Struggling with Budget Overruns? Here’s How Procurement Can Stick to the Purchase Budget
- Procurement teams often indulge in spot buying and exceed their original purchase budget.
- Siloed operations and lack of communication with finance results in budget overruns.
- This problem can be addressed by involving procurement early in budget building and planning.
September 13, 2024 | Cost Management
A manufacturing company plans to launch a new product line during the year. The company decides on a purchase budget and buys the necessary raw materials and components to commence production.
Midway through the year, it realizes that it needs more raw materials to meet the production requirements. It also finds that the prices of a particular raw material have increased due to a shortage of supply. It now has to spend extra money to procure these raw materials and exceeds its original purchase budget in the process.
Situations such as these have become common, especially in a business environment prone to disruption and economic uncertainty. In a volatile market, prices of raw materials and commodities can change quickly.
Like this manufacturing company, once you have set a maximum threshold for purchase budget during a period in your company, does your procurement team comply with this budget? And do you periodically review the money they have spent already? If you don’t, you may be letting the team engage in maverick spending and buying things at the last minute.
How can you ensure that your procurement team follows the protocol and stays within the purchase budget?
Why Procurement Teams Overspend
Let’s first look at a key reason for overspending.
Often, procurement is not directly involved in the budget planning and allocation process. Despite its involvement in core tasks such as supplier selection, contract negotiation and purchasing, procurement does not have a major say in budget planning.
As a result, the budget that is set is often not sufficient to meet requirements that may arise on an ad-hoc basis during the year. In such a case, teams have no choice but to purchase the required goods on the spot.
But can you lay the entire blame on procurement for such overspending? Not exactly.
A better option is to involve procurement in the budgeting process right from the beginning.
The Need for Budget-to-Pay
In many organizations, procurement has adopted source-to-pay (S2P) to oversee the end-to-end buying lifecycle. This essentially means that the function is directly involved in core activities such as sourcing, supplier selection, contract management, supplier relationship management and invoicing and payment.
While such an arrangement helps bring down maverick spending and improves purchasing compliance, there is a need to extend this program back to when budgets are discussed and decided.
As procurement has the responsibility of finding suppliers, negotiating contracts and ordering supplies when needed, it is in a prime position to provide cost estimates. During budget planning, procurement can also point out if the budget set for specific goods or services is not sufficient.
As organizations look for ways to enhance savings and cut down costs, particularly indirect costs, they need to invest in a budget-to-pay (B2P) arrangement.
A B2P technology solution enables the finance department to establish a proactive, fluid budgeting process and enhances visibility into business processes. Better visibility, in turn, helps to synchronize budgets, purchase orders (POs) and payables.
How Budget-to-Pay Works
Budget-to-Pay enables finance and procurement to jointly drive cost reduction initiatives right from the budgeting process all the way until invoices are matched and paid. Procurement works closely with finance during the budget-setting process to establish control towers that define targets for different budget control areas.
Every purchase request is then tracked against the fixed budget for that control tower. If the control tower is out of budget, it gets locked and no further purchase requests can be approved until funds are made available.
Unlike the S2P value chain where decisions are based on the availability of budgets, controls are set up in the procure-to-order process in a B2P setting. Budget checks are added to existing controls such as contract compliance. This increases the possibility of finance setting an optimum purchase budget that is sufficient to meet varied purchase requirements.
The Need for Spend Visibility
You may have a well-defined purchase budget in place. But you also need to monitor the budget periodically and compare it with actual performance.
Businesses therefore need advanced procurement technology to gain real-time visibility into spend. Real-time spend tracking and analysis boosts transparency and helps compare the performance vis-à-vis allocated budgets.
To conclude, the use of procurement technology simplifies the purchase budgeting process and enables businesses to make well-informed decisions. With its user-friendly features, such as guided buying, procurement software helps users choose preferred suppliers and purchase goods and services at negotiated prices.
