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Financials, Part 2 - Do you need Purchase Order Processing?

10th Mar 2005
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In his first article David Carter argued that, when thinking about Financials packages, you have to go right back to the beginning of your procurement cycle. In practice, this boils down to one question: do you install Purchase Order Processing (POP)? There are several good reasons for implementing POP, but there are also some good reasons for NOT implementing it. It depends on your company culture.

Purchase Order Processing (POP) has long been available as part of a set of Financials, but it's always been something of a Cinderella. Quite a few companies bought POP as part of their new accounts package, but in the end decided not to install it. In this article we'll look at the pros and cons of POP. First, however, what does POP actually do?

What a Purchase Order Processing module does
In an accounts package the POP module handles the earlier stages of the purchase transaction. In the first article we identified these as:
Raise a requisition ' raise a purchase order - take delivery ' match supplier invoice to delivery note ' generate purchase invoice

Within a larger organisation in particular this can involve multiple departments. The staff member who requires the item may raise the requisition, then send it off to their manager for authorisation. The manager passes the requisition on to the purchasing deptartment, who get prices from suppliers, then send off a purchase order.

The items arrive and goods inwards or the staff member record delivery. Then the supplier's invoice arrives. It is sent to the staff member who confirms the items were received satisfactorily. Accounts then key the purchase invoice into the computer and the POP sequence is now complete.

Benefits of POP
Purchase Order Processing can yield major benefits in two areas. First, it can streamline internal buying procedures. Second, it yields valuable management information about costs.

More efficient, no paper
POP is particularly effective within large companies and those where staff are distributed across different locations. This is because a single centralised system is now linking all the various departments together.

In particular, technology can greatly speed up the movement of documents between departments. The various documents ' requisitions, orders, delivery notes, purchase invoices - used to be in paper form and circulated via 'snail mail'. Now they are in electronic format and staff can circulate them to each other pretty well instantly via email and the internet.

No need to key in the invoice
When supplier invoices arrive in the post, the usual procedure is for Accounts dept to get them first, and then type them onto the computer in an invoice register. They then post the invoices off to the relevant member of staff for authorisation.

But when a POP system is in operation, the invoice is passed direct to the staff member, who simply recalls the order to the screen, checks that the items and prices are correct, and converts the order into the purchase invoice automatically. This is the benefit of an integrated package. There's no need for accounts to do any data entry, and the invoice is authorised for payment immediately.

See your committed costs
POP also improves management information. It enables management to see committed costs - the costs which the company has incurred because an order has been placed upon the supplier, but no invoice from the supplier has yet been received.

Instead of these costs only appearing on the radar screen when the invoice finally arrives, you now see them instantly as soon as they are committed in the form of a purchase order.

Improved cash forecasting
This month's purchase orders are next month's purchase invoices, which are next month's payments. Recording purchase orders enables you to look farther ahead when making your cashflow forecasts.

Better control over expenditure
One thing that often worries accountants is that staff are committing the company to expenses which management know nothing about. The first thing they know about it is when the supplier's invoice arrives and it's too late to do anything.

By ensuring that all purchase orders go through a system, managers get control over what is being spent and make sure there is no big black hole of committed costs. Maverick spend ' staff buying things without going through the proper procedure ' is eliminated.

Disadvantage of POP ' it's bureaucracy
The problem with POP however is that, however you dress it up, it's really about bureaucracy.

If you install a Sales Order Processing (SOP) system, for example, employees will be pleased because it will enable them to do their work much faster. But no-one could argue that POP helps an employee do his/her job faster. After all, the quickest way for an employee to get what they need is simply to pick up the phone and talk to the supplier direct, or send them an email.

The whole process of raising a requisition, getting authorisation, issuing an official order is simply for the benefit of central staffs who want to keep an eye on the workforce. POP is not about doing the job more effectively, it's about control.

What are budgets for?
When I installed my first job costing system in a contract publishers, I was really keen to try installing POP as well. I trotted out the usual justifications ' control of committed cost as well as invoiced ones, opportunity to see cost variances earlier, give top management better control, and so on.

But the FD, a remarkably laid back character, simply wasn't interested. "They've agreed a budget, haven't they. Leave them to get on with it." His staff were professionals and he trusted them. Forcing them to put everything through some computerised ordering system would simply slow them down and make them irritated.

His view of a budget was that it cuts two ways. Once a budget has been agreed, the employee will be held to that figure when the costs are finally totted up. But until then management should leave her alone. It was up to her how she wanted to work within her budget.

Needless to say, morale in this company was very high and it was one of the most profitable in the industry.

It depends on size
So, it depends very much on the culture of the organisation. Bigger companies feel the need for control and for formal systems. In the public sector, in particular, where managers have to account for every penny, control over expenditure and committed costs is essential.

But smaller companies often like to stay flexible, to trust their people, and leave them to deal one to one with their suppliers. For these companies POP may be a mistake. They'd be better not to try to impose a formal system.

