Tricky Cost Savings Calculations
PurchTips edition #301
Are Your Cost Savings Calculations Defensible?
If you repeatedly purchased an item, the price of that item went down on January 1 of every year, and you bought the same quantity every year, calculating your cost savings for that item would be easy. But for items for which pricing changes less predictably and quantities vary from year to year, calculating cost savings can be trickier. In this edition of PurchTips, I will share formulas for calculating cost savings for items whose prices and purchased quantities are more volatile.
The first thing you have to do when calculating cost savings for an item that fits into this category is to calculate Last Year's Average Price for each item, which is done with Calculation A. In all calculations, "year" refers to the fiscal year.
Calculation A: Last Year's Average Price = Total Spent Last Year / Number of Units Purchased Last Year
Then, you should calculate This Year's Average Price for the item using Calculation B.
Calculation B: This Year's Average Price = Total Spent This Year / Number of Units Purchased This Year
You can now calculate This Year's Cost Savings for the item using Calculation C.
Calculation C: This Year's Cost Savings = (Last Year's Average Price - This Year's Average Price) × Number of Units Purchased This Year
Some procurement professionals like to keep a running tally of cost savings with each purchase order. To do that for a particular item, you can use Calculation D.
Calculation D: This Order's Cost Savings = (Last Year's Average Price - Price Paid on This Order) × Quantity Purchased
Then, add up the cost savings for each order to arrive at a total for the year. One caveat of using the order-by-order approach: You must include in your tally all orders even those where you paid more than last year's average price - for your total to match the total from Calculation C. Otherwise, it will not match and your savings claims can be legitimately disputed.
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