Summary Catch Up (Midterm 2) Part 2

The expenditure cycle includes all of the things a company does to interact with it’s suppliers, basically buying things and paying for them.

The revenue cycle’s cast of characters is organized in two primary categories. Operations take care of placing orders and processing receipts, and Finance/Accounting pays the bills.

There are four primary steps within the expenditure cycle:

Planning
Ordering
Receiving
Cash payment (A/P)

Planning involves all of the things the company does to set up the structure of their purchasing function. These aren’t things that are dealt with on a daily basis, but the framework needs to be there. The steps including selecting an inventory control method, identifying key commodity groups, negotiating supplier contracts, and monitoring vendor performance.

The choices for an inventory control method are economic order quantity (EOQ), just-in-time (JIT), or materials requirements planning (MRP). EOQ is the traditional approach to managing inventory, which entails examining a host of factors such as lead times and carrying costs to identify a re-order point when inventory gets too low. Just-in-time inventory is based on the idea that it is costly to maintain inventory – working capital is tied up in things we aren’t directly using, and we have to have a warehouse to put things in. Why not just buy things as we need them, and have them delivered to a specific location just in time? It can work really well, but requires you to do business with very reliable suppliers. MRP is used when production is done according to a schedule, and is most common for projects that take a long time to finish like a building or an airplane. An MRP system coordinates purchases so that things arrive right when a particular task comes up on the schedule.

We also want to identify the different commodity groups that we buy from. This allows buyers to specialize on a particular type of product so they develop some expertise. For example, an aircraft manufacturer might have some buyers focusing on raw materials such as steel and composite material, while others focus on technical avionics systems. These are very different types of purchases, so it makes sense to specialize.

We also want to negotiate supplier contracts at the company wide level to take advantage of purchasing power. It is very important to make sure these contracts get communicated company wide, so that they are used.

The last step in planning is establishing a framework for monitoring vendor performance. This involves thinking about what is important to the company, and coming up with a way to incorporate those factors into a score, which is usually a weighted average. Things that may play into this might be quality (important for a high-end manufacturer), price (important for low-cost provider), or timeliness (important for anyone using JIT).

The second primary step in the expenditure cycle is ordering, which involves completing purchase requisitions, completing purchase orders, and coordinating the procurement card program.

When ordering, it is important to remember that not everyone in an organization is allowed to go out and make big purchases in the name of the company. This privilege is delegated to individuals called buyers. However, needs for purchases arise from all over the company, and they way that individuals notify buyers about their needs is through completion of a purchase requisition. Purchase requisitions tell buyers what people need, where they should be delivered, etc. They also include a G/L account number to be charged, and should prove that the purchase is authorized by the requesting individual’s department. Buyers aren’t in the business of saying we should or shouldn’t buy something – they just go make the purchase. The department is the party that is going to know whether something should be bought or not, which is why they do the approval.

Once the requisition process is complete, then buyers can start the order placement process. This is going to involve getting bids, selecting a supplier, updating the inventory master file, and completing a purchase order.

Getting bids can be formal or informal. For a large purchase, the buyer may initiate a formal request for proposal (RFP) process, where they invite prospective suppliers to submit written bids showing what they can do. For less significant purchases, the buyer may choose to rely on Internet quotes or a few phone calls.

After selection, the buyer will need to update the inventory master file so that a) we have a way to account for the product, and b) we can document the vendor selection process so that we don’t have to do it again in the near future. Use of a vendor master file can be helpful (similar to what we saw how the customer master file is used in the revenue cycle) to store demographic information about suppliers.

The document to execute a purchase is known as the purchase order – it is a contract to purchase, and a promise to pay. Sometimes companies will issue “blanket” purchase orders to buy a large amount of material over a long time horizon, and then “release” against the blanket order any time they need something. This is nice for both the buyer and the supplier – it helps reduce buyer’s uncertainty about raw material sources, and it helps the supplier plan out their capacity.

Procurement cards are company credit cards that are used to make small purchases. Given that the major cost driver of the ordering function is the number of purchase orders processed, this can greatly reduce the number. Another strategy involves the use of reverse auctions, which is kind of like ebay in reverse where potential buyers go to an auction website and say what they would like to buy, and then potential suppliers bid on the work, with the low cost supplier winning the business. It is best in environments where the product is a commodity (like gas, lumber, etc.) where it really doesn’t matter who you buy from because the product is the same.