It’s year-end. Let’s spend all our money!

What are the risks for Procurement and the wider business because of Q4 madness?

 If you work in Procurement or if you’re responsible for managing a budget involving non-recurring project spend, you’re likely to be familiar with a perennial problem.

 While Procurement teams diligently try to optimise cash flow for the business by securing the best payment terms possible with suppliers, with this often being a departmental KPI, as we hurtle towards fiscal year-end all of these efforts can come undone in bizarre fashion.

You see, most companies operate their budget on a “use it or lose it” basis, meaning that if the allocated budget isn’t spent by fiscal year-end, the funds are lost. Wiped out. Gone forever. As if they never existed.

The obvious consequences of this phenomena are that if projects are not committed by the start of Q4 and with budget-holders keen not to face the ignominy of losing their funds, the last quarter can see a flurry of projects being rushed into action, perhaps resulting in the necessity for lighter-touch Procurement processes or in the worst case, bypassing proper Procurement activity entirely.

Day to day cash-flow management goes out of the window, and the emphasis changes to “stuffing suppliers full of cash” (pardon my vernacular) and ensuring all the allocated funds are spent. Like I said, bizarre, but understandable given the “rules of the game”.

 But there are other consequences of this practice, too, with potentially much larger risks. This is relevant to all kinds of project, but I’m going to focus on the impact on Capex / machinery procurement.

 1. Commercial leverage

Many suppliers in the capex arena are “industry veterans” and are fully aware of how the budget rules play in their favour as the financial year moves on. OK, so a supplier with whom you have a long-standing trust-based relationship is not likely to try and rip you off, but on the other hand, as a buyer with time not being on your side, the supplier is less inclined to yield to some of your (especially the more demanding) requests, running the clock down until you have no option but to agree to their terms.

 This is valid for all things to do with pricing, but also with contracting, where the business may incur huge additional risks; the supplier may not agree to an indemnity, performance obligations, and termination rights for example, and a host of other important terms.

 2. Specifications

One of the most effective ways to manage price and lead time risk on a project is to define specifications as fully and as clearly as possible, ideally having discussions with potential suppliers to identify any major specification omissions and to explore whether the supplier can meet them, prior to going out to tender. This can be a large and lengthy piece of work, but it’s essential, and often involves coordination across several departments eg quality, engineering, IT, manufacturing.

 If this activity is rushed and isn’t completed in-full, it’s likely to lead to costly change orders and potential delays to the project as a result of the specifications being amended throughout the machine build. Ouch.

 3. Value engineering

You may think that this is a “nice to have”, perhaps a luxury, if the schedule allows it. But I think this is an incredibly important opportunity to scrutinise and challenge technical requirements, stripping-out any features that add cost but don’t add any real value to the customer.

This again involves suppliers (utilising their deep technical expertise) and an internal team, so needs planning, preparation and time to conduct the activity itself and to commit the findings into the machine design.

 This activity will be time well spent as it could save significant sums on the asset itself, and on operational running costs over the lifetime of the asset.

 4. Financial risk

This one often goes under the radar. If your company has budgeted to pay in-full for a project in any given financial year, but for some reason hasn’t got round to initiating the project until Q4, that full pot of cash will still need to be spent (because of the “use it or lose it” principle).

 This could result in the lucky supplier completing just 20% of the work by year end (buying some raw materials, doing a bit of design work) but being paid for 100% of the project!! Happy days!! At least for the supplier.

 This creates a huge risk for your business. In an extreme case, a nefarious charlatan may disappear with your cash altogether! [By the way, this one really shouldn’t be a risk if your supplier due diligence is effective.]

 Being less dramatic, the supplier could go bankrupt and in which case you’ll struggle to recover the funds, and without the financial incentive for the supplier to keep to the agreed milestone plan, the risk of project slippage looms large.

Many of the above risks can be avoided or mitigated with good planning, visibility of future demand, advanced preparation of key documentation, and ongoing supplier relationship management with your most important suppliers.

 So, even if a project slated for initiation early in the financial year doesn’t get off the ground, with Procurement and enlightened budget holders having opened the eyes of the rest of the business to these often-overlooked risks of Q4 madness, there’s a strong rationale for a change in behaviour.

I teach Capex / Machinery procurement to Engineering teams and Procurement teams alike. I absolutely love this topic.

If you’d like help in managing the multitude of risks as well as obtaining far greater value in your next Capex project, please get in touch.