Jun 21, 2021

The Spend Analysis Fundamentals

by Arielle Kushner

Spend analysis isn’t just another corporate buzzword. It’s an essential process for managing business spend. It turns out that you have to spend money to make money, and you likely purchase raw materials and services from vendors to maintain internal operations and create the products you sell.

Making these activities more efficient through proper data analysis and informed decision-making is the main idea behind spend analysis. You can’t stop money from trickling out of your business, but you can certainly control and track how it flows.

Read on to learn everything you need to know about comprehensive spend analysis, from the basics to more advanced concepts.

How Do You Define Spend Analysis?

Spend analysis covers all the policies and practices a company undergoes for spend analytics. The intention is to increase spending efficiency by lowering costs and developing relationships with suppliers.

Compared to organizations that do not practice spend analysis, procurement-focused companies can proactively carve out savings opportunities and actively boost their own buying power. By taking a closer look at their approach to strategic sourcing, and pulling together purchasing histories and other sources of spend analysis data, this type of business can answer important questions like:

  • What are we buying and from whom?
  • What department is making the purchase and how often?
  • How much is being spent?
  • Where are the items being delivered to?
  • Are we receiving quality products in a timely manner?
  • Is there a way for us to agree on a better price?
  • How has our spending changed compared to that of previous years? Would changing suppliers or finding better deals improve our situation?

To help see the bigger picture, let’s look at conducting spend analysis in the context of an overall spend management initiative. When a management team discusses its procurement practices, it considers three components: spend analysis, spend visibility, and procurement process optimization.

  • Spend analysis. Just as its name suggests, an analysis takes your spend data and generates insights on purchasing patterns and reports on potential opportunities to save or negotiate more optimal contracts.
  • Spend visibility. It’s worth keeping an eye on all the metrics that could impact spending habits and supply-chain performance. Compared to analysis, visibility largely has to do with a detailed, holistic look at current finances rather than tracking only spending. Instead of waiting until the quarterly report, visibility enables a business to make immediate decisions with real-time data.
  • Procurement process optimization. The natural next step is to implement the changes you’ve discovered in the previous phases, whether it’s changing your supplier base or approaching supplier management differently, negotiating better contract terms, or reducing processing time for purchases.

It should be obvious that information is a common theme whenever we’re talking about spend management.

The Role of Information

The steps that procurement teams go through are typically to collect, formalize, classify, and analyze spend data. This data can come from any relevant source in the organization, such as enterprise resource platforms, purchase order records, financial ledgers, and suppliers.

Information is key to generating actionable insights, which in turn drive better spending performance, contract compliance, and ultimately cost savings. Data gives you a baseline to measure changes in financial activity and helps you create informed decisions for both short-term and long-term saving strategies.

How Data Is Treated in Most Organizations

Relevant spending intel is present in all sorts of locations, so what does procurement spend analysis do with it? A usual process would be:

  • Identifying all the sources, which can include any department, manufacturing sector (think strategic sourcing), or business unit.
  • Gather and cleanse the data into a central database for easy reference. Many enterprises and even larger companies handle financial activity from various regions, currencies, and languages. Extracting all this data in a way that makes it readable and comparable will take time.
  • Align the data in a way such that discrepancies, missing points, and redundancies are minimal. For instance, some companies use abbreviations (i.e. Dell vs. Dell Technologies Inc.) even though you would likely treat both indicators as interchangeable. Interpreting the data is much easier once you resolve these conflicts, and there are usually many more attributes of data, including industry codes and ISO certifications.
  • Categorize information into logical groups and hierarchies. We’ll get into classification later, but it essentially shows you what parts of the company are spending certain funds.

It’s all easier said than done, of course. A procurement spend analyst also needs to think about key performance indicators (KPIs) when analyzing procurement spend data.

The KPIs and Metrics to Look At

What metrics are most important to you? Some examples of KPIs you can measure through procurement data are:

  • Total spending and number of transactions
  • Number of suppliers and amount spent on each
  • Average purchase order value
  • The prices of materials
  • Amount each department/team spends
  • Payment terms and conditions
  • Maverick spending, or any informal transactions

There are far more, of course. The choice of KPIs depends on what you intend to accomplish through the analysis.

The “Spend Cube” Concept

Spend analysis can be looked at as a hypothetical three-dimensional cube, the sides of which are item categories (what you are buying), suppliers (who you’re buying from), and recipients (who receives the products). Each side can divide further into subcategories for more fine analysis.

