Charge It!

F or some people, credit cards are like alcohol: They can lead to serious addiction, often leaving users deeply in debt. But used correctly by businesses, corporate purchase cards can save money, improve control and streamline a companys purchasing and accounting departments.

Following are two scenarios that highlight the benefits of corporate purchase cards:

Scenario 1: An employee needs a $150 part for her computer. First she fills out a detailed purchase requisition in triplicate and gets the form signed by the appropriate manager; then the order is submitted to the companys purchasing department. A purchasing agent locates a vendor for the item and places the order. When the item finally arrives weeks later, purchasing sends a payment approval form to accounts payable, where a clerk cuts a check for the $150 invoice.

Scenario 2: The same employee buys the $150 item directly from the vendor, using her corporate purchase card, and gets it immediately. Meanwhile, the purchase card organization—not the individual vendor—e-mails an electronic (not paper) invoice directly to the companys accounting department, citing the item, the purchase amount, the name of the employee, the account the funds should be drawn from—and posts all that information electronically. That, too, occurs instantly. Since this purchase or others bought with purchase cards are fully detailed in the companys computer, the accounting department makes a single monthly electronic payment to the purchase card organization.

It should be obvious that scenario 2 costs the company far less—in dollar outlays and cumulative time spent on the transaction. In fact, in many cases the cost of processing a small order is higher than the price of the item itself, which explains why companies are turning increasingly to plastic. A recent survey of 1,314 senior financial executives by Phoenix-Hecht, a bank consulting firm, disclosed that 13% of the respondents used purchase cards and another 33% planned to within two years. Among companies with revenue exceeding $500 million the numbers were even more impressive: 25% were using the cards and another 43% planned to.

Companies using purchase cards generally limit the purchases to low-dollar items that are usually not stored by the business. They typically are referred to as maintenance, repair and operating (MRO) items and include products such as supplies for the office and maintenance department, incidental postage, small tools, employee apparel, software and subscriptions.

RELAXING RULES
To accommodate plastic, companies have had to relax some of the traditional purchasing controls, drawing criticism from accounting departments and from those responsible for ensuring that company purchases are made from a select group of “preferred” suppliers. Consequently, before a company implements a purchase card program, it usually works out

• What can be bought with the card.
• Which suppliers can be used.
• The number of transactions a card holder is allowed to make in a given period of time.
• The amount of spending that is allowed in a given time period.
• The maximum spending limit for an item.
• The process for postpurchase audits.

When a purchase card program is planned, few managers initially recognize that its implemention often resolves most, if not all, of the control issues that once consumed significant attention of the accounting and purchasing departments.

Low-dollar purchases represent a small percentage of most companies total spending. For example, MRO invoices at an ITT division account for 59% of its manufacturing units invoice volume but less than 5% of the total dollars spent on purchased goods; and 81% of its MRO invoices are less than $1,000, accounting for only 3.2% of total spending.

Although most MRO purchases are for relatively small amounts, most companies apply the same controls to those transactions as they do to more costly purchases. The administrative cost for such companies to acquire and pay for an item averages about $150.

In addition to being costly, the traditional purchasing process for MRO items can be time-consuming. At the ITT unit, it takes an average of six days between a users requisition and the placement of an order. Another company, Advanced Micro Devices, reports a purchasing cycle time of 14 days. To compensate for these waiting periods, employees tend to stockpile MRO items—consuming storage space and pinching cash flow.

While the rules and processes vary, use of a corporate purchase card usually requires the company to pay its monthly invoices within 30 to 45 days. Fees are negotiable, ranging from zero to $25 a year per card. In many ways a corporate purchase card works just like a personal credit card:

• Each cardholder is assigned a spending limit.
• The cardholder receives a paper or electronic monthly statement listing purchases.
• Vendors receive payment from the card company within one or two days of purchase.

But, unlike a personal credit card

• The participating company receives one summary bill a month for purchases made by all cardholders.
• As a way to maintain control, the company can block certain purchases by restricting card use to suppliers with specific standard industrial codes.
• The company can obtain online real-time access to card transaction activity.

Purchase cards usually have a dramatic positive impact on organizations procurement processes, leading some companies to forecast significant reductions in the cost of operating their accounts payable and purchasing departments. The sidebar lists some of the work that can be reduced or eliminated by using plastic.

Other benefits include the following:

• Managers no longer are interrupted to sign low-dollar purchase requisitions or sift through low-dollar transaction details identified on an accounts payable distribution report.
• Finance personnel can analyze purchasing patterns quickly and easily.
• The size of the active vendor database shrinks, allowing the purchasing department to focus more attention on strategic relationships with high-volume suppliers.
• The accounting department can spend less time on bank reconciliations and transaction processing.

Typically, each card is assigned numbers that correspond to a companys general ledger accounts so that card-issuer data can be downloaded directly into the companys computer. Hence, when suppliers “swipe” a card or input the card number, they actually are posting a journal entry for the user organization. Perhaps most important, a simple phone call to a supplier is all that is required to order an item.

