Avoiding Procurement Savings Disputes

PurchTips edition #304

 

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Why Are Some Procurement Savings Claims Rejected?

I talk extensively about the need for reconciling procurement savings claims with the change in expenses on consecutive annual income statements. After all, the year-over-year change in expenses is often the first metric that a Chief Financial Officer (CFO) would look at to determine if any "savings" has occurred.

An area where there is a chance of an unexpected procurement savings dispute is with capital expenditures, often called CapEx. Capital expenditures include purchases of equipment, vehicles, and other expensive assets with multi-year lifespans.

Let's say that you bought a machine for your organization last year for $100,000. Then, let's say that you bought that same machine for $90,000 this year.

What is your savings for this year? Most procurement professionals would answer $10,000. But, when comparing this year's income statement to last year's, a CFO may not see a $10,000 expense decrease and, thus, may dispute the amount of savings that you're claiming.

How? Well, there's a difference in the ways that capital expenditures and other types of expenditures (called operating expenditures or OpEx) are accounted for. With OpEx, 100% of the price paid is treated as an expense on the income statement in the year of purchase. In contrast, the cost of a capital asset is accounted for as an expense over the life of that asset, not just in the year of purchase. That's called depreciation, and depreciated costs can be spread out evenly throughout the life of the asset (called "straight line depreciation") or spread out unevenly in accordance with specific accounting rules.

So, if the machine in our example has a 20-year life span and straight line depreciation was used, then the associated expense on last year's income statement was $5,000 ($100,000 divided by 20 years). The associated expense on this year's income statement would be $4,500 ($90,000 divided by 20 years). Therefore, a CFO may give you credit for a savings of only $500 for this year! You'd probably feel under-recognized, right?

The key to avoiding procurement savings disputes is for Finance and Procurement to reach a common understanding of the value contributed by Procurement.

Learn all you can about finance now. Only then will you be able to get the respect necessary to make your case for how procurement savings should be recognized.

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