The procurement director for large financial services company recently asked me for reasons to use purchase orders. His procurement group was receiving pushback from the firm's accounting division, which was happy to issue payments merely based on internal management just "approving" supplier invoices (grrr).
In my email to this execuive, I put together the following list ofTop 10 Reasons to Use Purchase Orders:
Reason One - Online approval prior to PO issuance ensures the expenditure is budgeted and authorized before the commitment is made to a supplier. With invoice-only payment processing, an organization is already liable for the expenditure even though it was never approved by management.
Reason Two - An automated PO routing and approval process ensures that only authorized company representatives can commit to supplier expenditures. This focuses supplier relationships through the procurement organization.
Reason Three - If a PO is a requirement before a supplier can be paid, they won't start work for a business without it. Word travels fast in the supplier community, and can be aided by an email to each supplier reminding them that a purchase order number is required on all invoices. This will keep control in the procurement organization and prevent suppliers from shipping products of beginning work without prior purchase order approval being in place.
Reason Four - It has been documented in many studies thatmaterial errors exist more than 1.5% of invoice line items billed by suppliers. 80% of the time the error is to the benefit of the supplier (hmmm, what a coincidence...). Having PO/Invoice matching catches a majority of the errors and does not allow them to be passed through without reconciliation.
When Strategic Procurement Solutions performed a 360o Procurement Efficiency Review for this same financial services firm, their Accounts Payable organization was processing around 55,000 invoices a year valued around $200 Million USD. If we assume the average invoice contains two line items, that's 110,000 invoice line items being paid each year...indicating that there are about 1,600 (1.5%) line items having material errors. Dividing annual spending by 106,000 line items results in an average line item value of $1,818/line item...thus indicating $3.0 Million of questionable charges that purchase orders would tend to catch.
Reason Five - Use of a purchase order streamlines payment processing, since the processor doesn't have to enter line item details. They should pull up the purchase order and it's line item description and insert the billed quantity. The other information fills automatically into the invoice record with much greater detail than allowing different AP processors' subjective one word summary entry of the transaction....for example, "Metal" rather than "4' x 8' Sheet of 6061-T6 Aluminum".
Reason Six - Use of a purchase order ensures the charge goes to the GL account, charge unit, and project number the PO was budgeted to. "Creative" budget owners can't shift the expense to a different GL account.
Reason Seven - A purchase order should contain legal terms which mitigate risk in transactions. Even if it does not occur under a contract, the supplier's terms don't prevail. In an invoice-only transaction, the supplier's proposal/quotation legal terms could control the transaction, thus exposing the buying organization to greater risk on issues like title transfer, risk of loss during shipment, payment terms, freight costs, warranty, third-party patent infringement, ownership of work product, limitation of restocking fees, etc.
Reason Eight - A purchase order causes an organization to clearly articulate what they wish to buy from a supplier. If the supplier questions a description, they will usually do that before shipment/performance. But without a PO, the supplier is open to interpret a telephone or email order incorrectly, resulting in a miss-shipment. That results in the business unit or having to facilitate a return to the supplier, and procurement will usually end up having to clean up the mess. Returns are much easier when a purchase order has been utilized.
Reason Nine - A purchase order allows procurement to have visibility to backorders or partial shipments, thus facilitating follow ups and expediting. Without a PO, no one knows what hasn't been shipped...just what has been invoiced.
Reason Ten - A purchase order facilitates formal 'receiving' to validate received shipments. Without a purchase order, you have no formal receiving process...except for AP to send an invoice to the business unit asking them for approval. The business unit often will not dispute slightly different quantities in an invoice and procurement never is notified payment has been approved for something which wasn't formally received.
Consistent use of purchase orders will optimize the entire Procure-to-Payment process. Even contracted expenditures will be better-managed through purchase orders, by ensuring spending can be properly allocated to correct Contracts, SOWs, and Projects.
Of course, not every expenditure needs to be under a purchase order. Use of other techniques like PCards or Evaluated Receipt Settlement (ERS) can be similarly-valuable when used optimally. But purchase orders are a great tool for the majority of procurement transactions, especially when automated though an eProcurement technology solution.
Failure to strategically-use purchase orders will allow suppliers and internal departments to bypass procurement and thus executive management.
Strategic Procurement Solutions often helps companies and governmental groups to optimize their supply management operations. We do this in just a few short weeks through our360o Supply Management Efficiency Assessment. Please contact us at Info@StrategicProcurementSolutions.com for information about this service.
About the Author - Mark Trowbridge, CPSM, C.P.M., MCIPS is one of Strategic Procurement Solutions founders. His 30 years in procurement leadership began in the Manufacturing, Airline, and Financial Services sectors...culminating in a role leading three-quarters of the strategic sourcing activities, and all of the contracts management responsibilities, for Bank of America (then, the USA's third most-profitable company). During his final two years with Bank of America, Mark's areas of responsibility delivered a Quarter Billion Dollars in cost reductions. During the last 15 years, Mr. Trowbridge has worked in the consulting field with many leading corporate and governmental clients. His business travels have taken him throughout North America, Europe, the Middle East, Asia, and Malaysia. He is a frequent author on supply management topics, with articles appearing in publications like Supply Chain Management Review, Inside Supply Management, IFPSM's eZine, eSide Supply Management, and Strategic Procurement Solutions' own Best Practices in Supply Management Journal. Mark's is among the top 1% Most-Viewed LinkedIn profiles.
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