Spend Analysis – Part 2

In our previous article, we introduced a high-level spend analysis process, and the considerations for defining the program. We will now examine the process steps of data extraction and data validation.

 

Types of Spend

Spend is defined as the payments made to external parties for the supply of goods and services. With this understanding, let’s consider a process where spend is incurred and recorded within an organisation’s process. We shall call this the Source-to-Pay (S2P) process:
s2p

The process starts with the Procurement function and ends with actual payment made to suppliers. At different stages of the process, documents and records are created to indicate the successful completion of each step and to hand-off the process ownership to a following party. The spend value than can be derived from these records are:

 

Contracted spend – At the conclusion of negotiations with suppliers, contract documents are established and executed between both parties (organisation and supplier). The expected spend value (total to cover the contract duration) is known, and may be stated in the contract documents. At this juncture, no payments are made to suppliers yet. And not all agreements for the supply of goods are made with formal contract documents. Ad-hoc and one-off supplies are examples where contracts are not established prior to engaging the suppliers. Hence, the contracted spend value may not reflect the actual and total spend for the organisation.

PO spend – Purchase orders (PO) are good forms control of the cash cycle for an organisation. Even if term contracts were created, PO documents may still be used to “call-off” the delivery of goods at the required time. And for commodities which were not contracted but required on an ad-hoc or one-off basis, PO records ensure a good level of traceability and accountability of the purchasing process. All PO records contain a purchasing value, and this can be aggregated as spend for the organisation, even though no payments have been made to suppliers yet. And not all purchases can be covered by PO’s, such as property utilities and telecommunication services.

Invoiced spend – Goods delivered by suppliers are usually accompanied by invoice records that state the type of supplies delivered, their quantity, and value. The organisation’s obligation to pay suppliers starts from this stage, when the supplier invoices were accepted. Invoiced values can be regarded as spend, as the organisation will eventually pay the invoices.

Accounted/Posted spend – Within an organisation’s accounting process, details of supplier invoices are entered into sets of accounts according to the principles of book-keeping. Once entered into the organisation’s accounts, supplier invoices are recognised as liabilities and payments are scheduled based on the agreed payment terms. It should be noted that all supplier invoices are accounted, whether they are related to expenses or assets (which will be depreciated under other accounting rules).

Cash-out – At the final stage when actual payments are made to suppliers, the accounts are adjusted to reflect a lower liability position for the organisation. This is the “real” spend for the organisation. Although this type of spend is easily understood, it is nevertheless a view which is unnerving at the same time, due to suppliers being paid at different times (according to the agreed payment terms). So when a cash-out position is incurred and reported, it may be months after the expense is accounted and reported in financial statements. It is this delay in reflecting the cash-out position that creates doubt among business users that the spend data does not correspond with their view or understanding of the business performance. This is the predicament of cash-out, even though it is the closest to the definition of spend.

 

Adding the different types of spend to the S2P Process shown earlier, we have the following situation:
s2p2

 

Sources of Spend Data

The source of spend data varies according to the spend type used.

  • Contract database for Contracted spend is relatively easy to use, if contract storage solution was implemented and the records maintained in good order.
  • Purchase order systems for PO spend is easy to use, provided the PO system was implemented for a wide variety of commodities and implemented with few exceptions. Other forms of purchasing, such as suppliers’ ordering platforms, will need to be included in the scope if they were used as supplementary purchasing channels.
  • Invoice systems for Invoiced spend is easy to use, especially for larger organisations who implemented shared or centralised back-office functions (in-house or outsourced) to receive and process supplier invoices.
  • Financial accounting systems for Accounted spend and Cash-out. Accounting systems can be considered as the most reliable and comprehensive source of spend data as every organisation has an interest in maintaining its book-keeping function in good order. Data extraction and validation from accounting systems is complex and requires a fair amount of efforts to set up and execute.

 

Once the data source was identified, a method for extracting the data on a regular basis needs to be defined, set up and tested. Typically, a reporting function or a custom script is developed for the source system to create custom data files that can be transmitted and accessed by within the spend analysis environment. The data extraction routine need to be validated and checked for completeness, accuracy and compliance with the data standard defined for spend data. For organisations with multiple source systems, these steps of creating and validating the custom scripts need to be repeated for every source system.

 

Considerations for Spend Data Extraction

As in the Definition step (refer to the Spend Analysis Process in our previous article), key decisions need to be taken at the Data Extraction step of the process. In taking these decisions, the following should be kept in mind:

 

  • Be comprehensive and extract all spend with external parties, regardless of whether the spend can be meaningfully sourced and managed by Procurement or otherwise. Examples are interest payments made to financial institutions, duties and taxes and related party payments. If such spend was considered to be outside the scope of the Procurement function, the affected data can be marked and categorised as such. Restricting the data extraction for spend analysis will understate the overall spend, and create mismatches between overall spend and expenses reported in the financial statements.
  • Payments for all expenses, operational and capital expenses, should be included. This is in contrast with the practice of depreciating capital expenses to maintain the matching principle of financial accounting. For Procurement to carry out strategic sourcing activities, all forms of supplies are in scope, regardless if they are of capital or expenses in nature.
  • When more than one source system was involved, maintain a strict compliance to the defined spend data structure. This may require a documented ‘data dictionary’ that describes in detail all data points and their formats. Each source system will then have to map its data points to the defined data structure and submit their data files for validation.
  • Where available, extract data in the coded format and its associated text description instead of extracting text data only. For example, department and material data in accounting systems are typically assigned unique codes according to the organisation’s setup and needs. Such coded data is easier to operate and process in subsequent steps than data that contains text only. The downside is a little more effort in synchronising master data between the source (accounting system) and destination (spend analysis) systems during the reporting stage.

 

And thus far, we covered half of the spend analysis process. In the next article, we will look into the core of the spend analysis program, the categorisation of spend data.

 

Chee Kin has extensive experience in developing and implementing business strategies to transform business practices. In his career, he held responsibilities in the structuring and operation of strategic procurement in a logistics company both on the global and regional levels.

ThunderQuote is the most comprehensive business services portal in Singapore, Australia and ASEAN , where hundreds of thousands of dollars of procurement contracts are sourced every month by major companies like Singapore Press Holdings, National Trade Union Congress and more.

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