Making A Case for Purchase Orders to Improve Financial Processing and Controls

Introduction

The mention of purchase orders (PO’s) as part of a company’s internal control toolkit always evokes numerous complaints that using PO’s un-necessarily complicates the purchase and payment cycle. Back in the day when POs were manually processed, not integrated with the ERP or not supported with robust review, approval or workflow functionality, these points certainly had merit.

ERPs have come a long way in improving ease of completion, purchase review and approval functionality, workflow and integration with other ERP modules. The high-performance levels of PO applications today make the complaints of the past irrelevant.

While it’s true that purchase orders require building an additional document, they can greatly simplify subsequent vendor invoice entry and logging, invoice review and approval and can play a major role in the accounting period close. For example, when using PO’s, the review and approval process is essentially front loaded (in the PO process) and can be removed from the AP invoice distribution, review and approval processes.

Like everything else, to gain the most benefit from the PO process, build purchasing policies that are right for your company. Set PO requirements to an appropriate dollar value. There’s no benefit in completing a PO for every purchase. The last thing you want is for the PO preparation cost to exceed the purchase amount itself! For recurring costs (e.g., utilities and lease payments) an annual PO can be built as an option.

Again, build the processes that work best for your company.

Using POs to streamline AP vendor invoice entry and logging

Most Accounts Payable (AP) departments operate in a challenging environment. Many times, the level of AP invoice entry volume is substantial, and can easily overwhelm AP team members, causing a negative affect on transaction processing quality. Transaction processing issues can be traced to specific causes such as out-of-date procedures, poor review and approval processes, inadequate executive support and not using the current ERP to its full capability.

Invoice receipt and logging procedures vary greatly between companies. Most of the time, invoice receipt and logging tasks are based on dated processes which have been in place for many years. Companies still put incoming paper invoices into folders. Invoices may be sorted by vendor, due date or both. AP may or may not maintain some sort of received invoice log. Electronic invoices are printed and handled in the same manner.

Using these old-fashioned filing and logging methods causes invoices to be misplaced or lost making open invoice search and processing difficult.

A better way to receive and log vendor invoices is to enter them into the ERP as soon as they are received and use the ERP as a logging tool. Since the ERP tracks invoice information such as vendor, invoice date, discount date and due date, entering the invoices into the ERP can streamline the invoice entry and logging processes.

When using PO’s entering vendor invoice detail becomes automated. ERP’s support loading the applicable PO into the voucher screen, eliminating the need to manually enter vendor invoice header and detail information.

Invoice entry is controlled using process status levels (e.g., unposted, posted). Some ERPs provide additional levels.

Regardless of how the levels are structured, the invoice entry process only affects the General Ledger (GL) when the transaction is posted. This means that any vendor invoice header or detail revisions to the PO loaded data can be processed prior to posting without affecting the GL.

To streamline any subsequent invoice review needs, the invoice itself can be scanned and attached to the applicable voucher, using the voucher screen’s notes and attachments feature, as a part of the data entry and logging process. Electronic invoice records can be attached in the same manner. It’s a fairly easy task to generate AP reporting to display vendor invoices entered and saved in an unposted status. The unposted vouchers in the report should reconcile to the invoices entered, essentially creating an invoice log. Using basic reporting features such as filtering, sorting and search, invoices received and entered should be easily identified.

Using POs to improve AP invoice review and approval

The payables invoice review and approval process can be difficult to complete, as AP interacts with nearly every department in the company as well as with outside vendors. To successfully meet its processing goals, AP must rely on both streamlined processes and sound controls. If these goals are not met, the result is unhappy vendors which cause rushed processing and of course the attendant processing errors.

Another benefit of using PO’s is that they can be used to streamline or eliminate AP processing related to vendor invoice review and approval. Companies not using purchase orders still use some type of purchase request and authorization process. Documents such as purchase requisitions and check requests are used. The documents can be paper, e-mail based or a spreadsheet. Approvals in this environment are usually completed via manual signatures or e-mail.

The following example illustrates how POs can greatly improve this process. In an ERP, an open PO can only be created once fully approved. The review and approval process are usually completed using purchase requisitions which are completed in the ERP by the requester then auto-routed for review and approval. When the applicable vendor invoice is received, AP auto-loads PO information into the voucher screen eliminating the data entry process. AP then matches the invoice to the PO and ensures that the goods or services ordered were delivered. This process is called invoice matching.

Since the purchase itself was originally approved during the PO process, the voucher should be able to be entered and posted without additional distribution, review and approval. For uncomplicated invoices, this process makes a lot of sense. More complicated invoices can be routed for additional review and approval prior to posting if needed. I personally like using PO’s and think that they increase productivity and increase control over basic purchases.

POs can assist in the GL period close process

An organized and controlled GL period close is essential to the completion of accurate financial statements. Accurate statements are critical in expense control analysis and support informed financial decisions.

To ensure financial statement accuracy and that all transactions related to the period being closed are included, the applicable departments (including Purchasing) follow a pre-planned period closing procedure to ensure that all transaction activity related to the reporting period, is identified and recorded accurately.

To learn more about the GL period close process see: Financial Management: Accounting Period Close

“Revenue and expense matching” is an important accounting principle. The matching principle requires a company to report an expense on its income statement, in the same period as the related revenues. This requirement makes an open PO review a key part of the GL closing process, as an open purchase order (PO) and receiving review will identify purchase commitments made in the period, which haven’t yet been invoiced by the vendor or processed in accounts payable.

It’s very important to be sure that the PO and receiving review has been completed before closing the period. Purchasing and warehouse team members review all open purchase orders and receipts not yet entered the ERP related to the period being closed. A list is provided to accounting so that they can accrue the PO and receiving data using the GL reversing journal entry function.

Additionally, as a part of the period GL close the accountant and department manager meet to review department expense transactions (processed and expected) prior to generating financial statements. These meetings help to identify expense-related transactions which need to be included. Many times, a PO related service has been completed or a physical item delivered, for which a vendor invoice has not yet been received. The department manager provides this information to the accountant who then determines if the transaction should be accrued.

If you’d like to learn more about this topic, see: Analyzing Department Expense Variances How SL Can Help Control Expenses and Support Manager Accountability

In project centric companies POs play a key role in ensuring that all project related activities are included in project reporting. Open project POs can be displayed in project reports as “commitments” and allow the report user to identify all related project expenses (with or without a vendor invoice being received).

This information is important in understanding a project’s “estimate to complete” (ETC) and “estimate at completion” (EAC). Learn how a robust project management application such as Progressus can easily support ETC/EAC any functionality requirements.

Conclusion

Purchasing and purchase orders play a key role in several AP and accounting processes.

If used correctly, POs can strengthen AP processing efficiency while at the same time improve internal processing controls, especially in vendor invoice entry and vendor invoice review and approval. Open PO and receiving transaction review and accrual are key in supporting accounting period close success and reporting accuracy related to financial as well as project centric reporting.

Use the functionality and best practices described here to gain the full benefits from your ERP’s purchase order functionality.