The cube enables cross-comparisons and can show how each element interacts with the others. For instance, if your transactions are scattered or the same supplier has multiple agreements with multiple business units, you can instantly tell through the spend cube. You can essentially see your spending from multiple angles this way.

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The Types of Spend Analysis

It’s no secret that procurement or spend analysis is multifaceted and complex. There’s no one process, goal, or approach that works best for all organizations. The analysis can be approached in multiple ways: direct vs. indirect, categories vs. taxonomies, and many other types.

Direct vs. Indirect

Direct spending refers to any purchases your business makes to manufacture the products and services it sells. Examples include raw materials, components, and equipment.

However, not all spending goes immediately to manufacturing. Companies also need to support internal operations through indirect spending, which can include consulting services, marketing agencies, travel costs, human resources, and utilities.

Categories vs. Taxonomies

When managers talk about spend categories, they usually refer to classifying transactions based on organizational definitions of similar purchases. For instance, IT could be considered a category that covers both software licenses and hardware.

A spend taxonomy, which is more specific to the procurement team, organizes spending based on hierarchies. Think of taxonomies as branches of a tree that organize based on sub-categories of spend.

The UNSPSC (United Nations Standard Products and Services Code) is an example of a taxonomy system that many organizations build upon for their own classifications. It includes:

  • Maintenance Services
  • Professional and Administrative Services
  • Computer Hardware and Software
  • Food and Beverage Products
  • Healthcare and Insurance
  • Transportation and Mail Services
  • IT and Telecommunications

Angles of Approach

There are other ways to approach spend analysis in addition to the types we’ve listed here. The following are brief overviews of each methodology.

  • Item-based. One way to look at spending is to consider it according to each item/SKU you purchase. You might find that certain items are coming from multiple vendors or purchased by multiple departments. This strategy will dig out any maverick spending or inefficient leakages.
  • Category-based. Are you buying too many similar products from multiple vendors? If so, you likely have an inefficiency to address. Category-based analysis groups purchases into hierarchies to facilitate navigation and help find leakages. You can specifically use categories to prioritize your optimization towards your key spending categories.
  • Vendor-based. Think of how much of your spending is going to your most critical vendors. For the businesses you rely the most on, create a dedicated spend profile to help you make decisions regarding future contracts and deals. It will help you find patterns and identify new opportunities.
  • Contract-based. Non-compliant contract terms can be a source of loss for the company as well. Some analysts look through the contracts of each vendor to find leakages due to noncompliance.
  • Payment Term-based. Sometimes the timing of the payments matters just as much as the composition of a business’s spend profile. Some companies offer discounts for early invoice payments. However, paying early might result in less working capital on your end. A payment term-based solution aims to address this balance issue.
  • Tail Spend. Regardless of how comprehensive your spend analysis program is, there is bound to be certain transactions that fall through the cracks. Your strategic management will likely cover around 80% of all spending, with the remaining 20% referred to as “tail spend.” While it takes up a smaller portion of expenditure, it’s important to still consider tail spend since it receives the least attention and is often inefficient.

Remember that no one solution is guaranteed to work in your circumstances. Consult with the procurement team regarding what you can do to get the most out of your spend data.

The Benefits You Can Expect From Spend Analysis

You may be wondering whether spend analysis is worth the effort given how complicated it seems. What kind of return on investment is in for the procurement analysts?

Finding New Ways to Save

Everyone wants to cut down on costs while minimizing the impact on productivity and production quality. The only question is how you can do so. Spend analysis as a whole pinpoints cost inefficiencies in the organization and helps you consolidate your list of suppliers to that end.

Maverick spending is a particularly annoying issue, as it can be difficult to detect and continue to drain on your budget. Spend data gives the insights for addressing undocumented spending.

Perhaps you can order small items in bulk to share amongst multiple departments, or one contract might be more profitable to you than another. No matter how you achieve it, spend analysis is the tool for finding out how.

Streamlining Internal Processes

Not only will you have deeper relationships with vendors, but you may find ways to boost efficiency in procurement teams so that fewer employees are required for the job. From budgeting to filing financial reports, expect less time spent in general on these tasks so that more time is available for more productive jobs.

Investing time and resources into procurement studies also helps different business units work together cohesively. If two departments use similar products and services, then new financial strategies could involve ordering “in bulk” to save. You can leverage spend analysis across the entire organization.

A similar practice can be applied with other companies too. It’s not uncommon for multiple client businesses to order goods together for bulk discounts.

