How to Create a Formal Purchasing Program
It's easy to neglect the area of purchasing in your business. Of course you buy goods and services, but you don't always plan the purchases as well as you could. As a result, you may spend more money than they need to, buy goods that aren't of the proper quality for your needs, or choose suppliers that don't offer the level of customer service you deserve.
If you fail to devote enough attention to your purchasing, your cost of doing business could rise to an unnecessarily high level. As operating expenses increase, profit margins shrink, you would either have to live with lower profits or raise your prices, and neither of these choices is appealing. By keeping your costs under control, you'll be able to keep your prices at competitive levels and maintain a desirable profit.
To purchase wisely, you need to buy the right quality and quantity of materials or products at the best possible price and at the appropriate time from the best vendor.
The purchasing process is much more streamlined in small companies than in larger businesses, especially when the businesses are still fairly new. The owner usually decides what to buy, when to buy, where to buy, and how much to buy. As the business grows, however, the owner may no longer be able to handle this task and will have to delegate it to others. While a small business probably won't need to create an entire purchasing department, it will need to have a purchasing manager. By selecting one person to manage all of the business's purchasing activities, you will decrease the risk of duplicating orders for the same materials.
Purchasing need not be the purchasing manager's sole duty; in fact, your business may not do enough purchasing to require a full-time purchasing manager. You should select an employee who can handle purchasing, as well as the other duties he or she my already have. This individual should be able to communicate clearly with your business's suppliers. Although purchasing duties probably won't occupy all of this individual's time, there is more to purchasing than placing orders. The purchasing manager will have to gather orders, make sure they are complete, and stay within any limits the company may have set on spending, select an appropriate vendor, order the goods, check their condition upon receipt, make sure the invoice is correct, and speed payment of the invoice by forwarding it to the accounting department.
Before you delegate the purchasing function to another employee, you should write out a purchasing policy for your business. You may even want to create such a policy while you are still responsible for purchasing, as a guide for yourself.
The purchasing policy, according to the SBA, should answer the following questions:
- Who has the authority to purchase items for the company? What items can that person purchase? Are there any spending limitations?
- What are the business's requirements for adequate supplier competition and what criteria will be used to select possible vendors?
- What is the company's position on the acceptance of gifts?
- Which types of contracts can the business enter into with successful bidders or vendors?
- What is the company's position on conflict of interest and personal loans from suppliers?
- What kinds of information does the company consider confidential?
- What is the procedure for dealing with legal questions?
The Ordering System
The steps your employees and purchasing manager will follow to request, order, receive and pay for goods and materials make up your ordering system. A good ordering system will help maintain satisfactory supplier relations, improve cash management, aid in inventory control, and increase the overall profitability of your company.
The Purchase Order
Once the purchasing manager has received a requisition, her or she will need to select a supplier and check the price of the items ordered. After agreeing on a price, the purchasing manager will send a purchase order to the supplier. This order is a formal request to the supplier to deliver materials or supplies according to the terms and prices agreed upon. Purchase orders, like requisition forms, can help small businesses keep track of their purchasing activities. Firms can refer to their purchase orders to see if suppliers have shipped the correct goods in the correct quantity. They can also see if suppliers are delivering goods on time. Purchase orders can also serve as support in any legal disputes if they arise between you and the supplier.
Although you can write out purchase orders by hand, you would give a better impression if you used standard multi-part forms that you can purchase at any stationery store. They should include information such as the type of product or service you are ordering, the quantity desired, price and delivery terms. The orders should also have an area for any additional information. Purchase orders should also include your company name, address, telephone and fax numbers, and logo. You can simply write in this information, stamp this information on your purchase orders with a rubber stamp, or design and print your own purchase order forms. Purchase orders should have at least three parts: a vendor copy, an internal file copy, and an accounting copy.
In addition to the standard purchase order, you might choose to use two other types: blanket purchase orders and annual contracts. If you routinely order fairly inexpensive items from a single vendor, you might want to place a blanket order for those items with the vendor. The blanket order covers specific items to be delivered over a specific period of time, such as six months or one year. This type of purchase order lets you take advantage of quantity discounts and saves you the time and trouble of reordering small items you need often. You will also receive a monthly invoice covering your purchases for a given month, instead of several small invoices covering each individual purchase.
Annual contracts cover the purchase of a specific product from a vendor over a period of 12 months. An annual contract will usually let you fix the price for buying a specific quantity of a given item over a year. You can also arrange to have goods delivered as needed, either monthly, weekly, or on another specific schedule.
A packing list will accompany orders you receive. Make sure that the items shipped match the items indicated on the packing list. Inspect all of the items shipped carefully, paying special attention to items that appear damaged. Initial the packing list to verify receipt and file it in a folder until you receive the invoice for the shipment. In many cases, you won't have to send payment with your order; your suppliers will either include an invoice with the shipment or send the invoice to you separately soon after sending your order. When the invoice arrives, check it against the packing list and the purchase order. Write a check for the appropriate amount, note the check number on a copy of the invoice, and file the invoice and packing list.
If you receive any damaged items, or if a vendor sends you items you did not order, let the vendor know as soon as possible. The vendor will tell you the best way to return the items and to receive the ones you actually ordered.
