A prospective customer asked me a question that was simple but complex to answer. I normally have an answer right away, however this question required a response greater than a couple of sentences. The question was, “Why does a company need a purchase order (‘PO’) system? Many startups seem to be functioning fine without a PO process, so why should I even consider a purchase order management software?”
A purchase order is a commercial document and first official offer issued by a buyer to a seller, indicating types, quantities, and agreed prices for products or services. Normally, a PO goes through various stages of approvals internally before it is issued to a vendor. You can think of a PO as pre-approval of spend that will happen in the future. In some instances, POs can be specific to a vendor, and, in others, POs can be considered a blanket document providing certain departments within an organization approval to use a designated amount for particular types of spend.
If you are in the finance organization, all of your company’s expenses will come through your group somehow, someway in the end. So, why does any organization need a purchase order management software? Let’s look at a few examples to showcase how a PO system can help your organization run more efficiently.
Example 1 – You get hit with an unanticipated expense:
Your AP clerk receives an invoice for $50,000 from a vendor for some marketing/engineering/sales spend. The finance group had no idea this expense was coming in. However, the other departments had been working with this vendor for the past three months, and it fell within their annual budgeted spend. In this situation, finance most likely would require the invoice to be approved before payment. If the invoice amount is above a certain threshold, a c-level executive may also need to approve it. In this particular example, there are several advantages to having a PO system versus not having one. Advantages include:
Having a purchase order management software would inform finance and management of the anticipated expense. Being able to forecast when you will be incurring certain expenses increases your overall fiscal health. Knowing when certain months will be heavy with expenditures will allow a company to be agile and find alternatives when cash is low.
Your company is proactively managing expenses instead of being reactive. Having the ability to manage your vendors up front can increase negotiation power rather than reacting to services incurred.
Collaboration between different departments would be facilitated by a PO system. Communication is key in any organization, and having a PO system in place fosters collaboration, dialogue, and cohesion among departments.
Organizations that have a PO process in place have stronger visibility over their spend and can manage cash flow better.
Communication with the vendor would be done earlier on in the contract process and any non-transparent issues would be brought to light sooner.
Finance and upper management may decide to change forecast midstream and would see these future expenses coming through, allowing for clearer expectations and increased communication.
The ability to prevent unwarranted expense or fraud would be significantly improved with approval workflows at the PO level. When management is reactive, it leaves them open to unwarranted spend.
Specific types of expenses can be prevented. If a specific vendor or type of expense is being curbed by the organization, this would allow prevention rather than reacting to incurred expenses.
Example 2 – A vendor with inconsistent practices flies under the radar:
Most companies without a purchase order management software rely on a budget versus actual profit and loss analysis performed periodically, which measures historical results. This is a detective control and may uncover vendor patterns but in a manner that may be too late. Having a PO system in this example would provide the following benefits:
The ability to identify and purge bad vendors: Using bad vendors is like fueling your body with junk food. They might be tasty initially, but the calories pack on causing your health to deteriorate over time. Having a purchase order management software in place will let you determine vendor patterns and identify the good vendors from those that consistently over bill and blow budgets.
Fiduciary responsibility to shareholders: At a company’s beginning, its relationships are important and typically tied to a personal connection. However, more controls need to be in place as the company grows to ensure arms-length transactions. Vendors that have strong relationships with first-hire employees may not be easily reviewed and assessed. Having a PO process will illustrate which vendors you do business with and causes a periodic review of those vendors. This ensures you are receiving maximum value and acting in the best interest of your shareholders.
Vendors, especially service vendors, have a tendency to charge as much as they can. Adhering to a budget is near impossible if limits were never put in place. Having a PO system forces vendors to reference a PO in accrual estimates and invoices. Monitoring the balance of that PO naturally causes all parties involved to pay better attention to the bottom line. Vendors may not act in the best interest of their customers but rather focus on their billable time. It’s much easier to trim the fat and watch for over billing before the entire budget is blown.
There are many more scenarios and benefits I can cite, but that would turn a simple article into a full-on business case. The common benefits to highlight for all of them, however, are watching your expenses and sticking to them. A PO system doesn’t establish a budget, it helps you stick to that budget. If you are spending too much money when you go out for dinner, there really isn’t anything that would prevent you from doing so until after you get your credit card statement. A PO system lets you know you’re almost at your allotted funds for this expense and makes it visible to your organization. If you’re looking to be prudent about how you spend your money, which is normally the case for smaller organizations where every dollar spent means that much more, your organization should definitely consider implementing a PO system.