The full view
From the April 2019 print edition
Chief financial officers look at procurement from 360-degrees and every possible angle. For them,
the process includes everything from mitigating risk to their organization involved in ordering products or services, receiving goods at the back door, to the supply chain and to financial cash flows. Supply chains are so important, from pricing to ensuring financial solid vendors.
Procurement practices are vitally important to the overall health of an organization. But if not properly controlled, the process can lead to huge profit losses and even bankruptcy.
Let me share a story of a good friend who lost sight of these important strategies. I met with Jeff, who worked in the HVAC business, several years ago. He had a thriving business that had been growing at double digits annually for quite a number of years. Some years the growth was 50 percent. This was the point where he really started to destroy the benefits of this growth. More and more focus was put on growth.
At first this worked really well and profits increased at a great rate.
The company started taking on more and more contracts, without following proper controls to manage procurement.
Focused on growth
Management was so focused on growth, quoting, selling and completing projects that there was little time for anything else. They were constantly putting out fires. It was difficult to hire competent employees so quickly. Discount pricing was not optimized. Getting two quotes on large items was a thing of the past. Ensuring financially strong subcontractors was not adequately investigated.
Purchase orders were put in the systems at zero dollars. Department heads were directing bills to be paid on the fly, since they urgently needed products and services. Supplier terms were not negotiated up front. Neither was best discount on product prices. There was no consideration for cash flows. Some large purchase orders were not put in the system until the day it was to be paid.
Finance couldn’t manage the cash flows because there was no disciple in following the rules. One day there was lots of cash in the bank and the next there was a huge deficient. Things were working great when the cash was flowing in—there was no urgency to control operations since profit was up. Things all looked great. Finance kept complaining, however it fell on the owner’s deaf ears as the company was making lots of money. Or so they thought.
This kept happening and all went well, so long as the customer was paying on time. Then one day, Jeff told me, the customer simply stopped paying. In no time at all they were out of terms of the agreement with the bank. The bank was about to call their loan. They were just barely meeting their payroll. Suppliers’ payments were being stretched to the maximum and beyond. The customer kept promising to pay. Meanwhile, the banks were knocking on their door.
And moreover, their major subcontractor went bankrupt. This led to incomplete work and poor workmanship, which then needed to be retrofitted and completed. Management quickly needed to find another subcontractor to complete the work, for a reasonable price. This was not an easy task, since they didn’t follow procurement practices in getting a second quote on the original estimated. Now they had to get quotes on completing the balance of the work. Nobody wanted to quote this, since there were so many unknowns, so the only option was to hire a subcontractor on time and material. This was a huge cost increase.
Get multiple quotes
The lesson to be learned is always have second or third quotes on large work. Always take the time and do credit checks on large and important vendors and properly access their viability. Always have a backup plan.
The company put too much focus on growth and not enough on keeping their eyes on the ball with respect to their procurement practices and, of course, their cash flows. The company started stretching its accounts payable terms to meet payroll. It urgently needed cash to inject into the business in order to survive. Otherwise, the inevitable outcome would be bankruptcy.
The company had lots of explaining to do with the bank. The bank’s credit department was called in to review the viability of the company. Everyone was stressed out; suppliers were calling, employees where let go.
Fortunately for them, the customer finally paid. But this was a huge wake up call for the company. The organization’s management pulled back the reins and started enforcing procurement practices and cash management on a weekly basis. Without cash, you can have a very profitable company. But you can also go bankrupt.
The lesson to be learned is this: if an organization does not put focus on strongly controlled procurement practices, even a thriving business can go into bankruptcy, practically overnight.