Deductions Amount to Significant Revenue and Profit Leakage
Surveys show customer deductions comprise 5% up to 20% of gross revenues, depending on the industry, with the highest incidence in consumer products (CPG), which relies on “billback” trade promotion deals. Even if only 10% of these accounts receivable deductions are unauthorized, a $500 million company will be losing millions of dollars of profits. After you add the expensive resources -often 75% of the A/R department, plus sales department time -required to research, reconcile, and resolve customer deductions, the bottom line takes a double hit. Using best practices in Deduction Management is key to improvement.
A/R deduction management is complicated. It’s easy for customers to make mistakes (it is interesting that errors almost always favor the customer), and easy for them to slip through the supplier’s deduction process. Unfortunately, we also know that more than a few customers take advantage. Regardless of why customer deductions occur, a significant percentage of deductions are too high or outright wrong. Here are the five simple steps to reduce the problem of unauthorized deductions.
Accounts Receivable Deduction Categories
Trade Business Practices, such as Trade Promotions, Discounts, Markdowns, Approved Returns. This category represents the most significant percentage of deductions taken, although they still have a very high error rate (customer applied the wrong price, deducted for too many units, etc.).
Preventable Deductions and Process Errors, including trade promotions not explained clearly, billing, EDI, and shipping errors, are often systemic and will continue happening forever unless the root causes are solved. Failure to meet On Time-In Full (OTIF) rules can cost massive amounts; in some instances, a significant percentage penalty is charged against the entire order.
Unauthorized Deductions include trade promotions not meeting the deal parameters, late discounts, customer returns errors, pricing, shortage, etc. In addition, excessive amounts deducted on otherwise proper deductions are included here, including too-high returns pricing, incorrect quantities charged back, etc.
While most, maybe 80% of deductions are legitimate, our experience is that most debit memos – even those part of “Agreed to” classification – contain errors that, in the aggregate, cost the seller huge profits.
5 Simple Steps to Improve Deduction Management Results
Step 1. Give them Inches; they take miles. If your company ignores unauthorized deductions or, unearned cash discounts, etc., many customers will continue to see how far they can push them. This includes the small-dollar “threshold” deductions you usually write off because the amounts seem too small to spend time on.
Action: Double-check cash discounts and make sure customers have earned the discounts by following credit terms, otherwise prove and collect them and come to an agreement. Otherwise, these will become a systemic drip of profits.
Step 2. Trade Promotion and Pricing Misunderstandings. Trade Promotion and product pricing often represent most of the money and require special attention to ensure that trade promotions are correctly interpreted. Because these deals are so significant, the errors also tend to be big. Complexity is the enemy of performance. If discounts, incentives, and timing are hard to understand, you can bet customers will misinterpret them and make payment errors. If your salesmen do not document verbal deals, your deductions – and losses – will skyrocket.
Action: Double-check all prices, terms, and conditions, ensuring that both parties understand the pricing deals. Iron out all differences and get e-mail confirmation or an amended order showing agreement. Make sure all deals in writing, and keep all conditions consistent and straightforward to avoid confusion. Third, make certain paperwork goes to the correct person or department.
Step 3. Failing To Follow Instructions. Large retailers have 100+-page billing, packing, and shipping instructions, and they scrutinizing the orders for every violation and deducting any oversights. Substandard packing and subsequent merchandise damage are other sources of deductions. For many companies, vendor compliance violation deductions amount to 1% of revenues.
Action: Build these vendor compliance rules into your systems and methods and instruct shipping department employees to follow retailer instructions to the letter, even if you have to modify your practices to meet the demands of your top customers. It could be that a simple change such as label re-positioning could save you big bucks.
Step 4. Deduction Resolution and Collection Proactivity. If you wait to take action until deductions or payments are 30 or 60 days past due, it only encourages customers to pay late, which will kill the cash flow. Worse, the customers will take unauthorized deductions when they pay late.
Action: Streamline or automate your collection process, reducing delays and unproductive paper shuffling to keep on top of past due accounts. Use automated workflows to manage unauthorized deductions and disputes, so nothing gets overlooked. A little vigilance goes a long way, and the sooner you resolve problems, the faster you will improve cash flow. If you find your company resources overwhelmed, outsource your collection of unauthorized deductions.
Large and small customers – whether by software or manually – keep track of how you follow up and adjust their payables rules accordingly. They behave better with proactive monitoring.
Because they are hard to work, deductions often go stale before they are researched; then documents turn up missing, memories fade, etc., and you will end up with write-offs. Act promptly and consistently, and you will have a significant impact on your company’s results.
Step 5. Seek Professional Help
Deduction outsourcing is worth consideration, especially for deduction backlogs. Studies show that handling unauthorized customer deductions can consume up to 75% of A/R, credit, and collection staff resources. Fortune 500 companies determined that the fully loaded cost of handling routine deductions costs hundreds of dollars per deduction, and if you use the sales force to track them down, it eats up 10% to 40% of the salesperson’s time.
A professional accounts receivable deduction management service can clean up backlogs and recover aging receivables and deductions that would otherwise be written off – thus leaving your accounts receivable department to deal with priority receivables. They can also make suggestions for process improvements specific to your industry. Even minor improvements can yield impressive results, and a complete audit and recovery program can yield big results and patch holes in your cash flow process.
If you choose the right firm, they will have genuine expertise in the field and include top-notch automation with collaborative workflow systems that can streamline the entire accounts receivable, collection, and deduction management process.