CPSPKREVISION.CO...CPSPKREVISION.CO.KE – SCM for SMEs 8 3. Companies An association of people or persons who contribute capital in order to carry out a particular business with the

CPSPKREVISION.CO.KE – SCM for SMEs

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Complete and comprehensive study notes in accordance to the syllabus.


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3. Companies

An association of people or persons who contribute capital in order to carry out a particular

business with the intent of realizing profit.

Characteristics of Companies

1. They can sue or be sued.

2. They exist as a separate legal entity for their owners.

3. They have perpetual life unless otherwise.

4. They are artificial persons meaning they are recognized by the law.

5. They can own properties under their names.

Differences between private and public companies

Feature Public Company Private Company

Minimum No. of

Shareholders 7 2

Maximum No. of

Shareholders Infinite 50

Transfer of Shares Freely transferrable stock in the

market.

Not Transferrable unless

members agree.

Number of

Directors 3 1

Commencement of

Business

Begins on getting trading

certificate.

Begins after certificate of

incorporation.

Prospector’s

Documents

Compulsory to be submitted to the

registrar of companies during

registration.

Not required to submit to the

registrar of companies during

registration.

Auditing This is compulsory and is made

public.

It is not a must to audit

books of accounts

Purpose of

Formation

They enjoy a lot of capital They enjoy limited liabilities

Annual General

Meeting

Compulsory Not Compulsory


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Advantages of public limited companies

1. More capital can be raised via selling of shares.

2. They have perpetual existence even after death of owners.

3. They enjoy better management due to presence of directors.

4. Transparency is ensured via the audits carried out.

5. They create employment.

6. Liabilities of shareholders are limited.

Disadvantages

1. Formation is challenging due to a lot of documentation required as compared to sole

proprietorship.

2. They are accountable to the general public and other stakeholders as compared to private

company which are accountable to a few people.

3. They require a skilled workforce which is relatively expensive.

4. Majority of shareholder are not able to keep in touch with the company’s affairs due to

their large numbers.

5. They lack personal touch with employees and suppliers.

6. Work is done by salaried managers who might have conflicting interest with the

shareholders.

Advantages of Private Limited Companies

1. Members are well known to each other.

2. Management and conduct of business is more flexible.

3. Statutory meeting and statutory reports are not required.

4. Number of directors is at least 2.

5. Members enjoy limited liability.

Disadvantages of Private Limited Companies

1. Share transfer is restricted.

2. Members cannot exceed over 50.

3. Shares can’t be quoted in stock exchange.


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4. It can’t issue prospects to general public.

Formation of Public Limited Companies

1. They submit an MOA (Memorandum of Association) to the registrar of companies. It

defines how the company will be carrying out its affairs, and how it should relate with its

environment (internal and external). It contains:

i) The business name.

ii) Objectives of the company.

iii) Statement of liability.

iv) Location.

v) Name of the company

2. They must submit Articles of Association. This contains rules and regulations of the

company’s internal regulations e.g. Audit books of accounts.

3. List of board of directors showing:

i) Names of directors

ii) Statutory documents (Documents whose legal requirement have been met)

4. Submit a prospection of the company to the registrar of companies.

Formation of Private Limited Companies

1. Submission of MOA to the registrar of companies.

2. Submission Articles of Association to the registrar of companies.

3. Payment of registration fees.

4. Must notify the registrar’s office of the company’s location.

Factors to consider when starting an SME

1. Market availability.

2. Capital availability.

3. Source of raw materials.

4. Legal requirements.

5. Technology.

6. Return on Investment (ROI).


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As we have seen, it is in the business plan that the entrepreneur sets out the objectives for the

business. He lays out in writing what his vision for the business is. The strategies will be both

short term and long term. They need to be achievable as unachievable targets may make the

business plan lose credibility. Subsequently, from time to time, the entrepreneur will be referring

to the business plan to check whether the growth of the business is in line with the plan he had

envisaged earlier on. If not, then he will have sufficient basis to manage the growth of the

business to direct it towards the right direction

A tool for planning and guidance

A business plan in itself is a planning tool. The big plans are laid out and the small ones that

make up the major plans are also followed up closely. The entrepreneur has set out what he

needs to achieve within a given time frame so he will set out all these in the business plan. It may

happen that the people he works with are unclear about the main objectives of the business. A

business plan will act as a learning tool for them. They can thus contribute to the success of the

business along with the entrepreneur. The business plan thus also acts as a source of guidance

where the way forwards seems unclear. Planning is very important if a business is to survive. By

taking an objective look at the business the entrepreneur can identify areas of weakness and

strength.

He will realize needs that may have been overlooked, spot problems and nip them before they

escalate, and establish plans to meet his business goals.

The business plan is only useful if used well. Ninety percent of new businesses fail in the first

two years. Failure is often attributed to a lack of planning. To enhance success, the plan should

be well utilized. A comprehensive, well-constructed business plan can prevent a business from a

downward spiral as “failure to plan can mean plan to fail”

Highlight risks involved

The risks involved in the business are perhaps something that the entrepreneur may not want to

dwell upon too much. However, for the plan to gain more credibility, the entrepreneur will have

to incorporate what risks his type of business is likely to encounter. These could be financial,

operational or control risks. The entrepreneur should also highlight the measures he has in place

to manage the risks that he fore sees. Once an informed reader looks at the plan with all these

risks highlighted, he may find it a more realistic proposal and be willing to invest.


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Communication tool

A business plan is a strong communication tool for the business. It defines the purpose, the

competition, management and personnel. It clearly identifies the vision and mission of the

business to all the stake holders. The roles and responsibilities of the operational and

management staff will also be clearly defined. The process of constructing a business plan can be

a strong reality check if the pertinent details are not well articulated.

Reference Tool

A well prepared business plan offers a benchmark against which actual performance can be

measured and reviewed. As has been mentioned, a business plan will tell the entrepreneur when

the trend in performance tends to deviate from the laid out plan. The plan provides an ideal

setup.

It may need to be changed, especially when changes in the economy or in the industry warrant it.

At all times the entrepreneur should keep his business at par with his targets as well as with what

the competitors are aiming at and even further.

