Finance for Purchasing Managers

Understanding the Financial Impact of Buying Decisions

Richard France

• Publisher: Routledge
• Year: 2016
• Topic: Business
• eBook ISBN:
  9781317135159
• Subtopic: Finance
• Index: Business

Managers involved at a senior level in the purchasing function require very particular financial skills. They need to: analyse the financial health and stability of their suppliers; model different cost and price scenarios; understand and manage budgets; and be comfortable with the financial aspects of capital purchases. Finance for Purchasing Managers is written from this perspective using buyer's language and interpretation. Richard France explores four key areas of expertise required of a buyer in today's environment: Financial analysis of suppliers - this includes understanding the financial aspects of a buyer's own organisation plus analysing key suppliers and how to use information to gain a negotiating edge. Pricing, costing and cost modelling - including costing methods and their application and how an understanding of these can give buyers a greater understanding when dealing with supplier quotations. Managing resources - including budgeting and sources of finance. This shows how budgets are drawn up and the importance of understanding the implications of the buyer's decisions on a supplier's cash flow forecast. Finally, capital and revenue purchasing decisions and techniques - covering standard investment appraisal techniques and how these can be used for deciding on the best deal from a choice of suppliers for both capital items as well as a standard long term parts supply contract. Finance for Purchasing Managers may be used to support the CIPS Level 6 Course 'Finance for Purchasers' but also offers a readable and practical guide for those at a senior level in purchasing whether in the public or private sector.

PART I
Financial Analysis of Suppliers

1
The Role of Finance from a Purchasing Perspective

The role of purchasing has changed significantly over the last 30 years, particularly in the UK. There are various reasons for this, but primarily it is because the country has moved from being fundamentally a strong manufacturing economy to being significantly more service orientated. Due to the increasingly high costs of labour, many large multinational manufacturing organisations have reduced their manufacturing in the UK and made direct investments in countries where the labour costs are significantly cheaper. Clearly, the industries to be hit by this strategy are those where a significant element of the costs arise from direct labour and where a company may buy items in for perhaps one quarter to a half of the costs of manufacturing those items itself. As a low labour cost country gets near to the capacity of its useable labour, there will be significant inflation that will then push up the manufacturing costs, as has happened in South Korea. Manufacturers will then move to the next country where there is still a significant amount of under-utilised labour that will operate for a low cost. Outsourcing in this way may have significant corporate social responsibility (CSR) issues if using under-age labour or working excessive hours. This places further responsibility on the buyer to ensure their company is not damaged by negative publicity associated with poor CSR practice. This is, of course, in addition to any moral or ethical views the buyer or the buyer’s company may have in this regard.

Many industries in the United Kingdom have virtually ceased to exist where they have been traditionally large employers of low-skilled labour. For instance, the clothing and pottery industries both employ a small fraction of the numbers they used to employ 30 years ago.

What do these changes mean for the buyer?

Fundamentally, buyers are purchasing supplies that are significantly further along in the value chain. For instance, in the engineering sector 30 years ago, a buyer might have purchased raw steel in large quantities in sheet or rod form, and then the company would add value to the raw material to turn it into a complete engineered part. This is still the case when purchasing for an overseas manufacturer, but often the buyer seeks to purchase either the completed part itself or a significant element of that completed part (perhaps 20, 30 or 40% of its final value). This means that the buyer needs a higher level of expertise in the product make-up and specifications, as well as being responsible for a higher value of external spend. In other words, the buyer’s role has become more vital to the success of an organisation, which gives greater credibility and responsibility to the role of the buyer. Essentially, organisations have sought, due to the volatility of demand, to turn the fixed costs of manufacturing into the variable costs of buying in.

Good sources of supply, therefore, have become a principal resource of the company, and the buyer and these sources need protection. As part of this process, the buyer needs a higher level of awareness of the financial stability of the sources of supply, as well as a sound financial understanding of what make up the supplier’s cost structures. A close liaison is therefore needed between the buyer and the accountant in an organisation, both to inform and to learn from each other in order that both may improve in the quality of their respective decision-making processes.

The broad role of finance is to plan and control the finance in a company by ensuring the company is able to fund the shorter-term working capital – this is the timing difference between converting inventory into Accounts Receivable and then into cash received, but aided by credit from suppliers (explained later in more detail) – and fund longer-term purchases of Non-current Assets to ensure the capacity to meet demand. Additionally, the control of costings and pricing is critical to ensure that the organisation is able to make ongoing profits to aid in its development. There is a critical difference in the public sector, in that there is a fixed, limited amount that can be spent, and the organisation is tasked with ensuring that the public obtain best value from the money spent. Essentially, this means break-even budgeting rather than profit maximization.

Historically, in many organisations, the purchasing function was subsumed under the finance function, but this has changed in the last 20 to 30 years so that there is a separate purchasing function often commanding a board appointment in organisations that have heavy buying-in costs. There should still, however, be a close relationship between the two, as overall control of costs falls into the remit of the finance function, and bought-in costs fall under the remit of the purchasing function. Each should support the other with their respective skills.

In a large organisation, there are traditionally two key accounting roles. The first is that of the financial accountant, usually at director level. The financial accountant will be responsible for the more strategic aspects of an organisation’s finances. This will include:

• reporting to shareholders;

• raising finance through a share issue or from a bank;

• producing year end accounts;

• liaising with the auditors;

• optimising taxation strategy;

• filing of significant company documents;

• ensuring the soundness of all financial systems;

• overall financially controlling the organisation;

• managing the treasury function; and

• ensuring adherence to accounting standards and (where appropriate) stock exchange requirements.

