For our clients that don’t use them, a common question is what is the difference between a Purchase Requisition and the more familiar Purchase Order? The easy answer is that a purchase requisition is an internal request to make a purchase and that a purchase order is the external contractual obligation between a vendor and a company as the purchaser. How and where a company draws the line between purchase requisition and purchase order is therefore all about process and a little about semantics. In this article we will walk through some common examples of Purchase Requisitions and how they can add benefit to the purchasing process.
The primary purpose of a purchase requisition, abbreviated PRor Purch Req, is to gather demand for goods and services that employees or departments need. That demand is then documented formally, sent through an approval process and finally arrives at the authorized purchaser’s desk. The purchaser than uses the document to craft a purchase order that is sent externally to the vendor that will supply the goods and services.
The crafting of the purchase requisition answers a series of questions depending on the industry and manner, in which they are utilized.
For example:
o What is being purchased? When is demand needed? Where is demand needed?
§ Office supplies, materials, labor, equipment, repairs, maintenance etc.
o What is the cost of the demand?
§ Quoted by vendor, bidding process, contractual source etc.
o Who will fulfill the demand?
§ Contractual vendor, bidding process, quoting process, approved vendor list, single sourceetc.
o What is the demand for? Why? Who is the demand for? Or How important is the demand?
§ Critical,Nice to have, ROI or Business Case etc.
§ R&D,Ops, HR, Employee Benefits etc.
Technically any purchasing approval process is a Purchase Requisition (PR) approval process. A PR approval process happens internally and generally requires minimum approval by the employee making the request and the departmental manager or lowest management employee with budget responsibility. As amounts increase, the management level required also increases in a tiered approach.
Approval Example
o P1– First Level Authority - Requester and Manager up to $1000
o P2– Second Level Authority – Approval by P1 + Director up to $5000
o P3– Third level Authority – Approval by P1 & P2 + CFO up to $25,000
o P4– Fourth level Authority – Approval by P1, P2, & P3 + CEO up to $100,000
o P5– Final Authority – Approval by Board required – Excess of $100,000
The exact levels may vary by company or even department, but the core concept remains the same. Minimize the risk of fraudulent behavior by staff, vendors and 3rd parties taking advantage of the process, but don’t over engineer the approval process into stagnation. Being agile enough to meet needed demand without opening ourselves to fraud is a delicate balancing act, and one without a one-size fits all solution.
We safeguard internally by formally documenting the approval process and the demand via purchase requisitions. This ensures employees are not ordering demand solely for their own use.
We formalize ordering to the vendor with the legal binding Purchase Order document. This gives clear indication of what is requested and what is to be delivered. Receiving purchase orders back signed by the vendor orvia a confirmation portal is also key. Finally, having strong terms and conditions and scope of work documents as part of the External PO Approval process is also important, if you should ever need to go to court.
Lastly, implementing a three-way matching solution in yourAP Process helps protect from Invoicing Fraud. The matching of PO to AP Invoice to PO goods receipt helps ensure what was ordered, matches what was received,which matches what was invoiced, and subsequently paid for.
Ensuring that each department is not ordering for only itself but that the requested demand is also vetted by finance or by a central purchasing team can further help reduce fraud.
Reducing fraud is one reason to centralize purchasing, the other is being able to leverage demand into cost breaks and discounts. Each department ordering pencils could cost more than if the entire need for pencils was consolidated and purchased together.
Even if the demand is small enough at any given point in time, having the data available for historical demand and use in negotiation could result in cost benefits. If over the course of the year we are buying 200 pencils from a supplier in lots of 10 we may only be paying $1.99 a lot +shipping. If we order 20 lots a year that is 20 shipping fees. It could be smarter to buy 20 lots at the beginning of the year and dole them out from central purchasing rather than paying individual shipping charges. These smallgains add up but are not necessarily visible from a departmental or site level.