Even after preparing a business plan, the entrepreneur may find that it is necessary to review it

from time to time due to changing circumstances that come to light with time. This enhances the

planning process and improves the business plan. Some aspects of the business plan may become

obsolete with time and may thus require updating. This may be done even once the business is up

and running.

Components of a business plan

There is no standard approach in preparing a business plan. There are many variations on the

theme of what exactly goes into a successful business plan. All the variations however have the

same basic elements. These are;

1. A brief description of the business background and purpose

2. Objectives: These should be both long term and short term

3. Products and services that will be offered

4. Competition

5. Market analysis and marketing strategy

6. Development and production plan/ Operations

7. Management and staffing


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8. Financial Plan: This includes current and projected financial statements

Other aspects of a business plan that may be necessary for a successful write up are;

1. Executive Summary

2. Attachments/ Supporting documentation

History and Background

The entrepreneur must have had a „moment of inspiration‟ that led him to start the business. An

idea must have been triggered by the need to fill a gap that he had identified. In this section, the

entrepreneur should communicate to the readers of the business plan how the idea was born.

This will also give a first impression to the investors or lenders who can then either give it

thumbs up or tread cautiously.

The business plan should clearly explain how the idea will be translated into profits. This is what

will give the investors a clearer understanding of the overall picture of the proposed business.

If the entrepreneur succeeds in winning the attention of the investor at this stage, he stands a high

chance of getting the funds he urgently needs. If this section flops, then no matter how well

written the other sections of the plan are, chances are high the reader will not be motivated to

read ahead.

Objective

The entrepreneur needs to be specific as to what exactly he targets to achieve through the

business plan. Most of the times, a business plan will be used to raise startup capital. At times,

the plan may be prepared to get additional finance. The objective has to be very clear to whoever

is intended to be the final reader.

Annual plans are used to manage a business. Business plans are used to attract capital. But there

are exceptions, and often the difference between annual plans and business plans becomes

muddled. Banks and other lenders or investors may require a copy of each year‟s annual plan.

And management may use the start-up business plan as a basis for operating the business.

The most important thing for the entrepreneur to bear in mind is keeping the primary objective of

and the primary audience for the plan clear. As a rule of thumb, if the plan will be used to attract

investors or lenders, this is the primary objective and outsiders are the primary audience. If the

plan will help manage the business, this is the primary objective and insiders are the primary

audience.

CPSPKREVISION.CO.KE – Proc. Costing & Budgeting

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Methods used in Cost Estimation and Forecasting

Cost estimation is a procedure used to measure costs of various items used in the process of

production. While cost forecasting is the process of accurately determining in advance the

cost that will be incurred in the process of manufacturing a particular product over a given

future period. There are various methods that can be applied by management accounts in cost

estimation and forecasting. The methods that can be used for this purpose are:-

a) Accounts classification (separating mixed costs) entails the examination of accounts

and regards and classifying each item of expenditure into fixed, variable and semi

variable. Although the method is quick and inexpensive, it is considerably subjective and

inaccurate.

b) Industrial engineering (cost estimation and forecasting) this is considered is the most

scientific method of establishing a cost standard. Work study techniques are applied to

determine levels of input needed to satisfy given levels of outputs. Those, inputs are then

turned into standards in order to estimate product cost in the future.

Advantages

1. It enables an organization to determine the most effective way to apply resources.

2. Standard can be set using efficient usage.

3. There is control of operation by comparing actual results with the expected results

Disadvantages

1. It is costly to use as it involves experts.

2. It is not effective for controlling many types of overhead costs.

3. It is not easy to apply in non-manufacturing activities since relationship between cost

and output cannot be determined.

c) High – low method (used for separating cost and cost estimation and

forecasting)

This method examines cost at high and low levels making an assumption that the increase

in cost between the two levels is directly due to the increase in activity and therefore

represent the variable cost. Two previous accounting periods are chosen one with the

highest activity level and other lowest activity level.

Steps involved

i) Select highest and the lowest activity level.

ii) Select corresponding highest cost and lowest corresponding cost.

iii) Obtain the difference in cost and the difference in activity level.


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iv) Divide the difference in cost by difference in activity to get the rate of variable cost.

v) Compute fixed cost by subtracting variable from total cost.

vi) Formulate linear prediction equation.

Example

The following data is provided:

Batch Size Labour Cost (Sh)

15 180

12 140

20 230

17 190

12 160

25 300

22 270

9 110

18 240

30 320

Required: Formulate linear prediction equation and estimate total cost for a batch of 35.

Solution

Rate of variable cost = 210 = 10/=per batch size

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Computation of fixed cost

Total cost 320

V. C. sh 10 x 30 300

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Y = a (fixed cost) + bx (rate of v)

Y = 20 + 10x

= 20 + 10 x 35


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= 370

Example

Andrew an automobile technician has been operating a garage in Narok for the past two

years. A year ago he converted part of his garage to a welding shop making and selling metal

doors and windows. He had anticipated that the cost of the wielding shop would primary be

final but has realized that the welding cost increased with the increase in with number of

welding job assignments. The costs of welding job assignments are as follows:

Period No. of welding job assignment Total cost „000‟ in sh

September 2008 280 700

October 2008 800 860

November 2008 1240 110

December 2008 1000 960

January 2009 600 720

February 920 910

March 2009 860 880

April 2009 1200 260

Required: Formulate an equation to estimate the total cost of the wielding shop and compute

the cost of undertaking 1256 assignments using:

(i) High – low method

(ii) Simple linear regression method

Solution (using High-low method)

Cost Activity

High 110,000 1,240

Low 700,000 280

490,000 960

Rate of variable cost = 490,000 = 427.08

960

Total cost 700,000


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Budgeting is a very crucial process in procurement. This is because it necessitates the

procurement staff to develop a procurement plan for a certain period of time.

Role of procurement staff in budgeting

Procurement staff is involved in:

(a) Conduct procurement needs analysis

(b) Drafting the list of your procurement needs – in line with your key objectives

(c) Analysis of reference total prices/costs estimates

(d) Listing of procurement needs adjustment to fit budget provisions

(e) Define the critical procurement KPI’s – cost, quality and time

(f) Monitor and Evaluate Progress.