BEYOND CONTROL
In addition, purchase cards strengthen control over department spending, solve nagging timing problems that currently disrupt management efforts at planning and control and reduce the ability of employees to circumvent the traditional purchasing system.

Most organizations operate from a yearly budget broken down into 12 financial periods against which performance is measured throughout the year. The budget is segregated by department, with each department manager assuming responsibility for spending approval and control. The general manager has oversight over each expenditure by approving requisitions before issuing purchase orders (POs).

This sounds simple enough, but it never works! At many of the facilities with which we are familiar, the departments overspend their budgets. Generally, accounting departments take time to log and accumulate spending data as the month progresses, making sure all department and general managers have the most recent spending analyses in front of them. In theory, this information is reviewed before making purchasing decisions to ensure proper budget compliance. In practice, it is rare for a department manager to review this document before obligating company resources. The financially responsible department manager who does review financial information before making a purchase usually consults the spending log maintained in the department. Thus, the company is committing double the resources needed to track spending in some departments, while in others any effort at budgetary control seems misguided and costly. Even worse: Managers rarely review spending control issues until after a problem occurs.

The lack of spending discipline does not seem to result from disregard or misunderstanding of the importance of budgeting, and little insight would be gained by “finger-pointing.” Rather, it appears the root of the problem is that managers rarely have the time to devote to such paperwork. Urgent business decisions cannot be held hostage to a slow-moving, paper-driven purchasing system. The burden is on proactive accountants to find better ways to help managers maintain spending control.

When spending controls are imposed by placing spending limits on cards, the problem is solved simply and automatically. Spending limits that, in aggregate, match the departments budgeted expenditures for the month can be set on each card. When card purchases reach the predetermined spending limit, no further charges can be made.

Instant budget control!

Setting predetermined spending limits not only enhances department spending control but also gives accountants and managers greater freedom to “manage by exception.” Managers dont need to be concerned with every transaction. The managers ability to identify and manage exceptions is strengthened because the purchase card program puts a spotlight on the department manager who now must ask for an increase in his or her spending limit to make it through the month. Furthermore, departments no longer need to maintain manual logs.

TIMING PROBLEMS
Accounting departments are under intense pressure to control cost and improve real-time reporting of financial activities. The philosophy today is to identify and report events that affect costs as they arise, if not before, and correct the cause of the problem before it gets too serious.

In most circumstances, MRO transactions span at least two accounting periods, leaving accountants scrambling to match and track spending with the proper budget periods. Because accountants attempt to track and control spending based on POs issued but report financial results on actual liabilities incurred, a departments monthly spending can sometimes appear under control—only to have an invoice placed months ago come through and turn things upside down.

Managers, too, are often upset to find they have overspent the current months budget when the purchasing report (based on liabilities incurred) had indicated that spending was within budget. Managers rarely remember being underspent in the prior month due to obligations they have to pay for this month. This timing problem often leads accountants to use company resources to develop an off-line system that records POs issued for comparison with the departments budget.

MRO timing problems also undermine financial forecasts, which are essential documents for management in todays business environment. As businesses struggle with continued pressure to reduce costs, accurate weekly forecasts have become increasingly critical.

Corporate purchase cards also cure problems associated with the timing of liabilities for MRO spending. A company owns the product when the purchase card is swiped. That data can be downloaded daily into the general ledger for an accurate accounting liability; thus, there is no need for a reconciliation between POs issued and liabilities incurred.

ENHANCED SPENDING CONTROL
The greatest threat to the integrity and accuracy of an accounting report occurs when managers ignore a faulty purchase accounting system altogether. When faced with what is perceived as an emergency—such as an immediate need for a part or service, an employee will often do whatever it takes to keep the business running. Usually, “whatever it takes” is an emergency purchase. Understandably, filling out paperwork is a low priority in a moment of crisis. So when the invoice comes in, accounts payable personnel must spend time reconstructing the entire chain of events to determine whether payment was authorized. This activity is particularly onerous if the requisitioner did not immediately follow up with the appropriate paperwork.

In some companies, “emergency buys” and after-the-fact PO activity get out of control, even to the point of becoming more common than the traditional process for MRO acquisitions. In such environments, the prevailing attitude seems to be that the paperwork “mop-up” is the “accountants problem.” The solution is expensive.

Off-the-books agreements between managers and suppliers are another way the traditional system can be ignored or manipulated. Managers can develop and exploit their close relationships with vendors to bend or break the rules of the PO system. For example, managers can get vendors to roll bills over to a period when there is money in the budget. Unfortunately, before a manager realizes what has happened, there is no money in the budget but there are bills yet to pay.

Such real-time accounting may not be viewed positively by everyone in a company. The traditional purchasing method gives employees a measure of slack in the system, which they may not concede without a fight. Gaming the system has become an art form in some organizations. Consequently, overcoming the inevitable resistance to initiate a corporate purchase card program requires top management support.

While corporate purchase cards cant solve all a companys purchasing problems, they can go a long way to streamlining operations.