying don’t adopt best practices, adopt them but at a later stage when your company needs mature procurement processes.
In the beginning, keep the purchasing simple.
Use a common sense process and then evolve it over time as your organization maturity increases.
Should you just stop at setting up the process?
Absolutely not, use OODA loop
OODA (Observe, Orient, Decide, Act) loop was originally developed by the United States Air Force Colonel John Boyd as a military strategy
But it can also be used on any business process and we recommend that you use this for the purchasing process.
Looking at the OODA loop from a purchasing perspective
Observe This the observation phase where you are gathering data about the current process. After you put together a process, gather feedback on how the process is working. There are 2 types of feedback you can gather or observations you can gather
Subjective: You can gather subjective feedback about the process. This can be gathered through water cooler conversations or 1-1 feedback from power users.
The feedback doesn’t have to be gathered formally via a survey, just ask your users how the purchasing process is working.
Objective: If you are a numbers person, then, by all means, be as objective as you want to be. Some of the data points which are useful for assessing the current state of purchase
• What is the trend of the purchasing volume?
• The average time it is taking to create a purchase order?
• The time it takes for the purchase orders to be approved?
• How many times the users are abandoning the order and for what reason
In the Orient stage, you are digesting the information/data you have gathered so far. The goal of the Orient stage is to synthesize the information and analyzing it is based on your past experience.
Let’s take an example – Let’s say you have many complaints that the purchasing process is very cumbersome. It needs too many touch points etc.
Based on your past experience, you might relate this to initial change management issues.
If the power users are adopting the process well but you are getting many complaints about the process from casual users then it could be a training issue or the process is really complicated.
In the Decide stage, you are deciding on what steps you are going to take to improve the process.
When you launch a new purchasing process, the decision point might include the following
• You went overboard in the original process design and it needs to be simplified
• The current process is working but needs minor fine-tuning.
• If you haven’t automated the process through a purchasing system, then that could be the potential next steps.
Once you have decided the next steps, the Act phase is putting together your plan in action. That could include working with different users to help them better understand the process.
That could include starting evaluating a new purchasing system, which we will discuss in the next section.
What role automation can play in setting up the purchasing process at startups?
Startups are all about the efficiency and making sure that you are making optimal use of the resources.
It is not uncommon to see one person wearing multiple hats to help with revenue growth and whatever is required to take the company to the next level.
With that in mind, automation of purchasing process can help a startup the startup to increase productivity and save time on manually chasing requisitions and purchase orders.
Let’s look at some of the ways purchase process automation can help you increase purchasing efficiency
Save time and increase productivity
By automating the purchasing process, you can save time and money. For example, if you have a purchasing process which requires approval for purchases and your users are manually walking through the requisitions and approvals – that is a huge time waster.
An easy to use purchasing system can automate the process of creating a purchase request but also greatly simplify the approval process.
Our customer often reports up to 50% reduction in the purchasing cycle and the cost associated with the purchase order.
Assuming the cost of a purchase order is $60, a 50% reduction is $30 cost savings per purchase order.
Let’s assume that you are creating 100 purchase per month, that is a cost savings of $3,000 per month or $36,000/year.
We talked about the obvious benefit of purchasing automation in terms of cost and time savings.
A secondary benefit is to have visibility into enterprise spend at one single place.
Not only you understand where you are spending money, but you also can easily forecast the cash flow requirements based on the open purchase orders as well as open invoices.
This information is also really helpful when you are trying to relate the output of a department to the cost of that department. For example, total marketing Spend vs goals achieved by the marketing department.
Spend visibility also allow an organization in making cost-cutting decisions by identifying noncritical spend.
It is not uncommon to hear this from our customers – our spend is too small to get any type of cost savings from our vendors.
Though it might be true in some cases, it is not always true.
What many companies don’t realize is that they are probably purchasing similar products from many different vendors.
If you don’t have a common purchasing process, it is likely that you are purchasing similar products from multiple places.
We often see 5-10% cost reduction for our customers when they consolidate their purchases with one single vendor.
Let’s assume you spend $100,000 a year between office supplies and other IT supplies.
A 5-10% reduction is $5,000 and $10,000 cost reduction a year.
We have covered the need of the basic purchasing process, role of automation and so on.
So where do you start first, here is a suggested roadmap on how you should approach setting up the purchasing process at your startup
Before you get started, make sure everyone is aligned with the changes you are suggesting. The executive team needs to be sold off on the value of the procurement team.
Let’s take a few examples of who all might need to be involved in getting executive buy-in.
For most of our customers, the purchasing process implementation is headed by the finance department.
They are usually frustrated with the manual process or don’t have resources to keep on manually reconciling the invoices with purchase orders.
So assuming you are in finance, we recommend the following stakeholders to be involved in ensuring that there is executive-level buy-in.
Assuming you are in finance or accounts payables department, then the first step is, of course, to get the blessing for your leadership for such initiative.
You probably want to include VP of finance of director of finance (depending on the size of the organization) and talk about the benefits of purchasing automation.
It is probably a good idea to have a business case ready so that you can not only discuss the cost benefits but also a realistic return on investment.
Purchasing and invoicing automation should not be considered cost but as an investment and returns should be measured by using the rate of return methods used by your executive team. For example, the payback method or Internal rate of return.
A discussion with CEO may or may not be required. But we still recommend that not from cost approval standpoint (you probably have to do that too) but more from getting the blessings on the change management aspect.
Let’s not underestimate the impact of change management. It is not wise to risk the whole project by not getting full buy-in from the executive team before you start implementing the new purchasing process.
If review with operations is not covered in the above step then you should review this change with operations lead.
Assume you are a hardware manufacturing company then the head of manufacturing should be involved in the review of the new purchasing process.
If you are a software company, then have this reviewed by the head of software engineering.
What if you are the CEO of the company?
We still recommend that you get buy-in from your direct reports to ensure that this project is a success.
Once you have an in-principle buy-in from the executive team, the next step is to define the new purchasing process.
Not that fast…
As we mentioned earlier, start with a basic and simple purchasing process and then improve it based on real feedback.
Take that simple process and engage with few departments to test the effectiveness of the process.
You might not have many departments in a startup and that is a good thing when it comes to rolling out the new process.
If there are not many departments, engage a few employees who often purchase product and services and ask them to test the new process.
Once you have ironed out the kinks, you are ready to roll out the process.
This is the last step in the process and you might or might not choose to automate the purchasing process in the beginning.
However, we strongly recommend that you should automate the purchasing process on day one.
First of all, it makes the rollout process much easier. Instead of relying on documentation driven process, a system driven process automatically takes care of the steps involved.
A purchasing system should be able to guide the users through different steps of the process.
Second, when you roll out a new process, you would need to provide support and answer any questions the users might have.
This can be easily outsourced to the software vendor. A vendor can not only help with tool related questions, but they can also guide the users with best practices and adoption of the new purchasing process.
So there you have it, everything you ever wanted to know about setting a purchasing process at your startup. Interested in seeing what ProcureDesk can do for your organization?
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