Departmental Budgets

A tool projecting the income and expenses of a specific department in order to achieve its

financial goals. A departmental budget allows the firm to analyze the costs and expenses related

to a certain department and whether the firm's income is sufficient to meet these expenses.

Further, it enables management to measure its financial performance over time.

Project Budgets

When starting a project, it is difficult to know how much it will cost. Project managers are held

to account for their budget estimates and with so much uncertainty in projects, it can be one of

the project managers' greatest challenges.

The ability to create an accurate budget is an essential skill for a project manager. It can be a

daunting task, especially for new project managers.

There are two main approaches you can take when creating a budget:

1. Top-down approach: deciding how much the project will cost and dividing the amount

between the work packages.

2. Bottom-up approach: estimating the total cost of the project by costing the lowest-level

work packages and rolling up.

Both approaches have their advantages and disadvantages and as a project manager. Let's take a

look at each approach in more detail:


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Top-Down Budgeting Approach

The decision is made, often by senior management, about how much the project should cost.

This amount is divided between the work packages. Keep in mind that this approach is more than

guessing; you need to explain how you will do the work within the allocated amount of budget

for each work package. Prior experience from other projects will play a part in validating the

budget allocation for work packages. It should be asked whether the budget looks realistic based

on experience from past projects.

The advantage of the top-down budgeting approach is that it focuses on achieving the project

within the budget allocated and leads to efficiencies and reduction in wasteful practices.

A disadvantage of the top-down budgeting approach is that it assumes that the person creating

the budget has enough knowledge and expertise to make a reasonable cost estimate. If they do

not, conflict may occur when a person required to execute the project is given an unrealistic

budget that is insufficient to deliver the project. There is a risk of deliberately low budgets

created with the belief that it will encourage cost savings.

Bottom-Up Budgeting Approach

The team, often involving the final budget holder, identifies the tasks and activities needed to

complete the project. The project is based on the lowest-level work packages and rolled up to

arrive at the total project cost. The direct and indirect costs are calculated for each work package.

The advantage of the bottom-up budgeting approach is its accuracy (as long as you have not

missed any task or activity). It is good for team morale because the project manager involves the

team in budget creation. This approach is sometimes called participative budgeting for this

reason.

A disadvantage of the bottom-up budgeting approach is the difficulty in getting a full list of tasks

and activities needed to complete the project. It is easy to miss some that will be needed and that

will later throw the budget out. Different Cost Types

There are two cost types that concern project managers when they create budgets: direct and

indirect costs.


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Direct Costs

These costs are easily attributed to the project and charged on an item-by-item basis. Examples

are:

Labour (people)

Consultant fees

Raw materials

Software licenses

Travel

Indirect Costs

These costs are for items that benefit more than one project, and only a proportion of their total

cost is charged to the project. Examples are:

Telephone charges

Office space (rent)

Office equipment

General administration

Company insurance

Reserve Analysis

A contingency reserve or buffer is added to projects (usually a percentage of the total project cost

and time) to cover risk. This fund is used when encountering unexpected events during the

project. You should adjust your contingency reserve to the risk level identified for the project. A

routine, well practised project will have a lower contingency reserve than a project breaking new

ground.

Your budget will be made up of direct and indirect costs, with a small amount assigned for

contingency reserve.

Estimating Costs

In addition to the top-down and bottom-up budgeting approaches, there are a number of other

techniques that project managers use to create their budgets. These are five alternative

approaches used to create budget estimates:

CPSPKREVISION.CO.KE – Proc. of Consultancy Services

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1. Anything else required under the act or the regulations to be set out in the request for

proposals.

1. Expression of Interest

An expression of interest is a multistage process.

It is used to shortlist potential suppliers before seeking detailed bids from shortlisted tenders or

bidders.

It is generally used when the information required from the tenders is specific and the procuring

entity is unsure of the capability of suppliers to provide the required goods or services.

The accounting officer of a procuring entity may:

i) Request for proposal through advertisement.

ii) Invite expression of interest or utilize the register maintained by the head or procurement.

The notice inviting expressions of interest shall constitute the following:

i) Name and address of the procuring entity.

ii) Brief description of the consultancy services being procured and if applicable the goods

being procured.

iii) Eligibility and qualifications to be invited to submit a proposal.

iv) An explanation of where and when expressions of interest shall be submitted.

The notice inviting expression of interest prepared by a procuring entity shall give minimum

period of 7 days for tenderers to submit the expression of interest.

The accounting Officer of a procuring entity shall advertise the notice inviting the expression of

interest in the dedicated government advertising tender portal or in at least one daily newspaper

of nationwide circulation.

2. Terms of Reference

This refers to a document or statement that defines the background, objectives and purpose of the

proposal. It is also referred to as the scope of work or mandate.

It defines the objectives and the scope of evaluation, outlining the responsibility of consultancy

teams and provides a clear description of resources available.


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Contents of Terms of Reference

a) The background of the assignment including the various necessity of the procurement.

b) Terms of Reference should contain the objectives to be achieved by the procurement.

c) The deliverables expected from the person to be awarded the tender.

d) The qualifications necessary for the person to be awarded the tender.

e) The duration of the assignment.

f) Any other relevant information as may be required by the tender.

Preparation of terms of reference

Most organizations have standard rules in place for designing and publicizing consulting

opportunities and requesting qualifications or proposals from consultants. The specific steps for

developing the ToR for a consultation will vary according to this context. Recommended actions

that mark common decision points for preparing ToR across all types of organizations fall

broadly into two categories: those that should be completed before the writing of the ToR even

begins and those that should occur during the writing and review stage. The planning stage

comprises the following elements.

1. Establish the need and purpose for the evaluation. Before drafting the ToR, the

consultancy firm manager needs to first understand the skill or investment to be evaluated,

including its social and economic context. This orientation will help the manager to better

identify the objective(s) of the evaluation.

If the intent or potential value of the designated exercise is not clear or if there are no data

sources to support a reliable impartial evaluation process, then plans for this assignment should

be reconsidered before drafting the terms of reference.

