What Factors Contribute To the Cost of Processing a PO?
Many factors contribute to PO processing costs. There are fixed costs (e.g. overhead, salaries, benefits, and infrastructure) and variable costs (e.g. postage, hourly staff wages, office supplies, etc.) that are incurred with each PO creation, approval, and fulfillment.
Variable costs are especially important to identify and, if possible, limit. These costs change from one purchase order to the next and can dramatically alter your calculations.
The easiest way to understand both fixed and variable costs is to break down the purchase order process and identify costs for each stage:
Internal Purchase Order Processing
This involves identifying needs, choosing what to purchase, selecting vendors, and creating purchase requisitions. This also involves the requisition approval process and creating the PO and sending it to the supplier.
External Purchase Order Processing
This covers interactions with suppliers after the PO is submitted. External PO processing can include revisions, clarifications, adjusted quantities; or discussions about shipping times, product availability, and potential replacements for items ordered.
After the order is placed, there may be costs associated with confirming shipping dates, order modifications, or other communication related to the status of the order.
Once you receive the order, it needs to be checked to ensure that quality standards are met and the correct quantity was delivered. If there’s a problem, there may be additional costs related to returns, additional shipping, and correcting errors.
Your accounts payable team will check the supplier invoice against the purchase order and the goods received notes (or other receipting information) for any discrepancies as part of the 3-way matching process. This can be automated using AP automation software within a procure-to-pay solution.
If the invoice and PO don’t match, you will incur more costs as staff will spend time on corrections, exceptions, and approvals.
After breaking the process into clear steps and tallying your fixed and variable costs, you should also factor in the time it takes to complete each step.
To figure out the time costs related to PO processing, ask yourself:
How much are you paying staff involved per hour for the tasks they carry out in each step?
How many POs are you processing and how long do they take to work through these steps?
How many exceptions are you dealing with and how long does each one take to resolve?
Manual processes in your supply chain can be incredibly time-consuming and are a great place to look at when considering how much automation can save you.
Also, the more you can reduce the involvement of senior management in the processes the better.
The cost per hour for their involvement will be higher than junior members of staff.
Calculating Your Average PO Processing Cost
Once you identify the fixed and variable costs for each step of the PO process and your time-related costs, you can calculate your average PO processing cost.
The cost associated with each stage is the average time spent on each process within it, multiplied by the minute-rate cost.
Resource Cost = (Average time spent on a task) * (minute-rate cost per resource)
Note: The minute-rate cost is the hourly cost divided by 60.
Calculating the staff costs for a buyer to create a purchase requisition starts with the annual compensation (including benefits) for that buyer divided by the total hours worked in a year.
For our example, the buyer’s salary + benefits cost $92,000 per year and 1,820 is the number of work hours for a full-time employee in one year.
$92,000 ÷ 1,820 = $51
We then take that hourly rate and divide it by 60 to get the minute rate:
$51 ÷ 60 = $0.85
Now you know you’re paying the buyer $0.85 a minute to create a requisition. If the average requisition takes 10 minutes to create, then you’re paying an average of $8.50 for each one to complete this step.
You can repeat this calculation for each staff member or other resource and total them up for each stage.
You can find your average PO processing cost by dividing the total cost for all stages by the total number of POs you processed in the period being measured.
Once you understand your costs, you can start to find tremendous opportunities for savings. You can also identify which areas are costing you more than others and focus on creating efficiency there.
Cutting 20% off of your PO processing costs has a strong impact when multiplied by 1,000s of purchase orders per year.