This week’s Wiki-Wednesday topics are Revenue (Net Sales) and Net Income (Earnings After Taxes). As at least a third of all procurement teams report into finance, pressure is mounting for us to articulate our value in financial terms. I’m covering both at the same time because while traditionally procurement has focused on Bottom Line (net income, EAT) impact, the time has come to start looking at the Top Line (revenue, net sales) as well.
Step one is understanding the difference between the two and where they come from - and not getting stuck in jargon and abbreviations. Here is a simple outline you may already be familiar with:
Revenue (net sales)
- COGS (Cost of Goods Sold)
= Gross profit
- SG&A (Selling, General & Administrative Expenses, the combined costs of operating the company)
= EBITDA (Earnings before interest, taxes, depreciation and amortization)
- Depreciation and amortization
= EBIT (Earnings before interest and taxes)
- Interest expense (the cost of bottowing money)
= EBT (Earnings before taxes)
– Tax expense
= Net income (EAT)
Looking at the terms this way also helps show why finance uses the terms top line and bottom line - they are simply referring to the place on the income statement where the impact of an activity is reorded. Top line impacts are those having to do with raw sales - moving more units or charging more per unit. Bottom line impacts are those that reflect the profit made on each unit sold by reducing the costs to produce or deliver goods.
Traditionally, procurement negotiates savings that either:
- Increase Gross Profits by reducing the cost of goods sold - categorized as direct spend, this would include raw materials or components in a manufacturing environment or wages in a service environment
- Increase EBITDA by reducing SG&A - categorized as indirect spend, this would include categories like copy paper for a corporate office or pest control services for a warehouse or store location
But is it possible for procurement to actually increase sales? It is possible, although procurement may not always have the power to make it happen, and none of us realistically expects to have credit handed over without some pressure, so this is another reason to keep the lines of communication open with finance. Here are some ways procurement activity may increase revenues and gross profit:
- If a reducion in COGS is passed along to the customer (rather than increasing gross profit) and results in increased sales volume.
- Taking a look at the "sacred cow" categories of spend that are usually direct and may have been held off-limits to procurement processes and ownership.
- Considering all sides in a negotiation with a supplier that may also be a client - a quick call to sales or account management should uncover any opportunities to leverage more sales for your company in exchange for a purchasing contract.
- Deliver innovation to the organization by communicating new solutions and delivery methods discovered during the bidding process and supplier management.
- Negotiate paymen terms that forward the corporation's cash management strategies - focusing on the number of days you will have to pay invoices as well as the cost per item bought.
All that being said, it is important to remember that maximizing profitability is the goal of any organization with long term aspirations. Understanding how many dollars of revenue growth are required to increase the bottom line by a dollar is an important metric and a good way to communicate procurement's value to finance. For a list of average net profit margin (and revenue required to generate $1 in profit) by industry, check out this posting on CPO Rising. The end goal is for procurement to make the largest impact to profitability possible, and whether from the top line or the bottom, half the battle will always be stating our impact in terms that the rest of the organization can buy into.