Image: Singapore Finance District, by Joan Campderros-i-Canas, CC license

“Financials” is a term used by software vendors and others that normally includes accounts payable, accounts receivable, balance sheet and P&L. There can be extensions of this definition to include such areas as payroll, treasury (bank account inflows and outflows), and tax management.

In an ERP system, all of the required financial postings are made as other transactions take place. A shipment to a customer generates an invoice and posts the accounts receivable for that customer. Production of finished goods creates inventory with its corresponding value on the balance sheet. Benefit: reduction in administrative labor needed to manually post transactions from one system to another.

Because the Finance module in an ERP system records all the operating transactions, that data resides in the main ERP database, which means it can be extracted for reporting and analysis purposes.

If the Finance module is “robust” enough, it will already have built-in queries or user-defined reports to analyze the basic transactions such as sales by customer, manufacturing costs by product, and other “intelligence” needed to manage the enterprise.

But my experience is that a standard ERP system never satisfies the analytics needs of a good finance department. In this case, you have two choices: spend a good part of your budget building custom reports in the ERP system (not recommended), or invest in an application-neutral reporting database.

This means more information is available that is critical to evaluating the performance of the business. Calculating actual dollar benefits of a new ERP system here can be difficult, but consider what you could save if you knew things like how much overtime pay you incur and in what areas of the business, how much profit or loss you are trending year to date, and which products generate the least profit margin.

ERP systems usually define authorization levels for different types of users, allowing control of sensitive transactions. The Sarbanes-Oxley law and other regulations require separation of duties to ensure financial controls are followed. Benefit: centralized control of transactions users have access to and a system infrastructure that satisfies auditor requirements.

An ERP system can enable you to match invoices with receipts and purchase orders so that what you pay for is what you ordered and what you received. The purchase orders, receipts, and invoices are all in the same system, so the system can compare them and immediately determine if the invoice is valid and should be paid or if it’s not. Benefit: elimination of overpayments or duplicate payments to vendors, reduction of paperwork and manual comparisons reducing administrative overhead.

An ERP system can also manage your contracts with vendors, including pricing and terms of payment. This means that data from invoices can be instantly compared to contractual terms to make sure the invoice is correct. The benefit is the same as above – elimination of overpayment. If your enterprise is large and is processing a large volume of vendor invoices you are bound to have at least a small percentage savings – say 5% of the amount you spend — and 5% of a big number may be enough to pay back at least part of the ERP investment.

A price-shopping or auctioning application or an online buying service can be an extension of the ERP system so that you can search for the best price for your materials, goods, or services, select the vendor, and place the order. Usually these apps and web-available services are specialized according to what you are buying, such as transportation and delivery services, office supplies, basic materials such as standard corrugated packaging, shrink wrap, paper stock, chemicals and industrial supplies, and more recently energy sources such as electricity and natural gas. Benefit: getting the best price and terms and automatically creating a purchase order which is integrated to your financial system for proper payment. Again, the dollar benefit can be a percentage of your total spend, especially if you think you haven’t opened up your purchasing to alternative vendors for awhile.

When purchasing is part of your ERP the proper postings to financial accounts are automatically done. When you issue a purchase order an entry is made in the ERP system that authorizes receipt of whatever you are buying. When you receive what you are buying a payable is created which goes on the balance sheet as a liability. All the accounting is taken care of.

Inside a Red Wing shoe factory.  Photo by Nina Hale, cc license.

The supply chain – a term used to describe all the activities needed to bring goods to market, is a natural beneficiary of a good ERP system because the supply chain extends from one end of an enterprise to another. Often the individual parts of a supply chain run on their own systems – a system for raw materials, another for planning finished goods production and deployment, and so on. It’s possible to have three or four separate systems running different parts of the supply chain. With an ERP system, all parts of the supply chain are connected to one another.

All of the costs and activities associated with each part of the supply chain are in one place, and they are mutually dependent on one another as either inputs or outputs. It is at least theoretically the logical software equivalent of the connected enterprise. And if the enterprise is truly connected and coordinated, then theoretically there is never any wasted inventory, lost sales, out of stocks, overproduction, late deliveries, etc.

A good ERP system will coordinate the supply chain like this:

• It will have a sales forecasting module that allows users to source historical sales data and model it to derive projected sales;
• The projected demand, by day, week, and month, will automatically determine quantities of raw materials needed, where, and when;
• The required materials will automatically be converted to purchase orders for those raw materials;
• The projected demand will determine a production schedule by plant and a schedule of where the finished goods are to be shipped;
• Sales orders are received, checked, confirmed, and sent to the warehouse or distribution center for shipment;
• Sales orders will “consume” a sales forecast so that managers can track shipments against projected sales;
• Sales orders will be routed for delivery via the most efficient method of transportation and transportation providers will be confirmed and scheduled;
• Inventory will be shipped to distribution centers according to the geographic demand of product;
• Distribution centers will receive sales orders for shipment, and shipments to customers will recorded, posted to financials, and used to generate an invoice;
• Warehousing and transportation costs will be posted back to the financial system and the corresponding accounts payable will be created.