In addition, a critical part of this early planning step will be to broadly consider the type of

evaluation needed to effectively achieve the targeted objectives within the desired timeline. The

scope, design, and methodology of evaluations span a broad spectrum and have direct

implications for the level of effort in terms of the tasks required and the length of engagement

2. Identify and engage stakeholders. Parties with a vested interest in the evaluation and

contracting process should be engaged throughout the process of developing the ToR; therefore,

it is important to identify relevant stakeholders and their roles early on. The list of stakeholders


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and their points of entry into the process will vary based on the organization and the nature of the

study, but likely categories for inclusion are the following:

a. The lead evaluation advisor or unit in the contracting organization

b. Technical staff engaged with the project or program in focus

c. Specialized staff responsible for contracting, procurement, or accounting arrangements

d. Partners for the project or program

e. Any advisory council or steering committee established for either the project or the

evaluation itself.

Once these stakeholders and their roles have been determined, they can be engaged at the

appropriate points in the ToR development process for contributions to content and quality

assurance.

It may be the case that the unit that commissions the evaluation is independent of the

administrative unit under which the program is implemented. In this case, the independent unit

may retain the right to the final shape and content of the ToR. Nonetheless, in order to

commission a fair, valid, and useful evaluation, it is good practice to confer with the

administrative unit early on.

3. Estimate resources available or needed for the evaluation. The process and flexibility for

establishing a budget will depend on an organization’s or partnership’s resources and practices.

Understanding the opportunities and constraints provided by the available budget will be

important for thinking through the scope and timeline of the evaluation and identifying who

should be involved. Evaluation contracts range from short-term assignments for individual

consultants costing under ksh100,000, to much more complicated large scale and/or long-term

studies implemented by teams for ksh900,000 or more.

The ToR does not necessarily identify the specific budget for consultants, but this area still needs

to be explored and clarified as part of the decision-making process.

4. Determine whether an internal or external evaluation consultant or team is needed. Both

internal and external evaluations are legitimate and each approach has advantages. Developers of

the ToR should decide whether the evaluation scope of work is best suited for an individual or a


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These factors include: Operations, Training, Maintenance, Environmental, Quality, Warehousing

and transportation and so on.

Identifying the total cost of ownership requires looking at the entire process of procuring and

consuming the product/service something that can only happen with cooperation and input from

both the buyer and seller.

Establishing the total cost of ownership mind-set is a goal that the procurement function needs to

embrace and perpetuate throughout the entire organization.

It may not be easy to convince the organization leadership to truly prioritize value over price.

i) Put the contracts under the procurement function

Procurement teams often negotiate significant potential savings during the sourcing process but

never fully realize them, reason being this may vary but often includes failure to communicate

contract terms to the affected department and units under failure to monitor contract compliance.

Too often, the executed contract is filed away and forgotten. More companies are moving the

responsibility contract to the procurement function rather than leave it unattended.

One benefit of this is ensuring the contracts are collected and maintained in a central repository.

The migration of the contract allows the head of the procurement function to more effectively

leverage the organization spend, particularly in the area of services where there is a greater

opportunity for reduction and risk mitigation.

Finally, take green initiatives and social responsibility seriously.

Buyers and consumers are taking environmental impact into consideration when they choose

supplier/service providers. More RFP ask suppliers/service providers about their green

initiatives.

Buyers/consumers are also considering social responsibility when making purchases. Social

responsibility consists of a framework of measurable corporate policy procedures that result in

behaviour designed to benefit the individual, organization and community.

Social responsibility is playing and increasingly significant role in best procurement

management decisions, in purchasing and risk evaluation.

1. Process Benchmarking

It gives numerical standards against which a client’s own processes can be compared.


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These are usually determined via a detailed and carefully analysed survey and interview. Clients

can then identify performance gaps, prioritize each action items and then conduct follow up

studies to determine the methods of improvement.

Performance benchmarking enables procurement managers to assess their competitive positions

via product and service comparisons.

It usually focuses on: Elements of price, Quality, Service Features, Speed, Reliability and other

performance characteristics.

2. Strategic Benchmarking

It identifies fundamental lessons and winning strategies that have enabled high performing

companies to be successful in their market places.

Strategic benchmarking examines how companies compete and its ideals for corporations with a

long term perspective.

Benefits of Internal Benchmarks

Identifying strengths and weaknesses

Shared learning across divisions

Results-led change and restructuring

Being better prepared for external benchmarking

It uses similar language, mechanism, system, culture, mind-set and top-management

support.

There is considerable ease in the access to data.

There are no problems in establishing communication between units.

The process does not involve confidentially problem in accessing data.

The returns of benchmarking efforts are relatively quick.

The approach is relatively silent, low profile, and a low threat affair.

It provides a test bed for quicker improvement.

Disadvantages of Internal Benchmarks

It lacks external focus and may foster complacency and lack of seriousness.

Internal weaknesses, such as cultural problem, leadership problem, etc., tend to remain

unaltered.

The results are generally marginal or just adequate improvement is visible.


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Benefits of External Benchmarks

An organization can compare with the best practices.

It helps organizations learn what type of practices work and they can be successfully

implemented.

They provide a basis for reviewing existing practices and developing new practices.

They also help managers to establish a strategy and set priorities.

Disadvantages of External Benchmarks

Danger of complacency and arrogance. Many organizations tend to relax after excelling

beyond competitors' standards, allowing complacency to develop. The realization of

having become the industry leader soon leads to arrogance, when considerable scope for

further improvements remains.

Benchmarking reveals the standards attained by competitors but does not consider the

circumstances under which the competitors attained such standards. If the competitor’s

goals and visions were flawed or severely restricted due to some specific factor, an

organization by benchmarking such standards runs the risk of trying to ape such flawed

standards or settling for extremely low standards.

Most of companies keep an eye on their competition instead of their own growth; it is

quite clear for all the company that such type of obsession with another company cannot

lead the company anywhere.

Challenges in Benchmarking for best practice in procurement of consultancy services

There are various difficulties involved in the process of improving by learning from best

practices. They include:

i) Having sufficient knowledge of your own system and processes to be able to compare

against others.

ii) Knowing where to find best practices.

iii) Knowing whether a particular practice is suitable for your situation.

iv) Adapting the practice to your organization.

v) Finding the time and other resources for all of the above.

CPSPKREVISION.CO.KE – Proc. Audit and Risk Management

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Types of Procurement Audit and reviews

1. Compliance/ Operational Audit

This involves a systematic review of the public entities procurement activities for the purpose of

assessing the efficiency, economy and effectiveness of procurement practices and controls

associated with procurement activities to determine the degree of adherence to procurement

laws, regulations and authorities in meeting the entities objectives and missions.

