I hope that you have enjoyed the article, “Tricky Cost Savings Calculations.”
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In the article, I walked you through four calculations that you may use in situations where calculating cost savings is not cut-and-dried. I’d like to take this opportunity to walk you through an example.
Let’s say that your price for an item was $100 on January 1 of last year. You bought 300 units at that price until the price changed to $90 on October 1 of last year. You bought 100 more units at that price last year and 100 more units in the first quarter of this year. Then, for the rest of this year, you bought 300 units at $85.
What is your cost savings for this year?
Some procurement professionals, in an effort to boost their cost savings numbers, would say that each unit they bought for $90 would produce a savings of $10 and each unit they bought for $85 would produce a savings of $15. That would result in a cost savings of $5,500.
That’s not correct!
The correct cost savings is $3,600.
“Whaaaat?,” you ask. Let me explain…
The issue with the calculation of $5,500 in cost savings is that the highest price from last year should not be your baseline.
So, what should be the baseline? $90?
Nope, not that either.
Walking through the calculations from the article…
Calculation A: Last Year’s Average Price = Total Spent Last Year / Number of Units Purchased Last Year
Last Year’s Average Price = ((300 x $100) + (100 x $90)) / (300 + 100)
Last Year’s Average Price = ($30,000 + $9,000) / 400
Last Year’s Average Price = $39,000 / 400
Last Year’s Average Price = $97.50
Calculation B: This Year’s Average Price = Total Spent This Year / Number of Units Purchased This Year
This Year’s Average Price = ((100 x $90) + (300 x $85)) / (100 + 300)
This Year’s Average Price = ($9,000 + $25,500) / 400
This Year’s Average Price = $34,500 / 400
This Year’s Average Price = $88.50
Calculation C: This Year’s Cost Savings = (Last Year’s Average Price – This Year’s Average Price) x Number of Units Purchased This Year
This Year’s Cost Savings = ($97.50 – $88.50) x 400
This Year’s Cost Savings = $9.00 x 400
This Year’s Cost Savings = $3,600
So, each unit purchased will contribute to cost savings by the difference between the price paid and a baseline price of $97.50.
Got it?
Good!
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