For more on this topic, Gartner has some interesting research here.

In many cases I think traditional ERP is becoming more and more unnecessary.

I don’t mean that the concept of ERP is become unnecessary, just the traditional ERP on the traditional platform as we have known it for the past 15 years. In the future I imagine the following trends will bring about this prediction:

• Enterprises will no longer be willing to spend huge sums for year(s)-long projects where they end up owning, hosting and caring for software that requires upgrades every 18 to 24 months, not to mention the expense and management of IT staff to support the data center, integrations, system backups and nonstop user demand for new features and changes to the software.
• Organizations will trend away from capital investments in software and toward paying for software as an operating expense. This is because: 1) a large capital project is much harder to sell than a relatively small long-term increase in operating expense; 2) associating software expense directly to the function that uses it is a better accounting practice; 3) in an ROI calculation, the added operating expense of a SaaS model only has to be offset by yearly savings brought about by the new application, instead of requiring that three or so years of annual savings pay for the entire cost of the new system.
• The software market will continue to offer new products and services that, while not a complete ERP system, could replace large components of an on-premise ERP.
• Companies will begin to piece together “point” solutions – single-purpose applications – in the cloud as SaaS solutions. By networking their applications in the cloud, they will achieve better functionality, far greater flexibility and lower cost than a traditional ERP system

This trend is not where the big ERP software vendors want to go. To them, the traditional model is quite profitable enough, thank you.

So there is opportunity for you.

• Identify the parts of your enterprise that gain the most from new software solutions
• Identify the information or transaction flows that must be integrated to realize the full value of your project
• Concentrate on software that helps you achieve 1) and 2); if it is a full ERP system then so be it, but I think the value can be isolated and realized in those important areas without making the huge investment a traditional ERP project requires.

ROI, or Return on Investment, is essential to making the right decision about enterprise software. In simple terms, ROI is the percentage return you are realizing on the money you spent on the software.

ROI = ($ benefits per year minus additional yearly costs from the application) divided by the costs of implementing the new system.

If you spend $2 million up front for an application and another $400,000 per year to maintain it, and the benefits produced amount to $700,000 per year, the ROI would be ($700,000 minus $400,000) divided by $2 million, or 15%.

What ROI should you get from a successful system investment? That depends on your company’s strategy and overall approach to these types of projects. But I would say 30% to 40% should be a minimum. That’s because an annual rate of return in this range would “pay back” the original investment in about three years, which is about the timeframe within which better software options may exist in the market.

Payback is another way to quickly assess the relative attractiveness of a system implementation. In simple terms, payback is the number of months or years it takes for the financial benefits to “pay back” the original investment.

In the example above, the upfront cost was $2 million and the net annual savings were $300,000. So how many years would it take to pay back the $2 million? The answer is $2 million divided by $300,000, or almost seven years. Using the three year payback guideline, this particular example would be a loser.

Where do the benefits come from? Benefits don’t come from the software – but from what you do with the software. If a new system is integrated in your company but nothing else changes you will get – zero – benefits.

One example:

You are a manufacturer but you track all of your costs on spreadsheets. A shop floor application and standard costing system would show you where you are wasting money and which products cost the most to produce and why. If you know these things you can cut the waste and consider different pricing for more expensive-to-produce products.

At the very basic level, an ERP system can enable you to match invoices with receipts and purchase orders so that what you pay for is what you ordered and what you received. The purchase orders, receipts, and invoices are all in the same system, so the system can compare them and immediately determine if the invoice is valid and should be paid or if it’s not. This can eliminate overpayments or duplicate payments to vendors, reduction of paperwork and manual comparisons reducing administrative overhead.

An ERP system can also manage your contracts with vendors, including pricing and terms of payment. This means that data from invoices can be instantly compared to contractual terms to make sure the invoice is correct. The benefit is another way to eliminate overpayments. If your enterprise is large and is processing a large volume of vendor invoices you are bound to have at least a small percentage savings – say 5% of the amount you spend — and 5% of a big number may be enough to pay back at least part of the ERP investment.

A price-shopping or auctioning application or an online buying service can be an extension of the ERP system so that you can search for the best price for your materials, goods, or services, select the vendor, and place the order.

Usually these apps and web-available services are specialized according to what you are buying, such as transportation and delivery services, office supplies, basic materials such as standard corrugated packaging, shrink wrap, paper stock, chemicals and industrial supplies, and more recently energy sources such as electricity and natural gas.

The benefits here are getting the best price and terms and automatically creating a purchase order which is integrated to your financial system for proper payment. The dollar benefit can be a percentage of your total spend, especially if you think you haven’t opened up your purchasing to alternative vendors for awhile.

When purchasing is part of your ERP the proper postings to financial accounts are automatically done. When you issue a purchase order an entry is made in the ERP system that authorizes receipt of whatever you are buying. When you receive what you are buying a payable is created which goes on the balance sheet as a liability. All the accounting is taken care of, and your financial controls are in place as long as your system permissions reflect proper internal controls. This is a huge benefit for regulatory compliance and tax audits.