Fill out an internal receiving report and distribute it to those who need to know when shipments come in, such as the person in charge of inventory control, the buyer, the employee requisitioning the items, and the person in charge of accounts payable in accounting.
Although purchasing is certainly an important task and deserved careful attention, you will not be able to spend the same amount of time on all of your purchases, nor should you. More expensive items, for instance, deserve more careful attention and consideration than less expensive ones. The following four considerations will help you decide what items deserve the most attention, according to the SBA:
- Unit cost. The SBA recommends that you give more attention to costly items than to less expensive ones. The more money you have tied up in a given type of inventory product, the more attention you need to give to that product in your purchasing, even if you sell few of these expensive items.
- Extended cost. The SBA points out that some items may have a low cost, but you may buy and sell them in high volume. In this case, you may need to give a higher priority to these items, although their unit cost is fairly low.
- Lead time. You need to consider the time to allow between ordering an item and receiving it. If a low-cost item has a long lead time, for instance, you would need to make regular checks on its delivery status. In that case, the SBA says, you may need priority.
- Shipment rejection. If there is a high possibility you will reject an item because of technical problems or deficiencies in quality, the SBA suggests assigning it a high priority.
The Costs of Buying
In addition to the cost of goods you buy, you also have to pay and account for the costs of acquiring and carrying inventory.
Inventory acquisition costs are costs associated with generating and processing orders, and include the following:
- Portions of employee salaries and operating expenses directly pertaining to purchasing, inventory control, receiving, inspection and accounts payable.
- Costs of supplies such as forms, envelopes and stationery.
- Costs of placing orders (telephone, fax, postage, etc.)
Inventory carrying costs usually consist of the following elements:
- Interest charged on your financial investment into inventory.
- Cost of insurance covering your inventory.
- Property taxes paid on inventory.
- Cost of storing inventory.
- Obsolescence and deterioration of items in inventory.
Prices for the goods and materials you buy may fluctuate. If you find that the price for a given item is rising, do not buy large quantities of this item thinking that the price will rise even higher if you wait. Instead, the SBA advises that you buy smaller quantities of this item, but buy them more often. You can quickly sell off the items you bought at high prices, instead of tying up money in overpriced inventory. Keep buying small quantities as prices return to their normal level. You will save money on your purchases, as well as reduce demand for the item, "encouraging" prices to drop. Once prices have stabilized at their normal level, you can resume buying in larger quantities.
While you might purchase many items from catalogs that list specific prices on specific quantities, you may need to contact suppliers for price quotes on other items. Before you buy an item, you should contact a number of suppliers and compare prices, delivery options and expenses, and so on. You can do this by visiting suppliers' websites or requesting quotes in writing.
Suppliers extend a variety of different discounts to their customers. Many vendors offer quantity discounts: the more units you buy, the less you pay per unity. These discounts can apply to individual purchases or to a specific group of purchases made over time, as you would make under a blanket order. Suppliers also offer seasonal discounts that apply to merchandise being sold out of season. The danger with buying off-season goods is that they may go out of style or become obsolete, and never go back "in-season." Vendors also offer cash discounts that you earn by paying the entire invoice within a specified time period. If you received an invoice with the notation "1/10, Net 30," it would mean that you could take a one-percent discount from the net amount of the invoice if you paid within ten days. You would otherwise have to pay for the entire amount of the invoice within 30 days.
Dealing With Vendors
Once you have compared prices from a group of suppliers, you can then select your vendors. Before you place an order with a vendor, you not only need to compare prices, but you also need to compare credit terms, emphasis on customer service, standing in the industry, and other related factors.
If you buy a number of different kinds of products, you may have to use a variety of vendors. If, on the other hand, a single vendor can meet all of your needs at reasonable prices, you may want to give that vendor the bulk of your business. Do not, however, rely solely on this vendor. You should keep in contact with other vendors, and watch for new ones. It's a good idea to be on good terms with more than one supplier. If your primary supplier ever fails to ship goods on time, suspends operations because of some natural disaster, or starts offering poor service, you will have other sources to use as back-up.
By using a few different sources of supply, furthermore, you will build more credit than you would if you used only one. Your primary supplier may also offer you better discounts or otherwise try to win all of your business.
You not only need to evaluate suppliers before you place an order, but you also need to evaluate their performance constantly. Consider the following points when you evaluate a supplier's performance:
- Timeliness of deliveries
- Completeness of orders shipped
- Quality of items shipped
- Quality of customer service
- Competitiveness of price
- Previous performance with similar orders
- Strength of financial condition
- Ability to meet design specifications
- Expertise of sales representatives and technical staff
Before you can approach a supplier, you need to know where to find them. You need to be aware of where you can find suppliers both before you begin business and after you have started. Keep looking for new suppliers. To look for suppliers in your area, search online and consult the Business-to-Business Yellow Pages and your local Chamber of Commerce. To broaden your search, consult websites, publications and associations pertaining to your industry; these sources should be able to give you a number of leads.
Many trade associations and publications publish directories listing suppliers to their industries. If you require industrial or mechanical equipment, consult manufacturers' directories such as the Thomas Register of American Manufacturers. Finally, talk to your employees. They may know of excellent suppliers you might use.