It includes a review for management control system for any activity, process, and function of

identification (risk assessment) of factors that may hinder the efficiency and effectiveness of the

function.

Its main objective is to determine whether procedures, processes and documentation for

procurement contracting are in accordance with the provisions of the relevant procurement laws

and regulations.

Purpose of this Audit

i) Assess performance.

ii) Identify opportunities for improvement of the procurement process.

iii) Develop recommendation for improvement of the procurement process.

iv) Verify compliance of operations with applicable laws and regulations.

How to achieve objectives of the operational audit

i) Reviewing and appraising the soundness, adequacy and application of operating

controls for the procurement process.

ii) Ascertaining the extent of compliance with established policies, plans or procedures.

iii) Ascertain reliability of reports issued to management.

iv) Appraising the quality of performance in carrying out assigned responsibility.

v) Recommending opportunities for operational improvements.

vi) Accounting for safeguarding assets.

vii) Ascertaining financial compliance.

viii) Ascertaining economy and efficiency in operations i.e. if the procuring entity is using

resources in an economical and efficient manner and determine the cause if any

uneconomical practices and inadequacy in the administrative procedures and

organisation structure.


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ix) Assessing program results, ascertaining desired benefits are being achieved,

objectives met and management considered alternatives that can yield results at lower

costs.

2. Value for Money Audit/ Performance Audit

This describes the combination of economy, efficiency and effectiveness within an organization

or its processes. The 3 concepts define the relationship between plans, objectives, inputs and

outputs.

Economy – Minimizing costs of resources used for an activity having regard to appropriate

quality.

Efficiency – Relationship between output in terms of goods or services and resources consumed.

Effectiveness – This is the extent to which objectives of an activity are achieved and relationship

between the intended and actual impacts of an activity.

In performing VFM audit, auditor should:

i) Clearly identify and appraise the framework of controls associated with the entity’s

VFM Strategy.

ii) Emphasize VFM considerations when planning for the audit works.

iii) Consider the need to adopt a particular approach to appraising value for money in

intensive systems.

iv) Ascertain the accounting officers requirements for VFM audits and if the organization

has adequate resources to meet the requirements.

v) Make clear the extent to which they intend to comment on VFM issues within their

statement of assurance in their procurement audit report.

Steps in conducting this audit

1. Understanding the process, the auditor should identify business objectives, high risk

procedures gaps in the processes and develop audit objectives and scope to focus on

VFM issues.

2. Identifying process gaps. May include: Identification of new controls needed for

improving the design for existing controls and those that could inhibit efficiency.


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3. Validating process performance measures and assess controls; involves value added

analysis of process design to validate performance measures which management relies

on.

4. Make process improvement recommendations; helps management improve effectiveness

and efficiency of the proc. process as well as controls in it.

Process of Risk Identification

Risk is a measure of a likelihood and consequence of an occurrence. Risk can also be identified

as anything that makes attainment of objectives difficult. It can also be defined as the probability

of an unwanted outcome happening.

Procurement risk is the potential of failures of procurement process designed to purchase

services products.

Risk management involves understanding and analysing the nature of the risk involved,

calculating the possibility of the risk event occurring, calculating the impact of the consequences

to offset or reduce the risk.

Risk assessment/Identification

This is the process within risk management that seeks to identify potentials problems or areas of

uncertainty.

It is the process of identifying all the potential things that might go wrong with an activity or

sources and estimating the probability of their happening coming up with mitigation measures.

Risk Mapping

Any assessment of the soundness of the procurement system will have to study the policies and

processes of risk management adopted by the public entity.

This is the first step in risk assessment.

1. Procurement function

An analysis is done on the legal basis for existence of operations of procurement agency by

considering issues such as:

a) Are the operations set forth clearly in a well-organized and documented manner in

accordance with the applicable laws?

b) Are the means of financing procurement clearly stated and in accordance with the law

and budgetary requirement?


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This is the formulation of a chosen approach/plan to deal with identified risks. Managers

formulate strategies using risk management cycle and selecting the most appropriate risk

mitigation options.

The 4-Ts of risk

1. Tolerate – Accepting the risk. This is where the assessed likelihood or impact of the risk

is negligible or there is no viable way to reduce the risk. The risk may be acknowledged,

registered or flagged for monitoring and periodic evaluation in case the likelihood or

impact of the risk escalates to defined threshold.

2. Transfer – This happens by taking an insurance cover or using dual or multi-sourcing or

using contract terms to ensure the cost of risk events will be born or shared with supply

chain partners.

3. Treat -- Implies taking active steps to manage the risks in such a way as to reduce or

minimize its likelihood, potential impact or both.

4. Terminate – If risk associated is too great or can’t be reduced, the organization may

consider not investing or engaging on the opportunity. It avoids unacceptable risk but is

not always possible. In addition, there may be loss of opportunity.

An integrated systematic and strategic level approach to risk management involves the following

elements:

i) Integrated management of an organization full spectrum of risk.

ii) Requires dealing with risk as a strategic issue from a high level corporate perspective.

iii) Recognizing fact that strategic success depends on your appetite towards risk.

iv) Engaging all functions and align all management level in the process.

v) Bringing the silos of risk disciplines.

Risk Management Process/Cycle

It is an expression of a continuous process of risk monitoring and management. It involves:

1. Risk identification

2. Risk analysis

3. Risk mitigation


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Identify sources of risk

Monitor report; adjust accordingly Assess probability and impact of potential

risk

Implement risk management plan Formulate risk management strategy

Allocate accountability and resources for managing risk

Steps in Risk Mitigation Process

i) Allocation of responsibilities for managing the risk.

ii) Identifying resources required to mitigate the risk.

iii) Develop action plans including resource budget and timescale.

iv) Obtain management approval for risk mitigation plan.

v) Obtain shareholder acceptance and coordinated effort for the risk mitigation plan.

vi) Outlining the risk reporting requirements for engaging risk requirement.

Contractual remedies for managing risks

1. Managing risk via the contract itself

The purpose of a contract is to set up roles, rights and obligations of both parties in a legal

relationship.

