3 Ways to Effectively Control Purchasing Costs
The use of metrics is critical to maintaining a business. We need them to be able to measure the success of our department and identify where processes need improvement. With so many technologies and so much data being generated at all times, it’s not uncommon to get lost in what metrics should be your key metrics (KPIs) and closely followed.Thus, from time to time, it is necessary to review the strategies, processes, and which indicators should really be monitored. To help you in this process, let’s review the main indicators that every purchasing department must follow, mainly to control and reduce expenses.
1. Purchase to pay
It is the entire process involved in the relationship between customers and suppliers – purchase, payment and receipt of goods and services.
Within P2P are also included:
- Purchase-to-pay: basically, the isolated part of how an organization acquires goods and services necessary for its production;
- Sourcing-to-pay: controls the accounts payable part and sees the operation more strategically from a spending perspective.
As part of the process, companies must have tight control over spending on suppliers. Making rational spending is the best way to ensure the sustainability of the area within any company.
As this is an action that involves multiple agents at different points of contact, it is necessary to coordinate the entire relationship very well so that the final objective is achieved without causing major losses in terms of increased complexity within the supply chain.
2. Total Cost of Ownership
The TCO calculation includes the direct and indirect costs of purchasing a product and extends beyond the procurement process. As such, it includes expenses incurred throughout the entire supply chain. Transport, taxes, customs costs, insurance and packaging are accounted for, among others, as inventory expenses considering three main factors: occupied space, handling and depreciation.
This calculation allows buyers to differentiate the purchase price from the long-term cost of purchasing a product, which is related to maintenance and repair costs for the product in the near future. In some industries, this value can refer to up to 5 years of maintenance on a machine, for example.
When we think about values applied in the purchasing sector, that is, its budget, one should keep in mind that even though the final price of each purchase is important, not taking into account the TCO of an acquisition can significantly impact the area’s annual expenses. Therefore, it is important to include the TCO calculation when choosing the best suppliers, the best manufacturers, etc. There are some additional costs that allow us to calculate the total cost of ownership (TCO):
Acquisition costs
The analysis starts with the item’s negotiated price, excluding any discounted amounts related to high volume purchases and on-time payment, for example.
Cost of Transactions
They represent services provided by suppliers, including the processes for calculating inventories, requisitioning materials, preparing and transmitting the order to the manufacturer, shipping document, handling and receiving the product.
Opportunity cost
The concept of opportunity cost refers to a possible loss of income, if the supplier chosen for the purchase of a certain product does not have quality materials, which will need to be maintained in the short term. At this point, it is worth analyzing the benefits of a more expensive supplier but with a better quality service or product or a lower purchase cost.
Logistical costs
Transport and storage of the product, both international and domestic, in addition to paying attention to the time required for its arrival at the final destination.
Currency fluctuation costs
When purchasing products from a foreign country with payment in that country’s currency, the currency fluctuation history must be taken into account. In order to guard against this variation, you can choose to buy in foreign currency at the current price at the time the purchase order is issued.
Commercial regulation costs
It is essential to list the commercial incentives and restrictions offered by the countries in which the supplier is located, including those established through commercial agreements between countries or groups of countries.
3. Purchase Price Variance (PPV)
As the name of the indicator suggests, the Purchase Price Variance (PPV) refers to the difference between two variables: the actual price of the purchased product and its standard price, always related to the number of units purchased.
To calculate it, just multiply these two variables by the actual number of units purchased.
- The formula looks like this: (Actual Price – Standard Price) x Actual Quantity = PPV.
This is one of the main indicators used to measure the variation in the price of purchased goods and services, being a tool capable of telling how effective the purchasing team is.
As a tool to understand how changes in the price of indirect materials can affect future cost of goods sold and gross margin as well, PPV aids pricing decisions by providing accurate forward-looking statements about the general future profitability.
When talking about PPV, the assumption is that the quality of the product is the same and that both the quantity of items purchased, the place of purchase, and the speed of delivery do not impact the price.
