Purchase Process

Purchase is a critical function in any organization. Purchase involves a large volume of cash outflow. Major risks involved with the purchase function are high cost of purchase, low quality/standards of goods purchased, unauthorized purchases, fraudulant payments to vendors, purchase from unapproved vendors etc.
In this article we will try to understand the basic activities in purchase function. Clarity of process is of great help is internal audit. Following is the process of purchase in brief:

1. Purchase planning: Planning process begins with estimation of sales and corresponding production figures. Based on the production plan, material requirement is drawn out. This plan is reviewed on a periodic basis, based on changes in sales and production plan. The purchase plan is approved by top management along with sales and production plan. Also at this stage market research is conducted for availability of alternative material, import substitute etc.

2. Procurement: Procurement involves the following activities:
-Identification of suppliers suitable to company’s requirement. Many companies use sources such as IMC, CII etc. for selecting suppliers, as genuineness of suppliers can be ensured from such sources. This is continues process to identify vendors for new items and also to find better rates, terms etc.
for the existing products purchased.
-Quotations are invited from suppliers and comparative quotation statement is prepared. Some companies follow a practice of obtaining quotations and preparing analysis statement for every single purchase although from same buyer. This suggests strict internal control. Written denial is obtained from vendors not willing to quote on request. In some companies a MOU is entered into with vendor for purchase of material at rates quoted on London Commodity Exchange. This helps in hedging the fluctuations in prices of materials. Similar practice can be implemented in other countries for purchase of material traded on regional commodity exchanges. In some companies the fuel procured for use in production is changed to low-carbon emission fuel to earn carbon credits. These carbon credits can be sold to developed countries that are required to maintain a mandatory level of carbon credits. This practice helps generate revenue, meet pollution control needs and increase goodwill of the company. At the time of comparing quotations, effects in price, pre & post applicability of tax needs to be considered. As no credit can be availed from sales tax, companies prefer to buy material locally where VAT is payable.
-At some companies a penalty clause is included in PO for non-performance or delayed delivery. This ensured proper recovery of damages from vendor for loss of production hours due to delayed or no supply. In some companies a Committee is formed (consisting officials from Accounts, Finance, Purchase & Production department) for approval of comparative statements. This helps in evaluation of comparative statements from finance and production point of view and also it reduces the chances of biased decisions on purchase.

3. Vendor development: Based on the previous purchases experience, a master list of vendors; suitable to companies requirement is prepared for future procurement. This list is updated on a periodic basis for inclusion of new products, for obtaining better rates or terms etc. At some companies vendor development is directly liked to KRA of purchase department officials.

4. Vendor evaluation: Evaluation of vendors is a requirement under ISO. A standard format is used for evaluation of vendors. Criteria like timely delivery, quality of product, credit terms etc. are rated to evaluate effectiveness against standards. At some companies audit of vendors was conducted by company for their evaluation. Also monthly meeting was conducted with vendors to discuss their ratings and areas were improvements are needed. Analysis of Dispatch Advice failure report and identification of reasons thereof is a part of vendor evaluation.

6. Bill Passing: Delegation matrix for bill passing is defined for approval of purchase bills. Credit limits are monitored to ensure non-stop supply. Trends in purchases need to be monitored to find out if there is any irregularity in purchases during particular months. Duplicate bills issued needs to be certified as issued in lieu of original.