The second role is that of the management accountant. This role will be responsible for the supply of management information, such as:

• the production of monthly management accounts;

• the production and control of budgets;

• short-term cash budgeting;

• the allocation of costs across departments in the organisation;

• the management and control of costs within an organisation;

• the production of costing information for both products and departments; and

• cost/benefit analysis and Capital Investment Appraisals, although the calculations could be undertaken or supervised by the financial accountant (for example, valuing companies for the purpose of purchase or sale).

These lists are by no means exhaustive, and the tasks contained in the roles frequently overlap. In a small company, all of the tasks are undertaken by one accountant. In a larger company, there may also be a separate company secretary, whose responsibility is predominantly administrative and procedural with regard to filing documents, shareholder recording, formal meeting arrangements and recording. (However, the formal position of a company secretary still exists in all companies and, in small companies, it is often another duty taken by a director.) In very large companies, there will be many accountants in each area of operation, so that a Finance Director would oversee the work of both finance and management accountants.

The financial accountant’s role traditionally would be more likely to turn into a board appointment simply by the more strategic nature of the role. However, with the closer alignment and merging of the disciplines, the management accountant’s role may well be strategic in some organisations (for instance, when involved in a Business Process Re-engineering project or in a Benchmarking exercise).

Types of Accounting Qualification

There are various types of accountancy qualification that reflect the roles undertaken. The financial accounting role is traditionally taken by a Chartered Accountant (ACA) or, in the USA, a Certified Public Accountant (CPA). Trained primarily in the profession by undertaking both accounting, audit and taxation work, this qualification is generally regarded (at the risk of offending holders of other accounting qualifications) as the ‘leading’ qualification due to its higher entry requirements, level of failure in examinations, and acknowledged more strategic content of the training (for instance, the high company law content). Approximately 85% of FTSE 100 boards have at least one ACA qualified member. A minority of students now train in ‘approved’ industrial organisations rather than in a professional practice.

The management accounting role is traditionally taken by a Chartered Cost and Management Accountant (CIMA). This qualification has developed over the years and has caught up significantly in stature with the Chartered Accountancy qualification and there have been possibilities of a merger with the Chartered body. The training is in the workplace with an organisation, rather than in a professional office, and so there tends to be limited exposure to different types of organisation compared to that of a Chartered Accountant, although more in depth at the place of work. It is a highly regarded qualification, and the best for a management accountant.

A further qualification, namely Chartered Certified Accountant (ACCA), is a hybrid of the two, and a person can train through an auditing company or in industry. It is a highly rated qualification and is a fast growing global organisation.

Additionally, in the public sector the most sought-after and highly rated qualification is with the Chartered Institute of Public Finance and Accountancy (CIPFA), and there was also consideration of this institute merging with the Chartered Accountants.

The main qualification for a company secretary is a ‘Chartered Secretary’, obtained through the Institute of Chartered Secretaries and Administrators (ICSA), and this is very much a finance role specialising in corporate governance.

All of the Institutes are ‘Chartered’, causing some confusion, but the term ‘Chartered Accountant’ traditionally refers to the Institute of Chartered Accountants where one qualifies as an Associate (ACA) or Fellow (FCA).

Accounting Standards

Accounting standards are set by the national standard setters of the relevant countries. They may or may not subscribe to the International Accounting Standards Board (IASB) recommendations. It is the intention of the IASB to create a single group of globally enforceable standards to which all national bodies subscribe. In the UK, the standards used were called the Statements of Standard Accounting Practice (SSAP – first published in 1971), which have been replaced by Financial Reporting Standards (FRS). Publicly quoted companies normally subscribe to producing accounts using International Accounting Standards (IAS), and each new standard is given a number, such as IAS 1 (which is about how financial statements are presented). The number of these is 41, although some have been removed. Any newly created standards are now called International Financial Reporting Standards (IFRS), of which there are 13 currently in existence; so there are both IASs and IFRSs with which to comply. There are also Generally Accepted Accounting Principles (GAAP), which are whole bodies of accounting methods in use in particular countries and cover much wider areas than IFRSs. For instance, the UK GAAP encompasses the UK Companies Act 2006. There are also Statements of Recommended Practice (SORP) which supplement accounting standards in particular industries.

Currently, all public companies are required to publish accounts using IFRS regulations; for years commencing after 1 January 2015, all accounts in the UK will be published under IFRS regulations, and so all the accounts and accounting terms used in this book will reflect this, although reference is made to the terms currently in use.

The implications of this ‘red tape’ are that, hopefully, it makes accounting statements more accurate, more dependable and easier to compare, nationally and internationally. There is a cost of compliance and in financial accounting to ensure compliance, with implications for financial reporting, directors’ responsibilities, risk management and control processes.

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Table of contents

• Cover Page
• Half Title page
• Title Page
• Copyright Page
• Contents
• List of Figures
• About the Author
• Preface
• PART I Financial Analysis of Suppliers
• PART II Costing, Pricing and Cost Modelling
• PART III Managing Resources
• PART IV Long-term Capital and Revenue Purchasing Decisions and Techniques
• Appendix Further Questions and Answers
• Glossary of Terms
• Reading List
• Index