Let’s dive deeper into differentiating the variables:
- The actual price of the purchased product is how much the company actually spends on that item;
- Standard price refers to what purchasing experts believe the company will pay to purchase the item during the planning or budgeting process.
Typically, the standard price is based on the last purchase price of the previous year, the first purchase price of the current year, or a price developed based on the best case available when the standard was created.
Conclusion
Developing an effective measurement for the purchasing team is not always an easy task. It depends on analysis of the department’s functioning and definition of the main priorities, goals and objectives.
Once you’ve identified the real needs of the business and understand the nature of procurement key performance indicators, it’s easy to choose those that are in tune with your defined goals.
Keeping track of the indicators and KPIs with your team will enable them to better understand the company’s purchasing habits, the performance of suppliers and whether the procedures are working as they should. Thus, it becomes easier to make any personnel changes, reallocate resources, mitigate risks and avoid bottlenecks; in short: evaluating problems, finding solutions and optimizing the department.
On our blog, we bring other metrics that also need to be monitored in the purchasing department:
5 steps to an effective purchasing budget
Good management and the growth of a company are closely linked to the budget planning of the purchasing department – after all, profitability depends on this area and the activities related to it, such as logistics and transportation.
Hence, the importance of purchasing professionals to act not only in the acquisition process, but also in the discussion on this topic.
It is based on the budget that we can define the purchasing strategy, deciding, for example, when is the best time of the year for a purchase, according to what has been established, avoiding expenses beyond the expected, or if there are materials being purchased with values above the average.
Integrated management
The guarantee of transparency between the areas of the company is another important factor that the budget provides, since everyone is aware of what was or will be invested in material, avoiding extra expenses and inconvenience.
With a good budget, management becomes more effective, allowing a more adequate allocation of resources and providing security for decision-making, since the debate is encouraged.
How to make a budget for the purchasing area
With all these advantages, the budget is essential in the short, medium and long term – especially when aiming at cost reduction.
The process of defining expenses for the next period requires full engagement of the areas involved throughout the process, so that the budget is met in a way that does not generate extra costs but saves the company.
Some steps are essential for building a budget with high credibility:
1. Identify the materials you need:
The purchasing department’s first step is to make a forecast of what the company will need to purchase in the next year. Make a list of what needs to be budgeted, also adding how much the department is willing to pay for that material or service.
For this, it is possible to analyze the purchases of the previous year and the quantity and variety of parts in stock. With the help of predictive algorithms, try to do a study on which parts could be repaired instead of being exchanged and calculate the costs that could be saved in this process.
Also note the price paid for each piece and consider a possible increase in value on that same purchase for the following year. Do not include in this calculation the parts that are part of fixed price contracts that will be maintained for the next year.
In this way, purchasing management is carried out more effectively, helping with decisions regarding whether to close a contract with suppliers.
Tip: It can help in understanding the budget to divide the materials into categories.
2. Search vendor options
From the analysis of what you need to buy, the time comes to look for where to get such materials. Consider suppliers that, in addition to a good price, have a good reputation, good customer relationships and favorable delivery times.
Be sure to search for suppliers abroad, they can present much lower prices in relation to national suppliers, mainly with cargo consolidation strategies and a planning that allows you to buy the parts in advance.
This is a step that requires a lot of attention and also a willingness to negotiate. Try to establish better payment terms, minimize prices and obtain more advantageous terms. Remember that signing the contract is not the final stage, it is necessary to closely monitor the supplier’s performance to make sure that the agreed terms are being met and to evaluate the possibility of a future contract.
3. Align everything with the finance area
All parts of the acquisition process must be aware of and aligned with the budget, especially the financial area that will make payments throughout the year.
Most companies follow a traditional management process, monitoring every step of an acquisition, from the beginning of the purchase process to its delivery. However, the financial sector may have some difficulty in carrying out this follow-up, generating uncertainties in relation to the figures reported by the acquisition and even payment delays. In order for this not to happen, it is important to make a detailed prior budget.
