This is a very short version of a P/L statement. In short, material and workforce are variable costs, as this cost is related to the number of units the company produces. Fixed costs stay the same since they are related to operating the company as a whole.

What happens when we reduce the cost of material by 5,000 USD, compared to an increase in sales for the same amount?

As you can see, procurement savings go straight down to the bottom line. They increase the profit by the same amount. In our case, the Net profit went from 19,000 to 24,000 USD.

Increased sales, on the other side, call for increased production. Hence the variable costs also go up proportionally. They stay 40% and 25% of sales in our case. As a result, the profit increases by 1,750 USD, from 19,000 AED to 20,750 USD.

Don’t get me wrong here. There is a couple of points that need to be taken into consideration:

* Sales can be increased indefinitely. Savings do have a limit.

* Sales has two ways to increase profitability. Besides selling more, they can increase the price as well.

Now, what is it so important to understand those relationships? The main reason is that they are so many ways for procurement to influence the bottom line besides only pushing the price down. Here are a couple of examples:

* Procurement can as well influence the consumption of material by finding more efficient raw materials. If there is less material used to produce one product, it is a saving. Even though the price may even go up. Now the raw material cost will become a smaller portion of the total cost.

* Outsourcing is another tool procurement can use to reduce the overall cost. If properly done, both material and workforce costs go down. 

* Getting more efficient equipment. So now you can produce more. While the cost of a new piece of equipment may push your total cost up, it will be divided by a bigger number of produced units. 

* Looking a bit wider, we can make our Supply Chain more efficient. If we arrange smaller, more frequent deliveries of raw materials, our stock can be reduced. And this means, fewer company funds are blocked in materials. As we know, money has its cost. So here we have another way of saving. 

I mentioned a couple more in my article “Sources of saving” which you can read here. 

To conclude, once you start looking at procurement from this perspective, you will find many ways to save money for the company. Every line in the cost part of the company balance sheet can be reduced. And procurement can, and should, participate and get some good results out.

So, get involved when the next rent renewal is due. Or go to the equipment exhibition. Ask for the financial report and go through the details. You will find new savings for sure. And will be seen as someone who takes care of the business.