BUSINESS NEEDS IN PROCUREMENT AND SUPPLY CIPS DIPLOMA LEVEL JANUARY EXAMINATION 2018

Transcription

1 BUSINESS NEEDS IN PROCUREMENT AND SUPPLY CIPS DIPLOMA LEVEL JANUARY EXAMINATION

2 Session 2 Estimating Costs and Prices & Operating Financial Budgets 2

3 Chapter Explain how costs and prices can be estimated for procurement activities a) Types of market data that can provide information on costs and prices b) Direct and indirect costs c) Producing estimated costs and budgets d) Approached to total costs of ownership/ total lifecycle costing 3

4 Homework a) Explain the difference between the terms cost and price (5) b) Describe FIVE sources of data that a buyer might consult to obtain information about the market prices of inputs (20) 4

5 Introduction Knowing what the costs are is important in the development of a business case Information about costs can be useful by:- Establishing the cost/ benefit analysis Knowing how the suppliers price to enable negotiation, evaluation & comparison Have a marker for cost reduction Making cost budgets and cash-flow management plans (more detailed in Chap 3) 5

6 1. Market data on costs and prices (1.2a) Q - Is there a difference between cost and price? Price What a seller charges for anything offered to the buyer Cost What the buyer pays for goods and services (not just purchase price!) Q So if you were negotiating with a supplier why would it be beneficial to know both? Getting prices from suppliers (easy, or is it??) Standard price lists/ catalogues Request for Quote (RFQ) Through negotiation Competition (auction/ ebay etc) By market forces (commodities) Economic indices (e.g. annual OCA rate increases) 6

7 1. Market data on costs and prices (1.2a) Price and Cost Research Can be expensive how come? Kraljic can be used to prioritise and focus on the important stuff! Two types of data; Primary and Secondary Primary data Data direct from source, usually spoken word Usually obtained from surveys, interviews, questionnaires and observations Specifically to costs and prices, primary data can be obtained from:- Communication with suppliers Buyers database of market data Marketing communications of suppliers Online market exchanges Advisory and information services Trade fairs and networking 7

8 1. Market data on costs and prices (1.2a) Price and Cost Research Secondary Data Information obtained for other purposes (desk research) Much cheaper than primary but potentially not as focused or up to date Specifically to costs and prices, secondary data can be obtained from:- Financial and trade or industry press Published economic indices Published and online market analysis Published statistical surveys Price listing and price comparison websites 8

9 2 Understanding supplier pricing (1.2a) Factors in suppliers pricing decisions External factors Prices charged by competitors Extent of competition (market structure) The nature of competition in the market Market conditions Customer perceptions of value Price elasticity of demand What a particular (desirable, powerful) customer is prepared to pay Environmental factors affecting the cost of raw materials Environmental factors affecting demand and affordability Internal factors Costs of production and sales How badly the supplier needs the business Risk management How attractive a particular customer is Financial position and product portfolio Where the product is in its lifecycle Shareholders expectations and managerial objectives in regard to profit margins The strategic objectives of the organisation 9

10 2 Understanding supplier pricing (1.2a) Supplier pricing strategies Usually based on:- Costs (push approach) Market factors (pull approach) Cost based pricing Covers costs and then adds figure for profit Examples can be:- Full cost pricing (full cost + mark up) Cost plus/ mark up pricing (direct costs+mark up to cover overheads with profit) Marginal pricing (price fixed to give a selected profit margin (reverse of full cost) Rate of return/ target return (profit based on ROI rather than whole cost) Contribution pricing (based on bare bones price of product) 10

11 2 Understanding supplier pricing (1.2a) Supplier pricing strategies Market Based Pricing Examples can be:- Price volume (e.g. volume discounts) Market share pricing (reduced price to gain market share) Market skimming (high introductory price then lowers over time) Current revenue pricing (only covers costs) Promotional pricing (discounts for a limited period only) Market segment pricing (different pricing for different markets) Competition pricing (supplier bids to win contracts) Factors in buyers decisions on price Position of the buyer in the market numbers of buyers v number of suppliers Potential volume the buyer has to offer Type of purchase (Kraljic) Prices paid by competitors Total package offered (not just purchasing price) Affordability of the buyer 11

12 2 Understanding supplier pricing (1.2a) Price and Cost Analysis What makes the right price? Can only tell from:- Price analysis Cost analysis Price analysis The one that wins out after comparison with other suppliers Can only compare with previous prices Understanding of the going rate Cost analysis Supplier needs to justify the price they are offering Suppliers can be asked to include cost breakdowns to enable:- Differences between suppliers cost breakdown and buyers own analysis Buyers will know if the price is justified or not Buyer can calculate a target price or price range for use in negotiation 12