4. Be realistic
You must incorporate the availability of your budget into the purchase requisition process. The buyer must know how much of the budget is available for a given item, speeding up the purchase cycle. Therefore, make sure that your purchases are within the established parameters.
5. Have technology as an ally
The use of tools such as software provides greater control of data, as well as spending, since it is possible to have an overview of the data in a quick and practical way.
The budget must be monitored on a regular and centralized basis, preferably in a single database, available for the different sectors of the company. The purchasing area must act jointly with the finance and the supplier, always being in contact to ensure that everything that has been agreed is done on time and at the correct value, making technology essential.
Conclusion
As we can see, the budget is among the most important aspects of an organization, and the role of the purchasing area is fundamental for its fulfillment. It is during purchase planning that the company guarantees the continuity of offering its products or services in the market.
Budget control allows companies to compare actual performance with the goals established during the planning phase making them able to increasingly optimize their operations.
At the same time, it can also turn on the red light when finances are out of control and excessive spending can affect the department, which can happen in times of recession, requiring resilience in your supply chain.
The biggest factors to reduce budget expenditures are linked not only to technology, but mainly to the collaboration of the areas that participate in this process, therefore, it is essential that purchases, finances and management are aligned.
Don’t forget: to shop at good prices, a great option is to count on Soluparts. Our team of specialists in the purchase of indirect materials always receives the best commercial proposals for your company. Request a quote.
Transforming the purchasing sector with planning
In an agile world like the one we live in, in which the dynamics and paradigms of supply chains change rapidly, digital transformation in any sector, including the purchasing sector, is unavoidable.
But for this transformation to be successful and expand the competitiveness and profitable potential of a business, we need to ask ourselves: how to promote this structural change in a sector that normally has traditional methods and needs to invest in updating and qualifying its employees?
Elaborating a good purchase planning that ensures greater predictability of demands, greater agility and better negotiation conditions – especially when opting for an annual contract with suppliers, which keeps the value of the parts quotations unchanged during the contracted period.
Benefits of purchasing planning
Planning in the purchasing sector is fundamental for the financial and cash flow health of an organization. It ensures that production will never stop due to lack of parts and that, when necessary, there will always be parts in stock. In addition, it avoids scrapping of parts, waste, unnecessary expenses – such as air freight in the case of last-minute purchases – and no lack of cash for any fundamental purchase.
Proper planning is capable of offering the procurement sector greater visibility of purchases, which can provide many benefits. Some of them are:
- Avoiding extra expenses, which blows the department’s budget;
- Greater efficiency: it avoids rework, forgetting materials to be purchased and prevents the same material from being quoted by more than one employee;
- Allowing the consolidation of orders, which makes negotiating the prices and deadlines for payment and shipment easier, and generates savings;
- Avoiding delays in the arrival of materials;
- Evaluating the need for technical knowledge to support the acquisition process. Especially when the internal technical capacity of the purchasing department is not available or is insufficient;
- Monitoring the purchasing process to analyze actual performance regarding planned activities and thus promoting adjustments – continuously and agilely;
- Allowing the purchasing department to meet additional needs with more quality and speed that were not foreseen in the initial planning;
- Increasing the transparency and predictability of the purchasing process.
The role of supplier choice in procurement planning
Procurement planning will only be effective if it includes the supplier qualification stage, which can avoid several inconveniences related to contracts closed with inadequate companies.
And problems with suppliers happen more often than you might think. A virtual community dedicated to purchasing professionals, Sales Hacker, has evaluated the relationship with its suppliers. Among the results obtained, we highlight two very worrying data:
- 84% of professional buyers reported that they always or often do not receive feedback from suppliers regarding their inquiries to purchase various materials;
- In relation to after-sales, 76% admit that the lack of return always or frequently occurs when they ask for information from the seller about any aspect of the purchased product – and many times already paid.
Many times, the discovery of a bad service, whether in quality, price, punctuality, ethics or transparency, only happens after being hired. That’s why it’s so important to research the supplier’s reputation before closing the contract, use advanced negotiation techniques and create performance indicators to analyze the services offered.
