Businesses and not-for-profit
organisations that fail to analyse how they spend their finances regularly may
pay 16 – 21% per annum more than organisations that closely monitor their
spending patterns. To be cost-effective, an organisation must periodically
review what it spends, as increased spending patterns may be incurred through:
- Spending ineffectively by purchasing products and
services that aren’t required.
- Paying prices 7 – 9% ahead of the open market.
- Incurring increased commercial, legal and Health and
Safety risks.
Analysing what is purchased is essential
to understand how an organisation utilises its financial resources before
taking the necessary steps to ensure they are used effectively. Buying more of
what adds value by spending less and eradicating ineffective spending is
crucial to maximising spending efficiency and the effectiveness of an
organisation’s financial expenditure.
The Management of Business Risks
Organisational risk threatens an
organisation's ability to achieve its financial or operational goals.
Commercial risk is centred on an organisation's trading plans that may differ
from those of others. It refers to the possibility of an organisation
inefficiently using its financial resources due to the uncertainties brought
about by its failure to manage risk.
Risk management is a procedural approach
used to identify, evaluate, reduce, or eliminate the chance of an unfavourable
deviation from an expected outcome. The more common risks to consider are:
- Financial: These can range from an
unexpected or unfavourable exchange rate change to a supplier’s
bankruptcy. Some financial risks include budget overruns, limitations in findings,
constructive changes, and missed milestones requiring additional funding.
- Legal and Contractual: These are often related to
disputes, interpretations of contractual obligations, or not meeting the
Supplier's terms and conditions. Intellectual property use or misuse can
also be considered a legal risk, especially when patent infringement is
possible.
- Health and Safety: This is one of the most critical
areas of risk management. An organisation must protect its staff,
customers, and members of the public from harm and ill health when
conducting business activities. Hazard identification and management are
essential when selling products, but never more critical than when
purchasing Supplier services on behalf of customers.
It is important to note that the
severity of risk may not be proportional to the damage it may cause, and that
some risks are unavoidable. No matter how much time and effort is spent on risk
avoidance measures, focusing on the actions required to mitigate and contain
them to reduce the damage is crucial.
It is imperative that organisations
mitigate their commercial, legal, health, and safety risks and transfer them
back through the supply chain to their suppliers by having the appropriate coordinated
customer/supplier contracts and applicable quality, assurance, or legislative
standards in place to meet CE, ISO, or relevant compliance commitments.
Risk Management in High-Performing
Organisations
Within high-performing organisations, a
procurement function will take the initiative by regularly providing spending
reports for budget managers to provide accurate and up-to-date information to
increase the understanding of where and how the organisation's financial
resources are spent. By presenting budget managers with regular spending
reports, a proactive procurement function can
- Meet with budget managers to regularly review areas of
spend.
- Increase the budget managers’ understanding of how
financial resources are used.
- Ensure a risk assessment is conducted across all
organisational spending areas.
- Provide opportunities to engage periodically with
budget managers.
- Suggest potential areas that should
be renegotiated or tendered.
An organisational-wide commercial plan,
usually of two to four years duration, must be formulated to ensure that all
areas of an organisation’s spending are regularly reviewed and formally
tendered or negotiated as appropriate. The aim of the commercial plan must be
to reduce the bottlenecks in people’s time to undertake tenders or negotiations,
whilst timing these to coincide with the start/end of current supply contracts.
The Risk of Spend Categories
A spending report is more detailed than
a traditional financial budget report, which is used by organisations to manage
their budgets. A budget report may contain information on up to sixty areas of
spending. A spending report drawn up by procurement aims to provide a more
detailed analysis of an organisation’s spending.
The number of defined areas of spend, or
“spend categories” as they are better known, will increase and can total more
than five hundred. A spending report aims to provide more meaningful data upon
which budget managers can base their tender or negotiation decisions.
Analysing how financial resources are
used is crucial for understanding an organisation’s spending patterns. The
ideal place to start is a list of Supplier invoices for the last 24 months to
capture all regular and irregular spending patterns. Organisations will need to
assign spending categories to each area of supplier spending.
The assignment must accurately depict
what the Supplier's spend is used for. However, where a Supplier spend is used
for purchasing assorted products and services, the spend category must be
assigned to the highest financial value of the various products or services.
Ensuring that financial resource use
efficiency is maximised can be broken down into multiple crucial steps. It is
essential to take a logical approach to develop a commercial plan to reduce
costs. A
commercial program's success will depend on engaging with stakeholders to
undertake the appropriate negotiations.