Supporting arguments for centralized purchasing include staff becoming specialists, i.e. familiar with vendors, their competitors and history,thus they are better negotiators. Consolidated data means procurement managers have better insight into the corporate financial picture, ordering trends, and vendor quality and risk assessment.
Detractors from centralized purchasing comprise remote control of budget and decision autonomy beyond the department and a lack of special attention or care when supply chain irregularities occur or during emergencies.
Using auto-generated purchase reqs is one of the most common ways to implement MRP or material resource planning. MRP is a process by which inventory is controlled, ordered and moved into strategic position based on demand.
This demand can come from several types of sources:
o Projector Sales Order demand
§ What do we need to fulfill orders we have today?
o Historical Sales or Use demand
§ What did we need to fulfill orders we had before?
o Projected Failure rate demand
§ How often does a component Y break on item X?
The simplest source of demand is which is backordered or a sales order item for which there is no current inventory on hand. This can be result of a stock outage situation orbe due to a policy of not carrying an item intentionally known as order ondemand. In either scenario the system is typically set to order this item automatically, often without an approval process, since there is revenue waiting to offset the cost. Supply on demand items that are ordered by a customer then ordered from a vendor and subsequently canceled or returned by the customer,are the number one cause of companies being stuck with stock on hand that they cannot later sell. In these situations, it is good to have a policy for charging customers a minimum charge for cancelling orders. Likewise, being able to cancel or return these items to the vendor will also help reduce excess stock.
The next source of demand is forecasted based on historical demand. Demand use is calculated for six, twelve or even eighteen months rolling average. The usage data that we could to use in this calculation is subject to selection. For example, we would not want to add the offloading of excess or obsolete inventory in our demand. Any special events or one-off situations, like a part recall, should be excluded from our data pool. Having special identifiers for these scenarios will make it easier to eliminate them. Next, for each inventory item, we should select a forecasting method.
Here are a few of the most common and a method to calculate them:
o Min/Max
§ Calculate the Minimum and Maximum stock we need on hand
· Minimum = Average Demand/Week * Average Lead Time in Weeks
· Maximum = Highest Usage over a week * Worst Lead Time in Weeks
o Safety Stock
§ Calculate the stock needed in a worst-case outage
· Safety Stock = Average Demand * Worst Lead Time
o Carrying Cost
§ Calculate how much it costs to stock an item
· Storage space cost per unit + handling costs + obsoletion/deterioration costs
o Inventory Carrying Ratio
§ Calculate the Ratio of unit cost vs carrying cost
· ICR = unit cost / carrying cost
o Economic Order Quantity
§ Ideal Purchase qty, minimum cost versus highest stock
· EOQ = Square root (Inventory Carrying Ratio * Yearly Demand Units)
o Re-OrderPoint
§ Calculate when to Order
· ROP = Average Demand * Average Lead Time
o Re-OrderQty
§ Calculate how much to order to return to a stable state whichever is greater of the below
· ROQ = (Stock on Hand + Safety Stock – WIP Demand)+ Average Demand * Average Lead Time
· ROQ = (Stock on Hand + Safety Stock – WIP Demand) + EOQ * Average Lead Time
As you can see from the image above, these methods are far from foolproof but can go a long way to improving fill rates and inventory turns. For deeper reading I recommend this article which covers a lot of the pros and cons on different methods of calculating demand and getting even more statistically accurate results.
For now, we have enough insight to talk about how to set up a system like Acumatica to automate PR and/or PO generation.With these values calculated we can start to populate our ERP system withparameters. When these parameters are triggered, we can have a PR or batch of PRs generated to go thru the approval process. Procurement management can approve some or all and reject others. Then based on rules we set up in the system wecan send these through a quote or bidding process or straight on to purchaseorders. In the case where these PRs are not missing any data needed to become fully fledged Purchase Orders, we can automate the creation and transmission process, freeing the purchasing team to handle the delta POs that require more manual effort.
I hope you found this article informative and useful. Please contact us here at CS3 Technology if you would like to know more on the subject or if we can be useful getting your own purchasing process improved.