An even more practical option is to count on the services of companies specialized in the acquisition of materials, which can offer many advantages to the organization.
Annual purchase contract: is it worth it?
The option of an annual purchase contract with a specific supplier helps to plan most of next year’s purchases and close their values, ensuring that everything is within budget. Also, this modality optimizes the purchaser’s routine, since the same quotations made when the contract was closed don’t need to be repeated when the part becomes necessary. Having an annual contract is our golden tip to strategically plan your department’s purchases, from short, medium and even long term.
Soluparts is a spare parts specialist that offers an annual contract. In order to close said contract, it’s necessary to make a survey of the acquisitions made in the previous period, as well as meetings with all sectors of the company to understand the individual demand of each one of them in the next year.
With this list of indirect materials, sent by the client, Soluparts’ team quotes each one of the items, consolidating them in a single document – which is used for contract elaboration. This way, during the current year, when there is demand for any of the listed parts, there is no need to send a new quotation request – just send the purchase order, which greatly benefits the process of purchasing parts as it becomes more agile.
In Soluparts’ Annual Contract, the price of parts remains unchanged for one year. Thus, the buyer becomes a contract manager, and gains time to handle other strategic tasks.
If you still have any questions about how it works and what are the benefits of the Annual Contract, we have prepared an infographic to help you, click here to download.
To understand how to start drafting an annual contract for your company, talk to our spare parts specialists.
7 tips to not exceed the purchasing area budget
In the corporate environment, budget planning is intrinsically linked to the maintenance and growth of a company.
In the purchasing department, particularly, the collection for reduction and control of expenses, on the part of the management is enormous. The profitability of the whole company depends on the good management of the department and the activities directly linked to it, such as logistics and maintenance. Thus, the purchasing professionals stop acting only in the acquisition process and start to participate actively in the budget discussion.
In this article, we will discuss the importance of budgeting for the purchasing area. Also, we will bring some tips on how to stay in line with it and even reduce costs (a great challenge, facing the complex, volatile, dynamic and competitive reality of a company).
Why is the purchasing budget important?
The experts who discuss the subject point out some factors related to the relevance of a budget for purchases:
- It informs the purchasing strategy, making clear what is possible or not to buy, according to the established budget;
- It helps to measure spending, signaling when there are problems with finances, if there is a spending beyond the forecast that can hinder the acquisition process, or if there are parts being purchased with the value above the market average;
- It ensures transparency between the areas of the company, and the purchasing department can be responsible for their finances;
- It assists in a more effective management of the acquisition finances, since a budget will allow the appropriate allocation of resources for purchasing projects;
- It provides insights for decision making. Purchasing budget information (spending trends) can help you make better choices.
- Because of the advantages described above, budgeting for the procurement area is essential for reducing short, medium and long term expenses.
Tips to stay within your purchasing budget
In order to obtain success in the elaboration and monitoring of information regarding the purchasing budget, there are several guidelines that can be followed:
1. Identify the products that need to be purchased
Define which parts should be purchased, how much, when they will need to be used and how much you are willing to pay. Search supplier options and consider those that have a good reputation, good prices, customer service and better response time. Finally, close the deal with the supplier that offers the best conditions.
This process can become tiring, as it involves negotiation steps, but it is extremely necessary!
Stock management, which extends to other branches or other plants, is also very important to maintain the budget of the area. Before buying a part whose use is low, it is worth to verify if it is in stock in other branches and, if so, request the part to the branch that needs it.
When this stock check is not done in the correct way, there is the risk that parts are scrapped – and this is the main cause of unnecessary expenses and waste.
It is worth remembering that low turnover indirect materials stored in fixed assets deposits decrease the working capital and can lead to the loss of good purchase opportunities due to lack of available capital.
2. Get approval from other stakeholders
Promote budget credibility and legitimacy by involving other strategic areas (such as accounting and finance), which may suggest savings.
Some companies have the annual budget defined by the financial board and, during the month, a meeting is held with the entire purchasing department and the board to follow up on expenses. Similarly, other internal department meetings are needed to study spending reduction strategies – these periodic budget-focused meetings are important to keep expenses under control!
