Traditionally the procurement and Finance & Control discipline (F&C) are tightly interwoven. This relationship becomes especially evident in dire economic times, when cost reduction is a top priority and – even more than usual – procurement is looked at to contribute to cost savings. Obviously Procurement has much more ground in common with F&C, both on a strategic and tactical level; for example the relationship between corporate and procurement strategy, supplier management, risk management, implementation of ordering systems (P2P), measurement of realized savings, etc. This post explores some of the interfaces between the disciplines and presents a few suggestions on how F&C and Procurement can collaborate.
The essence of procurement
To describe the connection between the financial and procurement domain let us dwell for a moment on the essence of the procurement function. This can easily be described using the following simple figure.
The basic task of Procurement is to adequately meet an organizations demand for the goods and services required to achieve the goals of that organization. A clear understanding of these demands and thorough knowledge of supplier markets enables Procurement to negotiate proper contracts. All relating activities can be summarized as “Sourcing.”
To facilitate an effective order process, and usage of available contracts, an organization should strive to have all employees using an optimized order process (process compliance) and authorized contracts (contract compliance). This is called “Control.” A prerequisite for an effective procurement function is insight. Insight into the needs of the organization, procurement behavior, characteristics and trends of supplier markets, the extent that available procurement processes and accompanying systems are used, etc. All efforts aimed at obtaining this insight can be lumped together as “Transparency.” Let us take this model to examine the interfaces between Procurement and Finance more closely.
It is good practice to define a sourcing strategy per commodity. Each category has its own characteristics and these determine the requirements that goods, services and suppliers must meet. At the basis of all of these considerations are the strategic objectives of an organization. If, for example, a company is aiming at leading the market in innovation, then it makes sense to search for suppliers that are capable of supporting that ambition. Should they alternatively pursue a cost leadership strategy, then they would rather contract suppliers that are perhaps less innovative, but are the most capable of offering quality products under favorable cost conditions.
A critical success factor for a successful cooperation between Procurement and Finance is that the objectives of sourcing are clear to all. As stated, these objectives are for a large part determined by the corporate strategy. Because of his role in the board, the CFO typically has a responsibility in implementing the strategy and aligning it with the strategy of the different corporate domains. Based on the corporate strategy the different procurement commodities can be prioritized and the sourcing strategy per commodity can be determined. A second success factor is that the sourcing objectives are translated into clear, measurable performance indicators, which clearly articulate how the performance of Procurement will be measured. It is obvious that these might go further than sheer cost control. Other factors could be the extent to which the competencies of suppliers are used to create additional value for the organization, improved quality management or increased supply reliability.
Sourcing is mainly about organizing the tactical aspects of procurement. Control deals with the translation to operational level. It is here where the real ordering of products and services takes place, including receipt of goods and handling of the invoice. To maintain a grip on this it is important that there are clear, practicable order processes, adequately supported by systems. Only when you make sure that employees are supported by effective processes and tools can one demand that they are leveraged at all times: process compliancy. This highlights an important interface between Procurement and Finance. The interest of Procurement in this interface is that negotiated contracts are made accessible for those employees authorized to order goods and services. This way, people have a standard way of ordering things and information is recorded uniformly in systems, which makes it a source for information for new procurement activities (see transparency). This is the way for F&C to keep a grip on costs and to have insight into on-going obligations. For a successful cooperation between Procurement and F&C it is of imminent importance that the design of the order process and the accompanying administrative organization is carried out as a joint operation.
Next to process compliance, control relates to contract compliance. Not only is it vital that employees follow the correct ordering process, but it is also important that these purchases, if possible, are based on procurement contracts. This has financial advantages, such as bundling of purchases into one contract with one supplier to obtain better conditions, and is likely to simplify the control of risks, because the monitoring of risks is very cumbersome when sources of supply are not assigned methodically. Similar as it was for “Sourcing” it is important for “Control” that both disciplines (Procurement and F&C) define the performance indicators collectively.
Transparency is the area where the connection between Procurement and F&C becomes the most visible. Assuming it has been set up properly, transparency provides the eternal source of information and inspiration for improvements in tactical and operational procurement processes. It also determines, to a great extent, the contribution that Procurement can deliver to achieving the corporate objectives.
Through enforcement of process compliance the obligations are consistently and uniformly recorded. This provides the financial function more insight into the availability of liquid assets and the impact on working capital. This insight helps steer the financial streams, for instance by deploying instruments like dynamic discounting. Once the operational procurement process is truly in control, it becomes possible to negotiate more complex payment conditions with suppliers, containing arrangements such as supply chain financing. In times of ample working capital one can decide to pay invoices earlier and reap the payment discount, which in general yields more return than placing it on deposit. Alternatively, in times of stringency one can decide to pay invoices later. Indeed this makes it impossible to take advantage of a payment discount, but it still costs less than funding a short-term financing need by overdrawing the current account.
The consistent tracking of all purchases helps Procurement in their sourcing activities. It helps keeping an eye on the buying behavior of the organization. It can also be seen as a means to agree on more fiscally sound budgets, even more so if it can be combined with information derived from the sales & operations planning. Ultimately, an advanced information system might make it possible to control in real time the margin on sales, enabling the company to take corrective measures if the margin threatens to go below a certain desired level.
Prerequisites for collaboration
Above we have tried to prove with some (non-exhaustive) examples that there are many interfaces between Procurement and F&C. Implicitly we mentioned what it takes to optimize the collaboration between the disciplines. It is vital to recognize that Procurement and F&C are interwoven to such a degree that it is virtually impossible to make a clear division of responsibilities. To achieve optimal results the two disciplines have to work together. A non-negotiable prerequisite is the enforcement of the usage of the right processes. This helps recording data in a uniform way which leads to a reliable source of transactional data. To get to this point the deployment of the right technology is required. For example; a robust transaction system to support user activities, workflow functionality to guide process steps, a database to store detailed information, a management information system to create detailed reports and to support analysis. But the most important prerequisite that must be met to establish a successful cooperation between Procurement and F&C is the availability of qualified staff with the right expertise. Not only expertise in their own field, but also in the field of the other function. The buyer must be familiar with the jargon of F&C and the other way around. Only under these conditions will both disciplines be able to put themselves in the other parties’ shoes in order to pursue new opportunities to improve the performance of their organization.