Categorizing and Classifying Spend - Five Practical Tips
Last updated Feb 7, 2022 - 3 min read
- Table of Content
Categorizing your spend is the starting point for category management and a more data-driven approach to procurement. In this article, we'll share some practical tips on how to get started.
Let's start with some theory about what spend categories are and what they should reflect:
A spend category, or category, contains similar types of purchased products or services. In other words, a category should support the market classification - thus reflecting the supplier market and what we are buying.
1. Identify Available Spend Data
The category structure should reflect your spend data. On a general basis, more detailed data provides greater opportunities for increased insight. We've provided some of the most common spend data sources below;
- Invoice system
- Accounting system
- Purchase order system
- Supplier master data
Learn more about the most common sources of spend and procurement data.
2. Build the Category Structure
The next thing to consider is what are you actually buying. Apply your procurement knowledge and consider spend throughout the entire business - that's, spend across all your business units, locations and functions. A category should reflect what you're buying, regardless of who buys it or what the purpose is.
Don't dive right into the details. Our experience tells us that the category structure becomes more holistic by starting with a top-down approach, ensuring a more efficient and precise categorization. It's easier to define subcategories, or more specific categories, when the top-level categories are identified. The spend data may also provide valuable insights into the distribution of more detailed subcategories.
3. Understand the data and categorize
There are several ways to distribute, or classify, the spend data into the various categories ("classification/ categorization rules"). The distribution options will depend on details and parameters available in your data. We have listed some parameters that we typically use when categorizing spend:
- Accounting information (e.g. account name)
- Supplier names
- Industry data (NACE-codes)
- Article and item descriptions
- Product- and service codes (e.g. UNSPSC)
- Text descriptions (or similar)
It's all about understanding your data and how you can use that information to distribute and categorize your spend and transactions. In many cases, it may also be necessary to combine multiple parameters to classify spend to one or more categories.
Let's look at a simplified example:
Facility Services AS buys goods and services. All spend, i.e. all incoming invoices, are posted to the following accounts in the accounting system; "Cleaning" and "Canteen". Assuming that the accounting information is correct, this information can be used to categorize spend. For example, all cleaning transactions can be distributed to the "Cleaning services" category, and all canteen transactions can be distributed to the "Canteen management" category.
4. Be Pragmatic and Make Continuous Adjustments
In a perfect world, a category at the most detailed level should reflect a unique supplier market. But a category structure will almost never be 100% perfect. For most businesses, the 80-20 rule will serve as a good and pragmatic guideline. If you're building the category structure from scratch, this will be a sound starting point.
Please keep in mind that your category structure is dynamic and evolves with your business. A more data-driven approach will also provide new insights that can be used when categorizing your spend. Continuous adjustments are vital to maintaining an appropriate structure.
5. Use Digital Tools - Steer Clear of Excel
Digital and dynamic tools are a must have for all procurement departments and professionals. There are several reasons why this pays off when classifying spend and maintaining the category structure, such as:
- Increased transparency for your organization
- New data is automatically categorized
- More flexibility and ease of use
For many procurement functions, Excel is the basic tool for spend classification and analytics. Our advice: Stay clear! Excel isn't a suitable tool over time, especially if your spend is characterized by a certain complexity and size. Common characteristics are complex formulas and low transparency, while also requiring advanced user expertise. All at the expense of capacity that's already limited. The tool is neither dynamic nor flexible enough to maintain a dynamic category structure.
Good luck! And don't forget that dynamic spend categories are a prerequisite for successful category management.