3. Plan your expenses in advance
The person responsible for the purchasing area needs to know the amount available to purchase a specific item, and they should clarify to the suppliers how much they are willing to pay for a certain product.
Planning here is also essential to understand what the negotiated condition for delivery should be. A purchase made a few months in advance allows the low price to be prioritized over lead time, for example.
A last-minute purchase, even if it is very necessary for the production, ends up having a higher price – not to mention the price of urgent freight, which ends up being more expensive.
A well-planned budget allows load consolidation, which decreases the price of material shipment. This is because a unique shipment is made of all the parts – but, for this it is important to have a partner that supplies several brands and that is able to keep the products in a warehouse for a unique shipment, something that Soluparts offers.
4. Have a margin to make your budget more flexible
This margin will help adjust the purchasing area’s budget when faced with uncertainties and risks such as those related to projects, acquisitions and deliveries. It is important to keep stakeholders aware of these changes, so that they understand the real situation and how much of this margin has already been used. This caution is fundamental in times of economic crisis like the one we are living at the moment.
5. Document and monitor the terms with your suppliers
This step is essential to assist in the control of the agreements signed, which consequently keeps the budget updated.
Among the essential points it should be clear what the supplier should offer (and what the price, payment conditions and delivery terms are), conditions in case of breach of contract and the guarantee of confidentiality – check out the full article on the benefits of contract management in purchasing.
6. Use technology to your advantage
Use software that updates spending in real time and helps track orders and approvals. This way, the information will be more organized and the professionals will be able to focus on less operational activities and perform a more analytical work, seeking to optimize processes, reduce expenses and, consequently, increase the company’s profit. See our article about the 10 softwares for the purchasing department for tips.
Some purchasing department software issues automatic purchase orders for parts that are purchased regularly – for example every three months – based on the last price offered by the supplier. It is necessary to follow these orders closely so that it is possible to renegotiate the prices, which tend to increase depending on the contract.
It is ideal to try to understand why the possible increase happened and in what way it will impact on the expenses – this readjustment can be due to tariffs, for instance.
Keep quotations and contacts of other suppliers that have this same piece to contact them in case the price increases to the point of it not being feasible to purchase with the same company. As we can see, renegotiation and contract control are very important and need to be monitored.
In addition, create in your Business Intelligence software, a unique dashboard to analyze metrics related to expense reduction and budget control.
7. Have a team that understands budget
Large companies offer their purchasing professionals training on cash flow, financial management and budgeting to qualify them to make important decisions to control spending.
Knowing the operation of the supply chain and having logistics knowledge is fundamental. Also try to understand the productivity and profit cycle generated by each part purchased. This will help you define the priority and urgency of a specific purchase and the ideal Incoterms and payment conditions for it. For example, if the valve you purchased needs to produce for X months to generate Y of profit in 180 days, and this amount pay the valve, you can negotiate the payment for 180 days after shipping it.
Conclusion
In this article, we discuss the importance of closely controlling the purchasing area budget. The growth of a company, in today’s world, is complex and brings several challenges, which makes budget planning an important part of its success and profitability.
It is important to have a frequent dialogue between the purchasing team and the financial department in order to have an alignment among all. In addition, it is necessary to maintain flexibility, control and transparency over the decisions made.
The effectiveness of strategies to reduce spending in organizations makes them more competitive, by enabling investments in their growth and in people, for example:
- Renewal of machinery;
- Training of employees;
- Improvement and expansion of the physical structure.
To make purchases with good prices, a great option is to count on a company like Soluparts. Our team of experts in indirect material procurement always gets the best commercial proposals for your company.
We also offer an Annual Contract: from your subscription, the prices quoted for each piece remain unchanged for a period of one year, which assures more freedom to make purchases in the period you prefer.
This helps you to map and plan the approximate costs of spare parts for the next year, allowing better control of your budget. Try these benefits and keep your budget under control: Learn more about our Annual Contract.
