By: Ddivya Kumar -- Senior Research Analyst, GBS- Procurement and Finance
03 November, 2019
Despite having a strong procurement and finance team, many companies often spend hours arguing what constitutes savings and how it should be reported. The first and foremost step towards efficiently calculating and tracking procurement savings starts with having a standardized, transparent and clean budgeting method. An increasing number of organizations have considered rebuilding their budgets on a periodic basis by following Zero based budgeting method to ensure accuracy of budgets and savings and to gain high visibility of spend.
Procurement savings calculation methods may vary from company to company depending on the nature of the industry, however, the Best Practices that companies should follow to manage and track the savings effectively is the same.
There has been high level of adoption recently among both public and private sectors for Zero based budgeting. The contemporary fiscal constraints by 2008 recession have caused the increase in adoption among public sector. Privately-held companies in the CPG and FMCG industries are high adopters of Zero Based Budgeting. Zero based budgeting is best suited for dynamic organizations that focus on changing their procurement process and practices to improve efficiency.
|Baseline Budgeting||Zero Based Budgeting|
Baseline budgeting involves a method of preparing a budget which considers previous year's budget as a base
In ZBB, a budget is calculated/ allocated by reviewing the activity/expenditure at the beginning of each budget cycle and must justify each projected expenditure to receive funding
Previous year’s budget for direct and indirect categories
Considers factors such as market price, necessity of expenditure etc. for direct and indirect categories
|Accuracy of budget projection||
Medium: In most cases, this method does not account for the market price factor. Therefore there might be some instances where the market price is low compared to previous year’s purchase price and the budget is not projected appropriately
High: Considers market price and negotiated price factors which helps in determining the budget accurately
|Priority of budget allocation||
Low to medium level of priority to activities. Last year's budget is adjusted considering inflation factor
High Priority: Budget is allocated based on revenue generating and critical activities
|Budgeting process of companies (example)||
All Low: Medium procurement maturity companies
Best in class companies
While a majority of the respondents still seem to follow the historical budgeting model, there is a shift in the industry toward adopting a zero based budgeting model. This is expected to increase in the near future considering the flexibility and utility of the model.
Source: Beroe LiVE research Methodology (Sample size: 30+ organizations from Pharma, CPG, FMCG, Manufacturing industries)
The projected and actual expenditure should be tracked using a budget template which is developed collaboratively.
Zero Based Budgeting activity performed on a quarterly basis
Project Category wise Expenditure
Category managers project all category related expenditure which includes:
Review projected expenditure
Validate projected expenditure data
Approval of budget
Review of actual expenses
Cost saving is calculated using the following methods for direct and indirect categories. Based on Beroe’s analysis of the industries, we have observed that most companies use the ZBB model for indirect categories. However, in Beroe’s understanding it would be ideal to run it across both direct and indirect categories.
1. Accounting Savings: reconciling savings figures from Procurement and Finance
2. Savings Reporting:
Historical-based budgeting is still greatly utilized by B2B sector while Zero based budgeting (ZBB) is gaining increased utilization across consumer-driven enterprises as it is considered the most appropriate form of budgeting method, which closes all loopholes and ensures transparency and credibility in the savings reporting process.
The savings tracked from Zero Based Budgeting is the actual savings realized from efficient budgeting and negotiation. Disagreement as to who takes credit for category and non- category related savings achieved can be eliminated by following this method as there is clear documentation of how savings is achieved. Category Savings realized is accounted for by the procurement team which is then added to the bottom-line (into the COGS/ SG&A section in the P&L account) by finance team.
The savings achieved can also be used as a metric to measure the efficiency level of the buyer/ the procurement team as a whole to show savings. Companies that are dynamic and ready to revamp their budgeting and savings tracking methods to improve efficiency can adopt this method.
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