13 2 Understanding supplier pricing (1.2a) If a healthy, long term relationship exists then there may be:- Open book costing (books are shown to customer only to comfort) Cost transparency (both books are shown to buyer and supplier to reduce waste) Q What can be the risks and benefits of either of the above Can be beneficial by:- Keeping the prices realistic Keeps focus on what costs should be and acts as incentive for reduction Shows the minimum price the supplier can charge to enable supply Can show how big the slice of cake is the buyer is giving the supplier 13

14 3 Understanding costs Components of the cost base In the context of a manufacturing operation there are three types or components of costs:- Raw materials inputs to the manufacturing process Labour wages and salaries Overheads costs that cannot be directly associated with the output Direct and indirect costs (1.2b) Direct costs costs that can be easily linked to the output Indirect costs costs that cannot be easily linked to the output (as above) 14

15 3 Understanding costs Direct and indirect costs (1.2b) 15

16 4 Lifecycle costing (1.2d) Total cost of ownership can include:- Transaction costs Finance costs Acquisition costs Operating costs Cost of storage Cost of quality End of life costs 16

17 4 Lifecycle costing (1.2d) The price-cost iceberg 17

18 4 Lifecycle costing (1.2d) Usually a low price results in higher total package e.g Ryanair! Best value is better defined as the lowest who life cost Whole life costing Capital asset has many costs over the years such as buildings and machinery Economic assessment taking cashflow into account to assess performance Can be used for low value purchases as well as high 18

19 4 Lifecycle costing (1.2d) Discounted cash-flow The longer period of time results in harder accurate financial estimates Discounted cash-flow estimating future costs at present value (NPV) Process:- Buyer estimates future costs by:- Analysing cost structure Cost estimating Quantifies the benefit and matches it to each year DCF calculations used to state future costs at present value 19

20 4 Lifecycle costing (1.2d) Payback or recovery period The time it takes to pay back the original sum E.g.An asset worth 1 Million that generates revenues of 100K p.a Payback period is 10 years Accounting rate of return (ARR) Rate of return on an investment expressed as a % over costs If above asset returns the revenues for 15 years Total revenue Million ARR = 1.5M / 1.0 Million = 33,333 p.a = 3.33% ROI 20

21 4 Lifecycle costing (1.2d) Benefits and limitations of WLC Objective - To try and capture all costs over the long term Benefits:- Fair comparison of competing options Realistic budgeting over the asset life Highlighting risk with the purchase Promoting cross functional communication on costs Supporting VFM Limitations:- Not an exact science Not all costs are easy to identify and forecast Many factors could affect future costs A WLC exercise can be expensive and time consuming 21

22 5 Cost estimates and budgets (1.2d) Estimating costs Budgetary control the process of comparing estimates to actual Need to know which costs are variable and fixed Sales volumes need to be known to estimate variable costs Dealing with mixed costs Costs that include both variable and fixed High low method used to split the costs up High low cost calculation based on activity 22

23 5 Cost estimates and budgets (1.2c) Statistical techniques for cost estimation Estimates of costs can be obtained from:- Historical data Current data and information Market research and environmental monitoring 23

24 5 Cost estimates and budgets (1.2c) Who should be involved in cost estimation? Procurement staff Finance and accounting staff Marketing staff Procurement budgets Business case goals normally captured in budgets 1 st Step Project sales demand and estimated usage of materials and others 2 nd Step Estimate/ predict costs (variable costs, fixed costs, overheads, capex) Historical costs can be used to help cost estimates but need to take into consideration; Under/ over supply Changes in market and exchange rates Pricing trends and inflation 24

25 5 Cost estimates and budgets (1.2c) Procurement budgets A procurement budget can then be created by:- A list of anticipated costs or expenses for items Column for the budgeted amounts of costs for each item Column for the actual amounts for each item Cash budgets Projects future cash position of the company Important for smaller companies Company can be profitable but still not survive due to cash Timings of the cashflows need to be estimated Same as for cost budgets dates need to be compared with actuals and Should include:- Cash balance at start of period Receipts Payments Expected balance at end 25

26 Chapter Explain the operation of financial budgets for the control of purchases Assessment Criteria a) The purpose of financial budgets b) Cost entries and timings of cash-flows c) Performance and control of budgets d) Dealing with variances to budget 26

27 Introduction Is the benefits and cost that was estimated prior to the business case being achieved? Investigation may be required to explain the variances and what can be done do correct the situation 1 The purposes of financial budgets (1.4a) Budgets and budgetary control Can be asked in an exam to analyse a data set Usually done over time Budgetary control is:- The creation of budgets for a policy or plan Continuous comparison of actual results with budgeted results Identification of variances so action can be taken or plan changed 27

