CHAPTER |
9 |
Procurement Order Closure
Once a contract is awarded, that does not mean project team work is over. Almost every contract gets amended either during the execution of works or during the closure of works. It is an important task for the project procurement team to review these open orders on a periodic basis to arrive at the actual cost; otherwise, the profit margin cannot be calculated.
9.1 Importance of Procurement Order Closure
Normally, organizations book the purchase order received from the customer; this is called the sale order. Every sale order has the estimated costs entered against different heads, which were considered by the tendering team for a particular project, and are based on these estimated costs and received sale order prices; profit margins are calculated before getting the order from customer.
Table 9.1 depicts sample project margin calculations after consideration of various costs, which involve direct, indirect, and other miscellaneous costs. Every project buyer has certain targets to determine savings, which are set as key performance indicators for any buyer; however, very few buyers know how savings secured by their effective negotiations will lead to project success. Projects are unique in nature, and calculations done by tendering will never prove to be correct, especially when moved to project execution teams. Therefore, in order to keep the project margin intact, the procurement team contributes by savings, whereas the execution team contributes by ensuring that purchase orders issued during the initiation of projects are closed on time, so that hanging costs will not impact the margins and they can have real-time savings from the systems.
Table 9.1: Sample project margins calculations.
| Cost Elements | Plan (in Millions US$) | ||
| 1 | Project management | 15 | |
| 2 | Labor production overhead | 19 | |
| 3 | Total direct labor and overhead | 34 | |
| 4 | Material external | 4,842 | |
| 5 | Equipment external | ||
| 6 | Purchasing internal | 3,200 | |
| 7 | Subcontracting external | ||
| 8 | Site materials and utilities | ||
| 9 | Sourcing overheads | 109 | |
| 10 | Total sourcing and overhead | 8,151 | |
| 11 | Total production (Row 3+ Row 10) | 8,185 | |
| 12 | Transport | ||
| 13 | Travel and expense account | ||
| 14 | Other insurances | ||
| 15 | Bank charges | ||
| 16 | Miscellaneous | ||
| 17 | Other direct costs | ||
| 18 | Warranty cost | ||
| 19 | Risk analysis impact | 89 | |
| 20 | Cost of sales | 8,274 | |
| 21 | Selling price | (8,856) | |
| 22 | Gross margin | (582) | |
| 23 | Gross margin% | 6.58% | |
| 24 | Upstream value | (320) | |
| 25 | Commercial gross margin value | (902) | |
| 26 | Commercial gross margin% | 10.19% |
9.2 Procurement Contribution During Project Closure
It has been a critical role of the procurement leader to review the open orders and keep reconciling them with fixed frequency. In a project job, a majority of the work awarded is based on the project situation at a particular time, which may change. Reviewing and assessing the open purchase orders is an important activity to keep the actual costs booked in a timely manner and to keep tight control on margins.
Start-up organizations that have only recently set up a project procurement team often miss the important activity of reviewing open purchase orders, and this is usually when they incur losses or start investigating the reasons for project margin losses.