In management of contract performance, a contract is basically a statement of.

a) Exactly what 2 or more parties have agreed to do or exchange.

b) Conditions and contingencies which may alter the agreement e.g. circumstances under

which it could not be reasonable to enforce certain terms.


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c) Rights of each party if the other fails to do what has been agreed upon.

d) How responsibility or liability will be appointed in the event of a problem.

e) How disputes will be resolved.

Contract development and risk management

Contracts can be used to minimize or mitigate a range of supplier risks.

Remedies for contract failure

1. Injunction.

2. Quantum merit.

3. Specific performance.

2. Contract performance

Potential Risk Contract Provisions

Supplier delivers the wrong

quantity

Ensure there is quantity to be supplied, how

quantity delivered should be established, who

should deal with any supplier query

The product is not made to correct

specifications

Contract provides the product specs and sets out

how rectification should be made in case it is not

supplied according to specifications.

Buyer fails to pay supplier invoice Contracts specify when payments should be due

and what happens in case of delay

Supplier is late with delivery How late deliveries should be dealt with, whether

time is of essence to the delivery entitling the buyer

with additional remedies.

The product may be dangerous to

handle

Contract specifies how the product should be

delivered and packaged to avoid health and safety

risks.

A dispute arises Dispute resolution clause detailing procedures to be

involved.

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CPSPKREVISION.CO.KE – Quantitative Techniques

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Types of Quantitative Techniques

Differentiation

A popular type of quantitative technique is differentiation. Differentiation is a mathematical

process involving calculus and it is useful for seeing change over time within a given system.

Differentiation is generally used to figure out the changes in a system when a variable in the

system changes, measuring how the end result changes by altering a variable. This could be

used in many ways: in cooking, chemistry, and many physical sciences, yet it is less useful in a

social science. Differentiation also has an opposite, integration, which works in the opposite

way. Integration is used to see the changes to a variable when the system changes.

Regression Analysis

Regression analysis is incredibly useful and a whole host of people use this technique every

single day in their business life. Generally, economists are interested in the concept of

regression analysis, which is based around finding a causal link or correlation between two

independent variables in any given system. A common example for regression analysis is that of

measuring the salary of an employee and their level of education, to see if there is a correlation

between the two factors. You could also use this in cooking and many other fields, as you can

see. Regression analysis is useable in many fields and will save you time if you learn how to use

it and integrate in to your business.

Regression analysis uses two sets of data, predictors and independent variables. These values

can be anything, from total revenue to tax rate to advertisement budgets and so on. Comparing

the two is the basis of regression analysis.

Simulation

Simulation is a great way to get pseudo real world data on anything that can be simulated

effectively in a controlled environment. If you can simulate a scenario effectively, you can then

see how test subjects respond to stressors and often this information is very valuable. It’s not

just used for living things however, a wind tunnel is a widely used simulator to test the

aerodynamics of cars and other objects. This data allows the manufacturer to make tweaks in

design and concept and can show data which may lead to the product being discontinued before

production starts. This is obviously a good thing as recalling product lines is costly and should

be avoided at all costs. Simulation allows these kind of usability tests, even in unlikely

scenarios.

Factor Analysis


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Factor analysis is another often used data technique used for quantitative data analysis. This

type of analysis tries to thin down the amount of data that is available to be used by exploring

the similarities between multiple sets of data. This way, you can analyze the overall trends that

are hiding in the data without having to figure these out yourself. Market researchers and

economists are very avid users of Factor Analysis as it makes trawling through large sets of data

received from surveys easy and quick.

Indexes

Another one for the economists, indexes are a fantastic way to use quantitative research to

simplify and share data with the general public in an efficient and easy manner. Indexes are all

over the finance world, with each of the major stock exchanges (NASDAQ etc.) having an

index as a representation of how the financial market is doing. Analyzing indexes is useful as

they are a useful way to see how the overall trend of a given environment is behaving. People

base decisions worth hundreds of thousands of dollars on the existence of stock market indexes

every day and without quantitative analysis and research this wouldn’t be possible.

Game and Probability Theory

Game Theory is a class of thought that aims to find the most optimal strategy in any given

scenario. It achieves this by using quantitative methods and thought experiments and always

finds the optimal course of action in a competitive situation. This type of quantitative technique

is slightly less applicable to business, yet very useful if you find yourself in a situation where

you are unsure of the options.

The “Prisoner’s Dilemma” is a very common instance of game theory, showing why two people

may not cooperate with each other, even if cooperation is the best move, statistically. In the

canon of the Prisoner’s Dilemma, two prisoners are offered one of three options to remedy their

current situation. They are offered the chance to testify about the other person, getting released

from prison at the expense of the other prisoner spending times in the jail. The other option is to

be quiet, not telling the officer anything. If both parties stay silent, both parties are in jail for a

year, whereas in the other scenario, the jail time served is greater. This shows that the correct

thing to do is stay silent. Of course, in that situation, you would probably try to get out of jail by

offering evidence against the others. The dilemma occurs as both parties are given these

options, meaning if both parties try to get no jail time, they both end up in jail for longer.

Quantitative thinking techniques like these allow people to make more logical and useful real

world decisions and are a cornerstone of advanced logical reasoning.


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Probability theory is useful to use in conjunction with statistics allowing someone to semi-

accurately predict how someone or something will act in a given situation, assuming you have

access to all of the necessary data. Probability theory is useable to see patterns in apparent

randomness. This is how we know that the probability of getting a heads or tails on any given

coin flip is equal. The coin flip itself is random, yet over time it averages out to a 50% chance

of heads or tails.

Quantitative Data Collection

As mentioned above, the best way to collect non-biased and useful quantitative data is choosing

to conduct double or triple blind experiments which allow more accurate results for a given

portion size. Quantitative data can also be collected in many other ways, depending on the

situation you are trying to gather data upon. For data from inanimate objects, you can use

sensors and electronic surveying tools to gather numerical data. When you are trying to get

quantitative data from people, it is a little more difficult to get accurate data. Surveys and

questionnaires will get you some useable data but the data from these may be inaccurate. Many

people will answer untruthfully on a questionnaire for lots of different reasons. If you need to

find data on objects or the general population, city records and other standardized records will

be of a great help to you. For products, most manufacturers will keep records of their product

specifications, for the general public to browse. This is helpful for techniques, which need

complete information to use, such as testing audio or visual equipment and tests of this sort.