28 1 The purposes of financial budgets (1.4a) The purposes and benefits of budgeting Objectives of a budget:- To show organisational objectives as operational targets To communicate plans and targets to shareholders To motivate people in attaining the targets To motivate managers to identify risks and problems To measure unit or project performance To evaluate management performance Pre-authorise estimated levels of expenditure To coordinate operations To control procurement activities and costs 28

29 1 The purposes of financial budgets (1.4a) Limitations of budgeting Can include:- Can be clunky to create and maintain Take a large amount of time Can create conflict and politics Relates to income and cost estimates Data can become quickly out of date Over reliance on the budget and variance analysis Management decisions based on helping the department rather than whole company Managers can focus on short term, objective based factors 29

30 1 The purposes of financial budgets (1.4a) Type of budget Different ways to obtain budgeted targets:- Incremental budget Use last set of data and adjust with recent changes Zero-based budget Start from the start and gather information as new Two main ways to keep the budget up to date:- Rolling Budget Maintained consistently, possibly each month or week so that same timescale is created, e.g. 12 months Forecast Budget looked at during the year, possible at end of every quarter 30

31 1 The purposes of financial budgets (1.4a) Fixed and flexible budgets Important to know whether the cost is fixed or variable, or both Fixed budget- e.g. assumption that sales volume is 200,000 units for year Problem can come if assumption is correct figure can be higher or lower If figure is higher can procurement still meet the business needs? Flexible budgets are then used to counter this potential problem If higher all the variable costs are revised into the budget One important reason why it is important to know the difference 31

32 3 Performance and control of budgets (1.4c) Actual income entries Involves:- Entering actual income/ revenue figures against estimates Analysing the reasons for lower or higher than expected turnover Taking actions to prevent further shortfalls Actual cost entries Involves:- Entering actual costs/ expenses as they occur Analysing how fixed costs can differ from the budgeted amount Verifying that variable costs were in line with budget Analysing reasons for change between costs and turnover Analysing the differences in the timing of actual/ budgeted expenses Differences are known as variances 32

33 3 Performance and control of budgets (1.4c) Budget example Self explanatory Variances can be favourable or adverse 33

34 4 Dealing with budget variances (1.4d) Standard costing and variance analysis Variance analysis based on standard costs Standard cost is total cost of making one unit of product Examination of what an item actually costs compared to what it is expected to cost helps identify issues Example Standard cost of item Actual cost for 120 items Should have cost = 26 difference Each input should be looked at separately to determine where the difference lies: - e.g. materials and labour 34

35 4 Dealing with budget variances (1.4d) Standard costing and variance analysis Standard costing give a much larger control and management Encourages planning Highlights and price changes, inefficiencies etc quickly Disadvantages can include:- Expensive to install and run Information can become out of date very quickly Causes of budget variance Prices of the material bought in can change due to :- Shifts of power Commodity pricing Exchange rates Volume discounts New suppliers entering market 35

36 5 Operating the cash budget (1.4b) Standard costing and variance analysis Steps to prepare a cash budget:- Forecast sales Debtors to cash delay Knowing what to buy Paying suppliers time lag Taking into account other cash payments Show the net cash-flows as a table Cash-flow budgeting example 5.4 to 5.7 on Page 52 and 53 36

37 Possible assessment questions Chapter 2 LO 1.2a Describe FIVE factors that a buyer might expect a supplier to take into account when setting the selling price of their product (20) Explain the difference between the terms cost and price (5) Describe FIVE sources of data that a buyer might consult to obtain information about the market prices of inputs (20 LO 1.2b Using examples, explain the difference between direct and indirect costs (5) LO 1.2d Describe FIVE costs that should be considered when calculating the lifecycle cost of an item, apart from the purchase price of the item. (20) Define the term total lifecycle costing (5) 37

38 Possible assessment questions Chapter 3 LO 1.4a Using an example to illustrate, explain the term budget (5 Describe TWO approaches to budgeting used to establish procurement targets (8) Explain THREE purposes of preparing a budget for a procurement function (12) When operating financial budgets explain the difference between an incremental budget and a zerobased budget (6) Outline FIVE purposes of financial budgets (10) LO 1.4b Describe THREE cash outflows that might be entered in a procurement functions cash budget (9) LO 1.4c LO 1.4d The procurement function of a shirt manufacturing company forecasted that the cost of the imported material needed would be $4.00 per shirt, after the first three months of production it was established that the actual cost was $3.50 per shirt. Suggest FIVE possible reasons for the variance where the actual material cost is lower than the forecasted cost (10) Using examples, describe THREE reasons why the actual price of bought-in materials might be lower than the price shown in the purchasing budget. (15) 38