Cost Cutting through Root Cause Analysis

WICMA - Magazine Feb 2015

I want things cheaper so when I bought this pair of jeans from a retail outlet I was gushing at the discount I got compared to a branded one which I had bought earlier. It is a different thing that the fitting was not right and the material felt rough. But I sidetracked those concerns considering the savings. However, after few rounds of wash, the stitching started getting frayed and the material stretched unevenly. In the end I was pretty upset that my great bargain deal was such a flop. Well, it was bound to be for obvious reasons!

Everyone wants everything cheaper these days but the best of the quality. How much cheaper? Honestly, most people don’t know the answer to this question so anything lesser than the price currently being quoted is great. Why don’t people know how much cheaper? Because they don’t have the capability to figure out the method to calculate or are too lazy to do the legwork.

This is a constant demand in our packaging business too. Customers want cheaper cartons while insisting that we stick to their quality requirement. Most purchasers consider this to be the easiest way of saving costs. There are quite a few reasons; one of them being priority of payment. Packing material suppliers are the last ones to be considered while scheduling payment. There is too much competition in this segment and the work is not rocket science hence, every supplier can be replaced easily (well most of the time).

But the chief reason is lack of hard work and analysis. If one really wants to save costs, they need to fundamentally change the product and processes not the 1 or 2% of the packaging cost. There are ample scope for improvements and waste reduction if the basic product itself is analyzed and redesigned. But this requires serious involvement and hard work. It requires time and resolve to conduct root cause analysis. There is need for data collection, analysis, testing and rechecking. Most people are hence content with reducing the packing material cost which is least hard work and creates the illusion of saving and becoming cost competitive! It is when more international biggies come into the market will these companies realize what is competitive edge?

Businesses do not understand that there are other ways of properly reducing packaging costs. One good idea is to put some serious brains into design and drawing specifications. The designer quite often simply copies an existing template and changes dimensions. If you ask why they need BS of 20 and not 15, rarely will you get a clear answer. Often the specifications are more than what is truly required which jacks up the price. Everyone wants to play safe by adding unnecessary buffer and to cover for shortcomings.

Another way is to focus on advance planning. Now the larger buyers want “just-in-time” since they do not know what they want and when. If a corrugator is given proper forecast of requirement then they can build up inventory to meet the delivery dates instead of stocking up for anything anytime. Inventory turns will be more and the carrying cost will be less.

Let us take an example of Company A and B.

Company A has random requirements and n-number of carton sizes designed and developed by people over a period of time. They are not following any forecast method to identify which type of cartons will be required when. When the item is ready or nearing completion, the carton suppliers are asked to deliver the cartons. At the time of seeking payment, Company A delays at random without any reason. Often they feel humiliated if the suppliers follow up for payment or show a laid back approach towards releasing payment. The adage – customer is king is often taken too literally by many buyers. But they forget that the kingdom prospers due to its many subjects and not just the king.

Company B has created a standardized set of cartons to pack all their items in atleast one of them. (This is what today’s E-commerce companies are practicing). They have a clear system of tracking which items are being ordered, manufactured and are at what stage of completion. There is a visibility of status in the process. This company also has a data stating how much time is needed to make one item and ship. Based on this, whenever an item goes into production, all the relevant suppliers are intimated of the same. This gives every supplier time to plan their production and delivery schedules. Company B also believes in sharing historical data, future plans and planning schedules on a regular basis with their suppliers. Taking a step forward, they also communicate the material receipt and payment processing dates creating good levels of transparency and timely information delivery.

It is obvious that the supplier of Company B is not going to stock too much inventory and buy as required. They will also supply as per the time schedule and have a fair idea of the payment cycle. Continuous procurement will also help the supplier to plan production at their end. Payment and order cycle reliability automatically will impact cost of production and price of the item. Company B will surely demand good quality at lower rates and get it too.

The reliability of timely payment trumps all the other options. If a supplier is assured of timely payment and the commitment is honored regularly, the offered rates will be automatically cheaper. However, no one sticks to the payment cycle, everyone delays and hence, somewhere there is a compromise in quality or buffering in costs.

How is China so competitive in the manufacturing sector? Cost cutting as a means to remain competitive is a shallow approach. There are larger economic factors at play which pushes up the price. Fuel costs, taxes, cost of operating a business, lack of infrastructure, the labor market all contribute to the increasing costs. If these are contained, automatically our products can become cheaper in the global arena. We need some serious root cause analysis and structured approach to cutting costs as an organization and not squeeze the ever dispensable packaging material supplier.

