The Importance of Financial Management in Procurement
 
 

The Importance of Financial Management in Procurement

 

With spending being one of the primary actions involved in procurement, there is quite a bit of importance placed on financial management. Improper handling of finances by a procurement team or officer can lead to a ton of problems, not just for themselves but for their suppliers and the businesses they procure for. However, it's just not about how you spend money. Most of the time, it's important to pay attention to every facet associated with procurement finances in order to maintain the quality of the supply chain.

This article will explore the financial elements of procurement management and the impact they can have. Additional topics will include common problems that are associated with procurement financials and their solutions, how procurement teams can properly budget, and how they can track their spending to their benefit.

The Importance of Financial Management

Finance has an incredibly important role in procurement and it is important understand the value it offers. Too many people simply see money and funding as a means of getting the job done. The value is placed on the bottom line and everything else is ignored, so to speak. While that is a factor which should be addressed, it is one of many involved.

There is a misconception that cost equals profit in procurement; if you get something for a lower price than its worth, then you're saving money and increasing the value that you can sell it back for. The price tag on an item is not an accurate representation of its value--and it should not be treated as such. There can be additional costs in the long-term that decreases the profit you gain from it. You're more likely to save money with a more expensive version of a product so long as the quality is there.

 
 

Like other areas of procurement and business, finance has its own unique language that can easily get lost in translation. Communication is a constant in finance, and all parties need to be able to understand the conversation if they want to know what's going on. Certain terms and phrases, like Key Performance Indicators or KPIs, are used as a means of measuring and managing financial actions. If you have difficulty understanding what they mean and how they can impact your procurement efforts--for example, KPIs usually help identify if things are working and if your efforts are progressing as planned--then you will likely struggle. A lot of it is analytical and there is little room for error.

  • Cross-Department Collaboration--In most cases, there is already enough on a procurement teams plate that taking on the full responsibility of the financial management of their actions can be overkill. Experts recommend collaborating with the financial or accounting department of the business a procurement team works for. This can alleviate any burden on the procurement team--who may not have a full understanding of finance--and put it in into the hands of those who are going to be able to pick up on issues and complexities. However, that does not mean that the procurement team can simply pass it off and ignore it. They have to communicate with each other, agree on decisions, and just plain work together to accomplish their shared goals.

Common Problems
 
 

As with anything, there are some issues that can arise in procurement financial management. In some instances it could be a result of a lack of knowledge regarding finances, but you could still encounter problems even if you are a financial wizard. Many of the problems in financial management are a direct result of circumstances with limited options for how to handle them. Some of the more common problems that you may face in financial management include:

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  • Limited Budget or Funding--Sometimes, the problem is in the budget that you are given. Procurement agents are only able to spend the money that they have, and small or limited budget can really derail any plans that they have. Reductions in budget are often done to prevent reckless spending--another problem--and to curb waste. There may be good intentions behind the reduction, but it can backfire if it's cut too much. Addressing such instances of limited budgets often include being overly cautious in your purchases; a lot of negotiating and detailed evaluation of cost and value before making a decision.

  • Lack of Negotiating--There can be problems that arise as a result of something that is not being done rather than something that is done. Procurement officers who are failing to negotiate are simply accepting the costs of the purchases at face value, which may not be the best thing to do. It may be because they don't want to do it for some reason (e.g. lazy, inconvenient, etc.) or they just can't do it (e.g. inability). Not negotiating or just doing a bad job of it is skipping an entire step in in the procurement process and putting yourself at a financial disadvantage. The simple solution is to stop skipping it. Negotiation is a major part of procurement; if you don't want to do it, then you probably shouldn't be in a profession where it's required. If you don't know how to negotiate or you're just bad at it, then you need to take the time to learn and improve yourself.

  • Improper Spending--Not all purchases are going to be good ones. Mistakes and bad decisions can be made, sometimes because of poor information and that's not necessarily always in your control. However, improper spending can be a result of recklessness or carelessness. Some people will rush if there's a deadline that's fast approaching and they can make a mistake that way. Others just don't take the time to think things through the way they should. Members of the procurement team should be encouraged to slow down and take the time to address as many factors involved as possible to reduce waste and risks. If it's happening consistently--especially if it's with one person in particular--then the problem needs to be addressed at its source. Whether this means disciplinary actions, training, etc., will depend on the reasoning behind why it is happening.

