How to demonstrate savings from procurement

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The chief finance officer’s (CFO) interest is getting the project savings to the bottom lines.

Purchasing and Supply with Nyasha Chizu

The main objective of a chief procurement officer (CPO) is to achieve savings in the procurement process. Both functions have an interest in achieving savings and the challenge is CFO’s and CPO’s savings interpretation.

Savings is generally defined as economy derived from reduction in money, time or another resource. Procurement views it as preventing waste of a particular from inbound logistics. Keynesian economics defines it as the amount left over when the cost of a person’s consumer expenditure is subtracted from the amount of disposable income that is earned in a given period of time.

The various interpretations of savings bring confusion to the meaning of “savings” and how it relates to other business functions.

The CPO defines savings as an incremental discount negotiated from the supplier’s first quotation or otherwise benchmarked market prices across anticipated purchase volumes.

The finance manager view the same as the direct cost or expense reduction reflected as a positive variance or working capital improvements in the budget.

A business manager describes savings as pricing that is an improvement over prior-year price paid. The CFO defines savings as financial impacts that affect earnings or cash-flow plans, including financing and global exchange implications.

All the four functional definitions of savings are correct with difference is in the functional interpretation only.

This poses the big challenge to the CPO to demonstrate contribution to savings in business transactions due to the lack of company-wide savings guidelines that is not skewed to a functional interpretation of the term savings.

With no standards and appropriate guidelines for calculating savings, the process is not straightforward. Where the formula exists, it often changes depending with product category or project.

CPOs contribute to the reduction of direct cost and direct expenses through procurement duties and impact on cash-flows through improvements in working capital, trade financing and payment terms management. Such activities contribute directly to savings but are never reported or recognised as procurement contribution to savings in the organisation.

The major problem is the non availability of formal procurement plans. Procurement plans assist in the formulation of budgets and if properly used can be used to extrapolate the savings that are achieved by the CPO.

The procurement plan is derived from the business plan and associated procurement savings can be tracked and reflected creating an opportunity for the dramatic gap between project savings and those actually passing through the bottom line.

Without alignment of business plans and procurement plans, it is not possible to ensure savings are calculated, allocated and recorded correctly in the business plan.

For procurement to earn respect in business, CPOs must start insisting on development of a procurement plan that is derived from the business plan to ensure that savings are appropriately tracked and recorded.

This will inevitably reduce adhoc procurement decisions and procurement decisions that are against the price of value for money principle.

Procurement plans would be the thump card for public finance management system enhancement. Tender awards would be in line with the budgets as reflected in the procurement plan and the CPO would have the capacity to demonstrate savings.

Going forward, no procurement should be processed if it was not included in the procurement plan save for emergencies only to ensure value for money in procurement activities.

lNyasha Chizu is a Fellow of the Chartered Institute of Purchasing and Supply writing in his personal capacity. Feedback: chizunyasha@yahoo.com