Though it can also be argued that these suppliers lack organized approach towards pricing, quality and need to work in a framework of specified price band like many paper mills supplying Kraft paper. Is there a scope for improvement amongst us corrugators?  

Sales Tax driven IT Re-Assessment Liability on a Buyer and Alternatives

Published in WICMA's Industry Insight

(Expert Guidance of SHRI. SANDIP PARIKH, Business Owner and Vice President TSSIA)

EXAMPLE

Consider a situation where you have bought some raw material or consumables for your business in say 2012-13. Let us take the example of gum or stitching wire (for reference purpose only). The purchase was conducted from a registered VAT dealer (manufacturer or trader). Supplier had valid VAT TIN number at that time. The entire transaction was conducted with proper documentation – purchase order, bills, delivery challan, lorry receipt, and payment through bank. You have taken set-off on the VAT amount and at the stated interval you filed your VAT returns using E-231 and Form 704 too (if applicable) and possess the challans as proof.

THE VAT PROBLEM

Nowadays in many business circles, it is commonly seen that an Income Tax Reassessment is initiated by the IT Officer based on inputs from the Sales Tax department who provide information of sworn affidavits, deposition of suppliers and the purchase details. This becomes a huge problem for the Assessee that is YOU.

In the Income Tax Assessment of such cases, notices are issued to the suppliers and they remain unserved. Even the assessee is unable to produce these suppliers. Hence, the purchases are considered as bogus (even if it was legitimate) and the entire amount is added to income.

In an ideal situation, your supplier pays the VAT to Sales Tax department and files the requisite return forms.

In a second scenario, the supplier does not pay the total VAT amount to the department. One can know about the parties who have not paid VAT only through Annual Return Form 704 where in Annexure J1 one has to mention Sales and in J2 Purchases in details (VAT TIN of the opposite party, Net Value and Tax Value). Without Form 704, one cannot find these details from E-231. If the seller is not under VAT audit, he/ she will not file 704 and there will be mismatch of data.

In a third scenario, the supplier has discontinued/ closed his/ her VAT TIN after sometime. Subsequently, after 2 - 3 years it is identified during scrutiny. The Sales Tax department never intimates about closed VAT TIN details.

PENALTY AND ALTERNATIVES

Based on the second and third scenario, Sales Tax can disallow your VAT set-off and ask you to pay the amount with interest of 18% per annum. Further, if it is found that the supplier is a hawala dealer who has given fake bills and not the goods then your Income Tax will be affected too. This is when the supplier ends up providing an affidavit that only invoices were given and not goods. Sales Tax department declares these dealers on their website. There are many cases in various courts challenging this VAT issue.

The Sales Tax department should first try to recover the amount from the supplier who has failed to make the payment and then recover the amount from you (the buyer) as per section High court order. Income Tax should be informed only when it is a hawala transaction.

How do we protect ourselves from such biases when the purchases were made genuinely from a party?

        I.            When you buy any goods ensure that the TIN of the supplier exists. Remember to check the list of hawala traders on the Sales Tax website. It is recommended that the VAT site be checked regularly for continuation of TIN of your suppliers.

      II.            At the end of each financial year, check your J1 and J2 and contact your suppliers in case of discrepancy. It could be a genuine oversight in most cases but you have to confirm the same.

   III.            Request for a specific undertaking from the suppliers at the end of each financial year stating the bills and amount of VAT paid. This will render the sworn affidavits or deposition as invalid or inadmissible.

In the worst case scenario of supplier absconding or canceling the TIN and becoming untraceable, the Sales Tax department can demand the payment of VAT from you. It is however, highly unjustified to be penalized for purchases that were genuinely made and all documents presented to the Assessing Officer.

It is extremely cumbersome for small business players to keep track of the VAT TIN details of their suppliers on a routine basis to avoid being slapped with Reassessment notices and penalties levied couple of years later.

Statistics show that many companies shut shop each year due to economic factors, other business crisis and mismanagement or simple state of being unviable due to grave market conditions. Are the genuine buyers responsible in such cases? Or should we call for a change of system where the information technology enabled sales tax return filing system sends the buyer an e-intimation of VAT payment by their supplier?

Disclaimer. This is a generalized article for information purpose only. Please consult your Chartered Accountant or VAT Consultant for specific cases