  • Poor Documentation--On occasion the problem may be with the paperwork for a purchase rather than the spending itself. The procurement team needs to document their activities, including spending, in order to track their own progress and the status of their orders. It's harder to tell when transactions happened and if you are operating within your budget if there isn't a paper trail to record it. This can also pose problems for whoever you're working with (e.g. accounting, suppliers, etc.). Make it habitual to document transactions and spending as they happen--get receipts, make copies of invoices, and send what needs to be sent to the proper parties. If there are issues with getting documentation from other (e.g. suppliers), then that may be a red flag of a larger problem.

How To Budget

Budgeting basically means taking the funding that you have been allotted and estimating how it can be used over a period of time. So if you have X amount of money to use per month, there are certain actions that you decide to take in order to make sure you have enough to last you the entire month. Usually, a new budget is usually given yearly, monthly, or quarterly and needs to be planned out each time. Budgets can be used in a personal or professional setting, mostly the latter, and can be an excellent way to manage funds if done properly.

Not everyone understands how to use a budget to manage their finances, so it's normal to make mistakes as you learn. Budgets do not necessarily have to be complicated, but they can be if there's a lot of information involved. To create a feasible and understandable budget, there are four areas to consider:

  • Plan Ahead--The primary purpose of a budget is to plan things out in advance. This means that you do need to have some idea of what is set to happen within the timeframe that the budget is for, plus your current spending habits. If you normally spend X amount per month on something, then it's likely that's how much you will need to set aside in the budget for it. It's a simple division of the total amount of funding that you begin with--excluding any additional monies you may receive later--into areas of spending.

  • Understand Limits--In setting a specific amount aside for each area of spending, you are placing limits on your purchases. This isn't always a bad thing, but it can be. Such limits can keep you in check and avoid reckless spending and waste; stay under budget, maybe save a little, and everyone's happy. You do have to understand that those limits are there for a legitimate reason and not simply make your job harder.

  • Create a ‘Rainy Day' Fund--Running out of money, especially for things that are crucially needed, is a frustrating part of budgeting. You can still hit your limit even if you tried to avoid it, but things happen. One thing that you can do is create a ‘rainy day' or emergency fund, which can be built into the budget. This is usually extra funding that is squeezed in to give the procurement team some wiggle room for when something goes awry. That money could also be distributed into a savings-style account that is solely for emergencies but is added to with each new budget.  

  • Need Versus Want--It can be very difficult to limit your spending if you're used to getting certain things. There may be some allure to upgrading a purchase to get a little more, but such instances need to be done carefully. Especially if you have a tight budget that doesn't have a lot of wiggle room, you need to understand that there is a difference between want and need. Not everything is going to be a necessary expense and you don't want to waste money on things that you don't actually need. Members of the procurement team need to be able to identify what things are necessities and what are not to avoid harmful splurges that contradict financial management.

Documentation Of Procurement Finances

 
 

The need for documentation in financial management and procurement has been stressed earlier in this article. As with budgeting, that's not always something that people are aware of how to do or why they should do it. Specifically, there are three areas where documentation can be used successfully.

  • Written Budget--The budget you create should be written out in full. This makes it easier for the team to follow it, and for any needed adjustments (re: additional funding) that you might make. A written budget also makes it more real for some; they can see it in person and compare their actions to it to monitor any progress. That can actually make it more likely to compel people into following it and make it easier for it to accomplish what it is intended to do.

  • File and Organize--You can document every single financial element of the procurement team's actions down to the smallest detail, but it won't do any good if it's an unorganized mess. A file system of some sort simply makes documentation easier to do and to access. Break things down by purchase category (e.g. type of item purchased) and then by date makes things much more organized. Need to find an invoice to verify an order? Need to balance the books at the end of the budget period? With an orderly filing system, all financial documentation has its place where it can be found when it is needed.  

  • Auditing--The word ‘audit' has a bit of dread attached to it as most people associate it with taxes and financial misdeeds. However, it's not always a bad thing. An audit is an examination of financial documents that evaluates them and looks for inaccuracies that may suggest a problem. If the paperwork and the data doesn't match up, then chances are something is wrong. Regular auditing can help balance the books and catch documentation errors that can skew things later on. That doesn't necessarily mean that someone is embezzling funding from the team--although that's possible--as it can also identify poor financial recording and any problems early on.

 
 
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