Areas where Quantitative techniques are applicable

Finances

One area where quantitative techniques are applied in business is in the area of finances. Some

of the models that financial managers and analysts use are return on investment, decision trees

and net present value. Financial analysts determine how much profit a particular product brings

in versus the costs of producing that product. They run regressions and analyses to note trends

over time and determine how much to invest in a particular business line. Financial analysts

also use quantitative methods to determine productivity and whether or not to hire, retain or lay

off workers. They use quantitative data to manage risk and create investment vehicles.

Advertising

Advertisers use quantitative data to determine how many viewers or readers will see a particular

advertisement in a particular medium. They use data from rating services to find out how many

people click on a certain website or watch a particular television show at any time. Advertisers


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A linear equation represents a set of points which lie on a straight line. A linear inequality

represents an area of a graph. For example, x ≤ 7 says that X takes a value which is less than 7 or

is equal to 7. The situation can be illustrated graphically as follows. Draw the line x = 7, see left

hand graph in the graph below. This divides the graph into three sets of points for which x = 7,

the line itself; those for which x < 7, the area to the left of the line; and those for which x > 7, the

area to the right of the line. We do not require this last set. It is usual to shade the area not

required. See, the right hand graph in Diagram below

Graphical representation of the inequality x ≤ 7

Suppose x + y ≤ 10, which area does this represent? The procedure is the same as in the previous

example. First of all we draw the line x + y = 10. See the left hand graph below. Again the line

divides the graph into three sets of points: those for which x +y = 10, the line; those for which x

+ y < 10, the area below the line; and those for which x + y > 10, the area above the line.

A useful technique for deciding which is the rejected area on the graph is to take any point on the

graph away from the line and substitute its values into the inequality. If the inequality still makes

sense, then that point is feasible solution. If the inequality is untrue, then the point is infeasible

and lies in the rejected region. The origin is a convenient point to use. Substitute x = y = 0 into

the inequality x +y ≤ 10, we have 0 + 0 ≤ 10 which is a true statement, therefore the origin is a

feasible solution and we should reject the other side of the line. See the right hand graph I figure

below


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Graphical representation of the inequality x +y ≤ 10

Each constraint in the linear programme can be drawn in this way and the rejected area shaded.

If all of the constraints are drawn on the same graph, the area which remains unshaded is the set

of points which satisfies all of the constraints simultaneously. This area is called the feasible

region. For a linear programme, it does not matter which variable is plotted on which axis. The

origin should always be included on the graph. False zeros must not be used. Let us now apply

this procedure to the linear programme for example about the production of the two types of soft

drink. We can illustrate the constraints graphically.

Machine time; 0.02p + 0.04 m≤ 24 hours/day.

Plot the line 0.2p + 0.04 m = 24. An easy way of plotting the line is to find the points where the

line crosses the p and the m axes. Put p = 0 into the equation and calculate p, i.e. when m = 0, p =

1200. Plot these two points and join them to give the line. This method always works unless the

line passes through the origin. In that case revert to the alternative procedure of substituting any

other value of p and finding the equivalent value of m.

To find which side of the line to shade put p = 0 and m = 0 in the inequality:

0.02 x 0 + 0.04 x 0 < 24

This statement is true, so the origin is included in the feasible area

Special ingredient: 0.01p + 0.04m ≤ 16

Then you plot the line:


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0.01p + 0.04 m = 16

Again the origin is included in the feasible region so we shade out the area above the line

Shade out negative values of each variable

Putting these four constraints together on one graph gives:

Graphical representations of the constraints for example 1

The area left unshaded by all of the constraints is the feasible region and this contains all of the

possible combinations of productions which will satisfy the given constraints. The co-ordination

of any point within the feasible region represents a possible combination of soft drink production

for this firm.

We must now consider how to choose the production which will maximise the firm’s daily

contribution. The objective function is:

P= 0.01p + 0.30m (£/day)

If we like p = 100 £ per day, then we can illustrate the objective function graphically. If we then

give p another value, the new line will be parallel to the one for p = 100 £ per day.

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CPSPKREVISION.CO.KE – Category Management

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benchmarking, bidding or reverse auction could be used.

The sourcing and short listing step should provide a short list of:

KPIs:

-Suppliers who meet qualification criteria.

-Suppliers who rate among the best in what they offer. (Bench marking exercise can apply here)

-Long term-focused suppliers, willing to be bound in to long term and mutually beneficial

business relationships.

1. Negotiating and selecting suppliers

Negotiation is applicable where there is disagreement or potential disagreement between

suppliers and buyers.

Based on the strategic requirements, shortlisted suppliers or bidders (at least 3 per category)

must be invited to a final ‘face to face’ negotiation. This negotiation approach is preferable; as

personal traits and gestures are better observed here than is otherwise the case.

At this stage, ABC Classification of suppliers can assist in categorising and finally selecting

suppliers based on their capabilities.

Just as is the case in all businesses, time is money in procurement. Therefore negotiations must

not drag on forever.

KPIs:

Negotiations must:

-Bring unity and discipline in pursuit of set objectives.

-Achieve fair terms and conditions that solidify team work.

-Encourage mutual concessions aimed at removing impasse.

-Produce an effective unit that can outwit competition.

In strategic negotiations, parties must pursue a win – win (collaborative) approach. This ensures

that; while the buyer gets right quality and quantity at the right price, place and time, the

supplier equally makes a reasonable return.

No consistency in performance would prevail where returns do not match the effort.

2. Drawing and signing a buyer – supplier contract

Contractual agreement is the immediate step after negotiations. They take effect between two

legal subjects; one intending to sell (offering) and the other intending to buy (accepting).

The core purpose of contracts is to formalise the buy – sale agreements between consenting

parties.

KPIs:

Among other things contractual agreements must:


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-Be drawn and signed off immediately after agreement.

-Outline the agreed performance, pricing, terms, conditions, rights and obligations for both

parties.

-Outline the period (beginning and ending) of an agreement.

-Clarify on how risks and cost of unexpected occurrences will be shared.

-Outline penalties for willful misconduct and remedies for non-performance.

