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Procurement and finance: Be partners, not enemies

Finance and procurement must be partners, working together to contribute to a company's goals, including operational and financial performance objectives

Procurement, the purchase of materials and parts to support production, is a major function within a manufacturing...

business and a large consumer of a company's cash. As such, the procurement department must work closely with finance and accounting to ensure that the company's cash is used wisely.

The primary function of procurement is to acquire the parts and materials needed, in the proper quantity and on time. Secondary considerations are maintaining minimum inventory (just enough to avoid shortages) and keeping costs down. Procurement professionals understand the relationship between cost and supplier quality, reliability and performance, and constantly strive for the perfect balance among these factors.

Fortunately, procurement professionals have help in meeting this perfect balance. Every ERP system in existence contains procurement and purchasing functionality, integrated with planning, production and customer fulfillment applications. These purchasing apps collect a full and complete record of all purchasing activities from quotes to contracts, requisitions, POs, deliveries and receipts, acceptance activities, invoices, and payments. Through this history, the systems are able to produce detailed reports for general accounting, cost accounting, purchase price variance and detailed analysis. Most can also generate automatic journal entries tied directly to the activities and transactions for a complete audit trail. Through their integration with quality and traceability functions, these ERP purchasing applications support quality documentation and quality improvement efforts, and establish the infrastructure needed to manage quality problems and recalls.

Third-party procurement software is also available, particularly for indirect supplies, tooling and expendables. Spend management software is another product category that falls within the procurement arena and likely offers most or all of the functionality associated with integrated purchasing modules in ERP with additional management and reporting and analysis capabilities.

Drawing on these ERP tools, procurement and finance and accounting can work together to effectively balance materials needs and cost in the procurement process. Let's examine how a procurement specialist might approach this balancing act and how a partnership between procurement and finance and accounting might look.

In times past, procurement specialists were cost-driven and highly motivated to reduce purchase cost and purchase cost variance, or PPV, no matter what. As a consequence, suppliers were often forced to cut corners to maintain profit margins and quality was often suspect, supplier reliability was questionable, and sometimes suppliers went out of business because they couldn't maintain a viable business at the prices they were forced to accept in order to get the business. Buyers and suppliers had an adversarial relationship, with little or no common vision or shared risk.

Modern supply chain thinking emphasizes collaborative and cooperative relationships with suppliers in the proverbial "win-win" scenario where both parties are dedicated to providing great products and services to the ultimate customer, and both build a profitable business for the long term. But this ideal is simply not practical to accomplish with all of the many suppliers that a typical manufacturer uses. Procurement specialists therefore divide suppliers into categories and set up the necessary relationships and controls accordingly:

  • Commodities are readily available from a number of sources and are not a critical concern for either quality (most competitive suppliers meet industry expectations) or importance to the company or product (not a big part of cost-of-goods and not a critical function). These items are usually purchased on open markets on an arms-length, one-time basis, with no supplier relationship beyond the individual transactions.
  • A continuing relationship may exist for items available from only a limited number of sources or more critical to the product or production process. The relationship exists in the form of blanket orders, buying agreements or contracts to ensure availability of the items and locks in the price, which might be more favorable than it would be in one-time smaller-quantity pricing.
  • Leverage items are important (high cost or critical part of the product) but are available from a number of suppliers. Procurement can exploit the competitive market to get high quality and reliability at a competitive price. The relationship with the supplier might be more intense than the ones listed above and include some data sharing, collaboration or supplier certification.
  • Strategic suppliers get the full partnership treatment with long-term contracts, collaboration and data sharing, joint development for product and performance improvement and more. Strategic relationships like this are warranted for critical items that are a large part of the cost-of-goods or are exclusive or important parts of the product and may be available from only one or a few possible sources.

Notice that the emphasis is on the parts, the quality and the delivery reliability, with cost as a secondary consideration. Cost is certainly important, however, and procurement specialists are well aware of the need to minimize cost, but that consideration cannot be allowed to compromise their basic mission. Reduced cost or purchase price variance should not be primary measurements or incentives.

A focus on cost reduction might drive procurement to favor larger purchases that yield price breaks and reduce the shipping cost; however, larger purchases drive higher inventory levels; more storage and handling costs; higher consumption of working capital; and increased risk of loss, damage or obsolescence. Lean operations, which many companies are pursuing, also emphasize inventory reduction. As a company becomes more "lean," expect inventory reductions but higher unit cost (fewer quantity price breaks) and increased shipping and handling costs. Look at the total cost for procurement and inventory rather than at individual costs for the various elements of the procurement and inventory processes.

In negotiations with suppliers, procurement professionals can also trade off lead time (shorter lead time increases flexibility and reduces inventory, but might cost more); payment terms; delivery reliability (guarantees); quality; and other performance factors. They should be encouraged to confer with finance and accounting to ensure that company objectives are being met and financial performance is given due consideration in making these trade-off decisions.

Just as collaboration with suppliers is a part of the modern approach to procurement, collaboration with finance and accounting should be a part of a holistic approach to company performance management. Finance should not be the enemy of procurement or vice versa. These two critical business functions must work together continually to enable the procurement function to fully contribute to all the company's goals, including operational and financial performance objectives. Finance should not be the disciplinarian, trying to find fault; it should be the partner, with an equal stake in elevating the company's success and profitability.

Next Steps

Learn how to evaluate demand planning tools

Read more about how lean manufacturing and lean accounting work together

Discover new ways to improve on lean manufacturing

This was last published in February 2015

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How does your enterprise manage procurement and finance?
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We've centralized things with a single employee who's focused on managing our finances. Their job is two-fold.
  • When there's something we've decided to get, we let them know and ask for an update on what we can currently afford. They figure out the best way to pay for it.
  • At the same time, employees can go to them with thoughts and ideas, which they'll rate and then forward to the appropriate individual for further consideration.
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A relationship of intimacy between finance and procurement should be established in organizations for them to survive in today’s turbulent, harsh and unpredictable economic environment.
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Very good and important question. I will comment as an SME and a new player in the procurement business with ioc operating in Nigeria. its quite difficult to finance your invoice and be profitable if Banks and other financial institution turns blind eyes whenever you run to them to finance your PO. we are therefore left to look for financing from Non Banking institution with exorbitant interest rate and unfriendly terms and conditions. Banks are afraid to bear the Risk of performance because we are new in the industry and also for not having collateral as a mitigation to the perceived risk.
As you are looking for finance, Time will aslso be counting against you and any default will amount to revocation and termination of your Purchase Order.
Its difficult for young entrepreneur in the procurement business because of lack of finance.
This has been my story but am not ready to give up on my goal to build a thriving firm.
Let me let others comment and help with solutions to some of the points i highlighted .  
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