How To Set Up A Purchase Order Approval Process
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Mapping out a purchase order approval process is often overlooked. But to improve profit margins, efficiency, and remain competitive, this is a must. A purchase order approval process can help your business identify key areas that may require automation.
However, mapping is not an easy thing to do, mostly because a purchase order process is unique to each company. This is why we’ve prepared this guide to help you identify the key areas where you can improve company and employee performance.
But first, let’s see what a purchase order is.
What is a purchase order?
A purchase order (PO) follows an internal purchase requisition (PR) and is the first official offer issued by an organization to a supplier and indicates the types, quantities, and agreed prices for products or services.
Organizations use purchase orders for several reasons:
they allow buyers to clearly and explicitly communicate their intentions to sellers;
they help purchasing agents manage incoming and pending orders more easily;
they protect sellers in case of a buyer's refusal to pay for goods or services.
Purchase orders help streamline the purchasing process. Usually, they are the first step of the purchase to pay process in a procurement system.
Why you should set up a purchase order approval process
Let’s go through a few of the benefits of setting up an approval process:
Improved control over costs
This one’s the most obvious benefit. Since every purchase your organization makes must go through the purchase manager first, you have full control over what purchases should be made and which shouldn’t.
For example, you can avoid wasting money ordering the wrong supplies or having someone order supplies you already have in your inventory.
Skipping a purchase order approval process might seem faster, but you also expose yourself to the risk of missing obligations.
By having a process in place, not only do you know what’s been approved for purchase (and what invoices should you pay!), but you also know what’s in the process of being approved.
Over time, you will also be able to forecast trends based on the purchase history and linking your purchases with contracts.
How to set up a purchase approval process
Before you set up your purchase order approval process, you need to get a better understanding of different variables. Understanding your spend would help you design an optimum process.
Here’s what you should cross off your list:
Not all purchase categories follow the same process. By looking at your past purchases, you can get a better idea of what your company is purchasing and what is currently going through a purchase order approval process.
Average spend amount
A common pitfall is to set up approval workflows according to “best practices”. But as we’ve mentioned before, each business is unique. So each purchase order approval process should be unique as well.
For example, based on said best practices, you might decide that for purchases larger than $10.000, you need the CPO’s approval. But what if your average spend amount is higher than that?
This means most of your purchases will need your CPO’s approval, which will slow down the process considerably and make it inefficient.
How much decision power are you willing to give your lower and middle management?
To speed up the purchasing process, some organizations give their middle management more decision power.
However, if senior management likes to have more control over purchases, then that needs to be included in the way you design your approval process.
There is no right or wrong answer here, your process should reflect your company’s needs.
Do you want your process to be efficient or bureaucratic?
Everyone hates bureaucracy but, at the same time, having multiple steps in place diminishes risks.
The most efficient processes are those who are not very complex, but you have to decide what’s more important to you.
Taking this into consideration, here are two possible approaches:
Amount based purchase order approval process
A common approach is to design a process based on the total amount of the purchase order.
This is a good strategy because it takes care of approval before purchase orders are sent to the supplier.
How to do it?
First, look at your spend in the last 6 to 12 months. Ideally, you’ll want 20% of your purchases (or less!) to require the senior management’s approval. Based on this, you should decide on your threshold.
Categories based purchase order approval process
Another strategy is to design a process based on the category of the purchase.
Usually, organizations set up one workflow for all categories. However, different categories have different needs, so you should set up your approval process accordingly.
For example, if you purchase office supplies, unless your organization has an office manager that can verify whether the items are available in your inventory or not, you shouldn’t require anyone’s approval.
But when you make non-standard purchases, then it’s a good idea to route the requisitions based on the category of the purchase.
For example, if you want to purchase new equipment, someone should be in charge of deciding the exact requirements that meet the standards of your organization.
Common pitfalls when designing purchase order approval processes
No purchase order approval process is perfect. This is something you should continuously optimize. However, there are some common pitfalls that you can avoid:
Making your process too complicated
As we’ve mentioned before, the most efficient purchase order approval processes are not very complicated. We recommend starting with something very simple and then adding steps along the way.
Here are two things that can get you started:
A minimal workflow: all your purchases should be approved by only one person (and you should make it clear who that person is);
Clear guidelines: for example, for purchases above your threshold, you need the senior management’s approval.
Too many management approvals
One thing that could happen is you will end up having to ask for management’s approval for almost every single process. Needless to say, this will slow you down a lot.
So ask yourself why you would need management’s approval. Is it to control spending, or to keep them in the loop?
If you want to set up management approvals, set up a higher threshold.
Forgetting about your process
Setting up a process is one thing, but actually implementing it is another. Best in class companies have 85% of spend going through a purchase order process.
You have to analyze the efficiency of your purchase process regularly. We recommend a quarterly review of the process to measure the effectiveness and then adjust accordingly. An objective way to measure the effectiveness of purchasing workflow is to calculate and report on the end-to-end cycle time for a purchase order.
When it comes to designing an effective purchase order approval process, there is no secret recipe that works for everyone. You’ll need to implement and re-iterate until you find out what works for you. But hopefully, by following the steps above, you’ll find your feet easier.