Contractual agreements in procurement professionally address all pertinent issues including

survival and nonexclusive clauses.

3. Issuing of orders (the actual buying)

After contractual agreements, the strategic procurement team should issue out a well specified

order, a requisition order.

Depending on the agreement, some suppliers require deposits (e.g. a percentage of total cost

price) before arranging and dispatching orders.

KPI’s:

Orders must be:

-Specific (i.e. quality, quantity, time and place) for easy conformance.

-Cost effective. For instance, ‘consignment inventory’ and ‘bulk purchase’ systems significantly

minimise storage cost for suppliers and transportation cost for buyers respectively.

4. Receiving, inspecting and recording supplies

All receipts must be well recorded; damages, rejections or returns must be immediately reported

to the supplier.

Most delivery documents includes a notice for buyers to notify suppliers on faults, damages or

shortages within seven days of receipt; failing which complaints would not be acceptable.

KPIs:

-Receipts (i.e. procured products or services) must meet quality and other agreed performance

standards.

-Packaging order and material should respond to the agreed requirements.

-Rejections, shortages and damages must be recorded, returned or reported to suppliers as

quickly as the agreement requires. These records must be kept for a final supplier performance

analysis exercise.

To simplify stock taking (particularly for transiting goods), bundle receipts should be recorded

as packages, while loose items should be recorded by their specific names.

5. Issuing payments to suppliers

Upon receiving, checking and verifying goods or services, procurement departments must

notify relevant parties (including remittance teams or paying masters/financial institutions) on


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the order and condition in which these goods or services are received, effectively authorising

payment release or the opposite.

KPIs:

-Early payment terms (e.g. 2/10 net 30) should be utilised for as long as they are worthwhile.

-In the absence of early payments benefits, payment should only be made in the final days of

the agreed grace period.

– Account (credit) procurements should be preferred to ’up front’ or ‘cash on delivery’

acquisitions.

-Cash payments should be discouraged; while closed cheques, electronic funds transfers (EFT)

and bank’s letter of credit payments must be encouraged.

6. Performance assessment and management

In strategic procurement, performance assessment and management is an ongoing process of

ensuring that suppliers meet or possibly exceed performance expectations.

KPIs:

-Rejection rate (value of goods rejected /value of goods received) should be minimised.

-Long term relationships and team work spirit must be built and strengthened.

-Corrective consultations between parties must be encouraged.

In the current -fiercely competitive- global market, continuous improvement on operating

systems is no longer a luxury but a sturdy weapon for sustainable growth and success.

7. Receiving, inspecting and recording supplies

All receipts must be well recorded; damages, rejections or returns must be immediately reported

to the supplier.

Most delivery documents includes a notice for buyers to notify suppliers on faults, damages or

shortages within seven days of receipt; failing which complaints would not be acceptable.

KPIs:

-Receipts (i.e. procured products or services) must meet quality and other agreed performance

standards.

-Packaging order and material should respond to the agreed requirements.

-Rejections, shortages and damages must be recorded, returned or reported to suppliers as

quickly as the agreement requires. These records must be kept for a final supplier performance

analysis exercise.

To simplify stock taking (particularly for transiting goods), bundle receipts should be recorded

as packages, while loose items should be recorded by their specific names.


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Make-or-buy decisions also occur at the operational level. These considerations that favor

making a part in-house:

Cost considerations (less expensive to make the part)

Desire to integrate plant operations

Productive use of excess plant capacity to help absorb fixed overhead (using existing idle

capacity)

Need to exert direct control over production and/or quality

Better quality control

Design secrecy is required to protect proprietary technology

Unreliable suppliers

No competent suppliers

Desire to maintain a stable workforce (in periods of declining sales)

Quantity too small to interest a supplier

Control of lead time, transportation, and warehousing costs

Greater assurance of continual supply

Provision of a second source

Political, social or environmental reasons (union pressure)

Emotion (e.g., pride)

Factors that may influence firms to buy a part externally include:

Lack of expertise

Suppliers' research and specialized know-how exceeds that of the buyer

cost considerations (less expensive to buy the item)

Small-volume requirements


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Limited production facilities or insufficient capacity

Desire to maintain a multiple-source policy

Indirect managerial control considerations

Procurement and inventory considerations

Brand preference

Item not essential to the firm's strategy

The two most important factors to consider in a make-or-buy decision are cost and the

availability of production capacity. Cost considerations should include all relevant costs and be

long-term in nature. Obviously, the buying firm will compare production and purchase costs. The

major elements included in this comparison. Elements of the "make" analysis include:

Incremental inventory-carrying costs

Direct labor costs

Incremental factory overhead costs

Delivered purchased material costs

Incremental managerial costs

Any follow-on costs stemming from quality and related problems

Incremental purchasing costs

Incremental capital costs

Cost considerations for the "buy" analysis include:

Purchase price of the part

Transportation costs

Receiving and inspection costs

Incremental purchasing costs


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Any follow-on costs related to quality or service

SWITCHING COSTS

Switching costs are the costs that a customer incurs as a result of changing brands, suppliers or

products. Although most prevalent switching costs are monetary in nature, there are also

psychological, effort- and time-based switching costs. A switching cost can manifest itself in the

form of significant time and effort necessary to change suppliers, the risk of disrupting normal

operations of a business during a transition period, high cancellation fees, and a failure to obtain

similar replacement of products or services.

Breaking down 'Switching Costs'

Successful companies typically try to employ strategies that incur high switching costs on the

part of consumers to dissuade them from switching to a competitor's product, brand or services.

For example, many cellular phone carriers charge very high cancellation fees for canceling

contracts in hopes that the costs involved with switching to another carrier will be high enough to

prevent their customers from doing so. However, recent offers by numerous cellphone carriers to

compensate consumers for cancellation fees nullified such switching costs.

Switching costs are the building blocks of competitive advantage and pricing power of

companies. Firms strive to make switching costs as high as possible for their customer, which

lets them lock customers in their products and raise prices every year without worrying that their

customers will find better alternatives with similar characteristics or at similar price points.

Example of Low Switching Costs

Companies that offer products or services that are very easy to replicate at comparable prices by

competitors typically have low switching costs. Apparel firms have very limited switching costs