Ensuring Compliance

Are your orders delivered on time? Are they of advertised quality? Procurement teams have the resources to verify contract compliance, resolve over-payments, and avoid late penalties. The business as a whole enjoys better relationships with suppliers and more consistent budgeting.

Compliance also extends to legal regulations. State and federal laws might require certain procedures regarding financials.

Achieving Visibility and Awareness

There’s a reason why we’re in the “Information Age.” Data is key to understanding trends and activities in the business. Raw data comes from many places and formats, so interpreting it properly involves making it consistent.

The steps of spend analysis create actionable insights that can be used to craft informed business decisions to boost future revenue and lower costs. Becoming aware of your financial situation is the best way to avoid maverick or wasteful spending.

Another benefit is setting future business goals. Goals are only valuable when they are realistic and achievable, so what benchmark can you use to determine them? Spend data provides the understanding that helps you set realistic targets.

The Steps of the Spend Analysis Process

Spend analytics can be tailored to every business’s unique needs, but all processes typically contain the following essential steps.

Step 1: Know Where Data Can Be Found

Where exactly do you look for relevant financial activity? It may sound obvious, but modern enterprises and even smaller companies have multiple parts working simultaneously, and it’s easy to lose track of who’s spending.

Go through and search for the biggest spenders, which typically include procurement, finance, accounts payable, general ledger, and marketing departments. It may be surprising how many groups and projects in the business actually handle the budget. By understanding who has a hand in budgeting and spending, you’ll be able to better identify savings opportunities and cost reduction opportunities, as well as get a more accurate sense of your organization’s purchasing data.

Step 2: Extract and Collect

Once you know where to look, it’s time to start data gathering – bringing the information into a central location for easy analysis. Data that comes from different places in the company might be in different formats, so it’s important to keep everything consistent during this step.

For example, one department might handle international goods and services, which involve different currencies or languages.

Step 3: Clean Up the Repository

When companies collect spend data it is always susceptible to human error, so remember to “cleanse” the data repository before moving forward. Look for corrupted records, redundancies, obsolete information, and other inaccuracies.

When working with a group for data cleansing, set guidelines beforehand on what standards you will have regarding the information. This will help you improve data quality. The cleaner your data, the more effective the analysis and the business decisions that come from it.

In some cases, it may be wise to add extra facts for certain transactions. You might want to know where the order originated or what purpose the buyer gives for it.

Step 4: Classify Spend

Create meaningful groups to organize the deep records of transactions, as they make comparisons and data analysis much easier later. Common methods include grouping by supplier or purpose (i.e. marketing, IT, office supplies, etc.).

We’ve discussed categories and taxonomies before. Systems like UNSPSC or even a custom-made hierarchy all assist in showing you where your money is going. Groupings enable you to institute category-specific saving strategies as well.

Step 5: Analyze

Finally, enough data is collected, cleaned up, and classified. All that’s left is to draw conclusions from your detailed spend analysis. Discover whether you can afford to cut costs in certain categories or renegotiate agreements with specific vendors.

Measure your total spend according to predetermined key performance indicators to track how well each taxonomy should be performing. Make adjustments accordingly to improve future spending.

Creating Reports with Your Findings

How do you express your findings to upper management or procurement administrators? The best way to visualize the data and your intended next steps is to craft detailed reports. Remember that graphs and images work better for comparing data points over plain text. Examples of elements to use are:

  • Classic graphs and charts, a staple of any PowerPoint presentation. Use bar graphs, pie charts, plots, and others to put your results into context.
  • Pivot tables, a flexible option if you want to see the same pool of information from different angles. When the data becomes too complex, consider a cross-tabular report that adds dimensions as both rows and columns.
  • Pareto charts, which, as the name suggests, shows off the 80/20 rule. Since the majority of the spending generally comes from a small portion of suppliers, you can demonstrate this effect in a convenient chart.
  • Treemaps compare the sizes of certain spending categories with rectangles whose size is proportional to the amount of spending. You can tell at a glance how large one taxonomy is to another.
  • Maps display information according to geographical location. Businesses purchasing from international vendors may find use out of maps. 

The complexity of spend analysis conclusions necessitates the use of detailed reports. They clear up your findings and can persuade upper management to adopt your suggestions.

There doesn’t exist a “wrong” way to approach procurement analysis, but to increase the chances of success, here are some best practices to consider.

