How much does spending money cost you? That might seem like a facetious question, but the truth is, every purchase order (PO) made, approved, placed, and paid by your company costs you money to process. Added up across your supply chain, these PO processing costs can have a surprising impact on your bottom line.
Happily, with the right technology and process improvements, you can reduce your PO processing costs and bring measurable cost savings to the PO process.
PO Processing Costs: A Thorny Issue
Before you can reduce the average cost of purchase order processing, you have to be able to define and measure it. This processing cost will vary from company to company, and can be difficult to pin down due to differences in accounting procedure, industry specifics, and internal business practices.
That said, with some well-considered planning and process implementation, you can quantify these PO costs and begin reducing them.
“Looking at the math involved, you begin to see why the Center for Advanced Procurement Strategy (CAPS) found that the average cost per purchase order hovers somewhere between $50 and $1,000, based on industry and vertical.”
Calculating Purchase Order Processing Costs
To begin, consider that each purchase order will generate both fixed costs (e.g., overhead, salaried employee wages/benefits, infrastructure, etc.) and variable costs (postage, hourly staff wages, office supplies, etc.) over the course of its creation, approval, and fulfillment. The variable costs are especially important to identify and, if possible, limit, as costs that change from one purchase order to the next will wreak havoc on your calculations.
Keeping these costs in mind, break down the purchase order process, from procurement to payment (P2P):
- Internal Purchase Order Processing: During this stage, the person ordering the goods chooses an item to fulfill an outstanding need, selects a vendor, and creates a purchase requisition. They then submit their request for approval, and when it is approved, a purchase order is created and sent to the supplier.
- External Purchase Order Processing: This phase covers any interactions with suppliers regarding the submitted PO. This might include revisions, clarifications, adjusted quantities, or discussions about shipping times, product availability, and potential replacements for items ordered.
- Order Management: Once the order’s been placed, there may be costs associated with confirming shipping dates, order modifications, or other communication related to the status of the order.
- Order Receiving: When the vendor fulfills the order and ships it to your shipping and receiving department, the order needs to be checked to confirm it is of sufficient quality and correct quantity. If there’s a problem, then the PO may generate additional costs related to returns, additional shipping, order errors, etc.
- Invoice Processing: At this point, the invoice connected to the purchase order is checked against the purchase order and the shipping documents for any discrepancies. As with Order Receiving, errors and additional communication can generate higher costs as staff chase exceptions, wait for approvals, etc.
After breaking the process into clear steps, and having tallied your fixed and variable costs, the remaining factor to keep in mind is time.
- How much are you paying, and to whom, each hour for the tasks in each step?
- How many POs are you processing, and how long does each one take to travel through all five stages of P2P?
- How many exceptions are you dealing with, on average, and how long does each one take to resolve?
Armed with all this information, you can finally begin to tote up your average PO processing cost. Your exact methodology will vary, based on your internal accounting practices, staff compensation, etc.
The cost associated with each stage is the average time spent on each process within it, multiplied by the minute-rate cost. More simply:
Resource Cost = (Average time spent on a task) * (minute-rate cost per resource)
Note: The minute-rate cost is simply the hourly cost of a resource, divided by 60.
So, for example, if you’re looking at staff costs to create a purchase requisition (handled by a buyer), and the annual compensation (including benefits) for that buyer is $92,000 a year, that’s:
92,000 ÷ 1820 = $51
Where 1,820 is the average number of work hours for FTE, or Full-Time Employee, compensation.
We then take that hourly rate, and divide it by 60 to get the minute-rate:
$51 ÷ 60 = $.85
You’re paying the buyer $.85 a minute to create that requisition. If the average requisition takes 10 minutes to create, then you’re paying an average of $8.50 for each PO processed.
You can repeat these calculations for each staff member or other resource involved, and total them up for each stage. When you have all the totals for all five stages, you can find your average PO processing cost by dividing the grand total cost by the total number of POs you processed in the period being measured.
Looking at the math involved, you begin to see why the Center for Advanced Procurement Strategy (CAPS) found that the average cost per purchase order hovers somewhere between $50 and $1,000, based on industry and vertical. Even more importantly, you can begin to see how incremental savings can quickly add up; cutting 20% off the average cost of a processed PO has a powerful impact when multiplied by 20,000 purchase orders!
Cutting Your Purchase Order Costs
The first step in trimming the costs associated with your purchase order’s journey through the system is to embrace automation. When every second is tied to pennies (or dollars!) spent, ensuring your P2P is fast, accurate, and hands-free will ensure you’re getting the biggest bang for your PO buck. If you haven’t already, make a world-class purchasing software package part of your procurement strategy.
Using artificial intelligence and process automation, eProcurement software solutions have an absolutely transformative effect on your procure-to-pay process, including:
- Streamlined PO Cycles: Automated approvals (with reminders), preferred vendors, and total transparency can reduce the time a PO spends in the system from days to mere hours.
- Improved Accuracy and Less Risk: When each PO is automatically linked to and verified against its corresponding invoice and shipping documents, needless errors, exceptions, and wasted hours spent chasing them are eliminated. Invoice fraud and rogue spending go the way of the dodo as well.
The benefits of implementing a purchasing system don’t end with P2P, of course. Inventory management, supply management, you name it—centralized and powered by machine learning, these packages make every aspect of the purchasing process more efficient while reducing both risk and human error. Plus, procurement software easily integrates with both Enterprise Resource Planning systems (ERP systems) and Customer Relationship Management (CRM) suites, bringing procurement into your overall business strategy and shifting the focus from cost savings to value creation.
Trim the Fat from Your PO Processing
It’s a lot of math, but don’t let the numbers spook you (especially when software can handle them quickly, efficiently, and accurately for you). By embracing procurement software and leveraging the power of automation, you can whittle down your average PO processing costs to the bare minimum, and focus your time and resources on what really counts: growing your business.
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