The spending report aims to provide
budget managers with relevant, accurate, and understandable information to
conduct a financial review for their area of responsibility. The information
provided will be crucial to obtaining their support in undertaking the actions
required to increase the effectiveness of organisational spending and reduce
costs.
Strategic Risk Management
The analysis of an organisation’s spend
will need to split the spending into different groups and descending levels of
priorities, for example:
- Strategic Items (High Value + High Market
Complexity/Supply Risk).
- Leverage Items (High Value + Low Market
Complexity/Supply Risk).
- Bottleneck Items (Low Value + High Market
Complexity/Supply Risk).
- Non-Critical Items (Low Value + Low Market
Complexity/Supply Risk).
It is essential to prioritise tendering
or negotiation opportunities based on the size of the potential benefit of the
outcome of the tender or negotiation. However, it is equally crucial to ensure
that the risks of legal and health and safety compliance are considered in
prioritising the tendering or negotiation of spend categories and that the
risk is transferred back to suppliers by having the appropriate
customer/supplier contracts in place.
Commercial Cost Reduction
It is crucial to preserve any cost
savings, as these can easily be lost. So often, the top line of cost savings is
gleefully celebrated without much thought about how the organisation will
realise the savings. Here, solid commercial management skills can assist the
organisation in maintaining and increasing those hard-won cost savings. Several
ways of doing this could be:
- Consolidate the Supply Base: Supplier management is critical
to maximising cost savings. Identifying strategic Suppliers and
consolidating the total number of suppliers an organisation uses increases
the leveraging of the purchasing function. It can save time and money, as
Supplier selection is reduced during the purchasing cycle.
- Reduce Maverick Spending: Maverick spending, or allowing
people to select or utilise Suppliers without any thought, can account for
up to 25% of purchases made within an organisation and could potentially
reduce the chances of maintaining cost savings.
- Improve Risk Management: Every organisation has business
risks. One of the largest is over-reliance on a particular group of
Suppliers. While the aim should always be to consolidate the supply base,
when possible, one of the principal ways to manage risk is to ensure that
an organisation reduces its reliance on major suppliers.
- Reduce Internal Costs: Streamlining processes can reduce
operational costs. Procurement should work with organisational Teams to
define transparent processes with improved visibility and detailing of
overall spending and data accuracy.
- Use Category Management: Category management is a
procurement approach that identifies spending patterns by categorising
spending streams and allocating a category to each type of spend. It
assists an organisation in finding opportunities to save money and cut
internal costs by reducing multiple similar transactions and consolidating
the number of purchase orders and invoices processed.
- Contract Management: Spend leakage occurs when
purchasing outside the terms of the Supplier contract or framework
agreement. Organisations should monitor all purchases to comply with the
contract and payment terms. If non-compliant purchases cause spending
leakage, the organisation should work to put controls in place to prevent
it from recurring.
- Tender Management: Tender management is part of any
good sourcing strategy. When an organisation offers numerous suppliers the
opportunity to bid for products or services, their bid should include how
they will solve the organisation’s demand issue and provide the most competitive
pricing. However, designing and writing these proposals, also known as
specifications, can take time and effort.
- Demand Management: Research shows that every £1.00
an organisation spends on supply management returns £6.77. By decreasing
demand, an organisation can achieve the highest cost savings by reducing
overall product or service consumption, which can reduce or eliminate hidden
costs. This is especially important when considering products like
laptops, smartphones, or the leasing of company vehicles.
- Staff Skills: Training staff to become more
empowered and make better decisions for an organisation can improve the
bottom line over the long run. For instance, enhancing negotiation skills
can improve supplier relationships and contract management. Employees are
an organisation’s biggest asset, so investing in them and their
professional development is in the organisation’s best interest.
- Technology: Using e-procurement software and
other technology to communicate more speedily and efficiently with the
supply chain will improve access to supplier catalogues, ensure a better
range of product choices, and ultimately lead to increased savings.
- Inventory Levels: High stock levels in a warehouse
will not make any profit and will cost money to store. The longer the
stock sits, the more deteriorated it becomes, with a higher chance of
obsolescence. Keeping a close check on stock levels ensures it rotates
with the first-in, first-out principle to reduce waste.
As organisations face ever-increasing
cost management issues, they must review their current and future spending
requirements. Not carrying out a financial review will invariably increase
costs by 16 – 21% per annum, higher than the open market.
Assisting budget managers in
understanding where and how they spend an organisation’s financial resources
will facilitate their ability to set tendering or negotiation priorities
to maximise cost reductions for their current and future anticipated spending.
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