  • Get everybody involved. Maximize participation for best results. When it comes to data collection, getting everyone to follow the same guidelines for formatting speeds up the cleansing process. Likewise, having procurement and finance teams working together ensures more savings.
  • Automate data handling. From collection to cleansing to classification, traditional manual methods are slow thanks to the high complexity of modern sales data. Automated software solutions are becoming popular for this reason. By accelerating the job of procurement analysts, companies can catch up with the ever-changing market around them.
  • Aim for permanent solutions rather than band-aid fixes. You won’t achieve full optimization overnight, but aim for permanent changes in company culture that will facilitate spend analysis. Working with external consultants might work for now, but having to stick with them continually leads to excessive reliance on their services. Find a sustainable solution that gives you the efficiency benefits you signed up for.
  • Continuously improve. The work of a spending analyst is never truly finished. There are always new contracts to consider, new suppliers to work with, and new ways to optimize a company’s transactions. Make it an ongoing effort to review the current situation and keep making initiatives to boost revenue and minimize losses.
  • Measure results. Assess the impact of the efforts to find out the return on investment. The benefits of spend analysis transpire in higher revenues and more efficient internal operations.

Even with excellent protocol, occasionally spend analysis fails to deliver on expected results. In this event, it’s possible your procurement team is running into issues common to analysts.

Watch Out For Common Pitfalls

Don’t give up on spend analysis just because of a few setbacks. Here are some common pitfalls to watch out for in case you need to boost ROI even further.

  • Poor spending data. Cleaning up and classifying the information gathered takes time. Many managers consider this step the most labor-intensive, and problems with poor quality data are not uncommon. From errors to missing points, the best way to approach this issue is through automation and spend analytics software.
  • Doing too much too early. Some companies make the mistake of trying to go too far too quickly and end up overwhelming spending analysts with too much data. Starting small and building from the ground up is ideal for lowering risk and gives you an opportunity to take advantage of early feedback loops to improve the process.
  • Unsuitable tools. Software solutions and other tools are necessary for modern spend analysis, but how do you know which ones are right for you? With so many options on the market, let the management team decide on the best one for the current needs. Almost every tool you come across has its own set of pros and cons to consider.
  • Pushback from upper management. Procurement teams ultimately have to change what the organization purchases from suppliers, and many department heads fearing lower quality products and services may be unwilling to give up control. Spend analysts understand the need to get everyone on board with the initiative before beginning.

Successful spend analysis is as fruitful as it is difficult to achieve. Remember that it’s an evolving process worth your time if you put in the effort.

Why You Should Adopt a Spend Analysis Platform

Software tools empower many facets of modern business, and spend analysis software is no different. Automated data collection, for instance, streamlines the ability to generate insights from the vast array of transactional activity all across the business. Some solutions generate graphs to help you see spending patterns, and others assist procurement analysts throughout every step of the analysis.

Popular programs for the job include:

  • Microsoft Excel, for its ability to house numeric data, make calculations, and generate graphs. However, it also struggles to scale up, especially when you run into hundreds or even thousands of transactions.
  • Power BI (Business Intelligence) is a cloud platform for working with a large amount of financial information. It’s well known for its dashboards and portals.
  • Tableau is a similar solution for the same purposes. Its main selling point is ease of use and intuitive methods.

Companies rely on external software for significant portions of their workflows. Put considerable thought into your decision. During the selection process, it’s worth knowing some facts to know about business software.

Solutions can either be in-house, licensed, or in an SaaS (Software-as-a-Service) format. In-house software gives you full control but also requires maintenance costs. Licensed programs usually require a single purchase for use of the product. And SaaS is a more flexible payment plan that relies on a subscription with regular payments.

There’s also a distinction between software designed for larger enterprises and ones for smaller businesses. The difference in scope has implications with regards to pricing and capabilities.

Gain Overall Procurement Process Improvement

Getting started with a spend analysis solution can seem like a lot of work in the beginning. Collecting and consolidating your business spend data, identifying spending for both direct spend and indirect spend, and onboarding your employees to the right spend analysis software can all seem like big goals to take on. But with the right practices and plans in place before you dive in, procurement professionals (and finance teams alike) will soon see that to perform spend analysis and data extraction will equate to better data management, better supply chain management, fewer procurement costs, and seeing multiple process improvements.

Take Control of Business Spend with Tipalti Approve

No matter your approach to finance, optimizing spend should be a top priority. Tipalti Approve can help you get the visibility you need to gain valuable insights and make informed decisions, and bring more spend under management.

Interested in implementing a spend management system that simplifies and streamlines your business’s existing process? Check out Approve.com and request a free demo today!

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