With small companies, of course, there's also the question of whether they are actually capable of operating a formal system. I often ask accountants this simple question: "OK, if you get POP, then everyone in the organisation has to stick to the procedure, right up to the top. Right now your directors are used to ringing up their suppliers direct. But once POP is installed they'll have to do it through the computer instead. Can you see them doing this?' Brief silence.
"OK, forget it.'

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Replies (6)

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By Richard Willis
17th Mar 2005 12:52

Not 'How Big?' but'How Complex?', surely
I am surprised that David Carter seems to use the size of a company as an indication of the desireability or necessity for POP. Surely the main criteria should be complexity.
Granted a media company, which I guess is mainly buying services, but with some tangibles as well, could manage without the burden of POP, even if it were turning over tens of millions. However one thing that POP can reduce, used properly, is the potential for fraud.

The company for which I work, although not large, manufactures machinery and has an inventory of 18500+ items. Because we run a semi-just-in-time system, the same items may be ordered multiple times within any given period. Not having a handle on which delivery relates to which order, and ultimately to which order/delivery each invoice relates, would be a recipie for disaster.

Yes, we DID have a manual POP system before we had computers, and the computers have speeded up the process at all levels. So I agree that one shouldn't necessarily relate POP to computers, although to do it any other way in this day and age would be madness!

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By David Carter
17th Mar 2005 20:52

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Richard,
You are right, in that for stock-based companies POP is fundamental, since it supplies the "On Order" balance in the "Physical-Allocated+On Order=Free" calculation.
It's in service organisations where it fronts the financials that POP is a Cinderella, as I call it. Service POP and Stock POP are different packages, really.

Ron,
I take your point about the primacy of the invoice over the order, actual VAT to be recorded etc. You then go on to say:

"Clearly the ability to match this up with the order and check for discrepancies is a boon, but it's one most often started in the finance department, and only passed on to the originator when it doesn't match up."

Surely this is wrong. Every invoice has to be passed on the originator for approval. Even if the figures match up, there may still be errors, e.g. the item delivered was wrong, quality might be faulty, etc. etc.

Every invoice has to go the originator, who is best at sorting out any discrepancies because he/she knows the facts. In that case, what's the reason for involving Finance at all? None as far as I can see. But Finance insist on involving themselves because they are afraid of losing control.

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By rondomtis
17th Mar 2005 15:34

Purchase Order Invoices
I think it is a little misleading to suggest that a POP system allows finance to pass the entry of the purchase invoice over to the primary order source (because it's just a case of converting the order into an invoice).

UK VAT law requires the data from the invoice as presented from the supplier to be entered into the system (in particular the goods and VAT totals on the invoice must be typed in, not copied from the original order - VAT inspectors are quite hot on this in my experience). Plus of course the invoice is the point where you discover that the supplier has changed his price, or charged for delivery, or something else unexpected.

Clearly the ability to match this up with the order and check for discrepancies is a boon, but it's one most often started in the finance department, and only passed on to the originator when it doesn't match up.

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By listerramjet
10th Mar 2005 09:18

take your point, but
I would contend that your example has POP, but it is simply not computerised. It is a very common mistake to equate systems directly with computers.

I would also contend that your example organisation had its own bureaucracy, but a less formal one, and I believe that there is a similar mistaken belief that equates formality of procedure with bureaucracy, (and also internal control!)

It is most interesting to consider what is the source of that organisations success (and you said it was relatively successful in its sector). Probably, imposing a more formalised POP system would have had little impact on that, although probably it would have in any case been bent in lots of different directions.

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By listerramjet
11th Mar 2005 08:56

i'm not a luddite, honest!
You are spot on about the key benefits, and both of these can have a major impact on a significant area for many small businesses - namely working capital management - particularly when POP is integrated with stock control. This translates into lots of lovely information; something that many small businesses lack. Add the essential element of feedback from an automated Sales Order Processing system, and you have something that will provide comparative advantage. (And it will be interesting to see what microsoft come up with).

The difficulty is in fitting the automated system to the organisation - in practice many fall into the trap of fitting the organisation to the automated system. In my view this is one of the major causes of IT project failures (the other being "scope creep" during the project - or the "wouldn't it be good if" trap).

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By David Carter
10th Mar 2005 16:57

a very informal system
Alistair, obviously every organisation places orders on suppliers in some way or other and so must have some sort of system for POP. The question is whether you decide to automate it.

In this particular company the designers, production people etc simply talked to their suppliers direct and placed orders over the phone - all manual, word of mouth, no authorisation required. They were free to order whatever they required, as long as they made budget at the end of the day.

As to reasons for their success, what makes a good media company? It has to be people's attitude, I suppose.

Sometimes it seems to me that it is better NOT to computerise and to leave everything manual. In operational areas of the business where flexibility is required, automating systems often turns out to be a hindrance rather than a help, and people lose their enthusiasm.

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