Who makes purchasing decisions in your business?

escalating cash pileControlling expenditure should be a fundamental principle for any business and the business plan should contain details of the company’s purchasing policy and costs in relation to its gross margins and overheads.

Too often the ability to place orders is given to too many or insufficiently experienced people within a business without clear purchasing guidelines that define limits and protect margins.

It is important that there should be senior management oversight of purchasing and that those who place orders do so within the set parameters and budgets such that any additional expenditure needs management approval.

Any purchases that are higher than the set parameters such as above a % cost of sale will mean that goods are being sold to customers for less than the stated gross profit margins and sooner or later this may lead to serious financial problems for the business.

It may be that in some instances if directors consider a purchasing decision, for example if the price of raw materials has risen to the point where it reduces the potential profit margins too far on what seems at first to be a lucrative order from a customer, they would be wise to decline the order.

The two key questions therefore are firstly whether a business has a defined system in place for controlling purchasing expenditure and secondly who in the company is given the power to place purchase orders.

Tight control is key

Here’s a lesson from history to illustrate. Over a 40-year period as its managing director Arnold Weinstock built the General Electric Company (GEC) into a highly successful British owned global business.

He was notorious for maintaining tight control over expenditure and would meet managers annually to set the next year’s budget.  If they wanted to spend £500 more than the limit set they would have to get his approval and be able to make a good, detailed case for why it was necessary. Generally, they didn’t.

There is a lesson for smaller businesses about having robust purchasing systems with parameters such as setting the maximum % for variable costs and budgets for fixed costs.

In relation to overheads and investment in assets, these should be fixed in a budget to avoid over spending. All too often small items are overlooked like staff ordering stationery because they can’t find the stapler or pencil sharpener, when in actual fact there are usually several hidden in desk drawers. Even relatively small purchases can quickly mount up.

While a business will want everyone to be able to do their jobs without every single purchasing decision having to be approved by senior management it is important to both set the limits and then to monitor them.

It is also about being very careful about who in the company has the power to make purchases and how orders are placed. Ideally every order should be placed with a purchase order where a copy is matched up to the purchase invoice. Orders by telephone and email are difficult to monitor and can result in unpleasant surprises, especially when they exceed the budget. And, all too often the person concerned has left when a really big problem arises.

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