August 5, 2016
Customer Deductions Remain A Major Corporate Profit Loss
Revenue cycle processes at some companies have improved somewhat over the past decade, driven by billions spent on technology.
Larger companies have shown progress in billing and receivables settlement “efficiency” by lowering the cost of billing and payment transactions using automation or overseas outsourcing. However, we see little or no improvement – often a worsening in “effectiveness”, by which we mean the percentage of gross revenues converted to net cash. Depending on the product and customer type, this Dilution Rate could be from 6-15% of gross revenues. Most of this gap is the result of legitimate customer deductions for trade promotion, pricing, etc.
However, a material percentage, perhaps 15%¹ of this gap, can be due to customer error or abuse and should be recaptured by the manufacturer. Other losses include systemic manufacturer compliance, process or shipping errors part that, if not uncovered and corrected, repeat forever.
To use a very simple example, if the Dilution Rate is 10% of revenues, and you can reduce that by 10%, you are recapturing 1% of revenues. If your pre-tax profit is 7.5% adding 1% represents an increase of 13.3% in total corporate pre-tax profit, a huge gain.
The above represent critical reasons why you need to research and work deductions in detail instead of engaging in settlements or writing off balances. Getting to the bottom of a problem enables you to take action to prevent re-occurrence.
Our view is that the race to inexperienced labor and transactional-izing deduction handling has actually increased manufacturer net costs (the idea being that labor savings are less than the lost profits inherent unrealized deduction recapture).
The types of deductions generally include
- Agreed business practices, such as promotion and price bill-backs.
- Manufacturer failure to comply with customer rules, including administrative, compliance, processing, including EDI, and data synchronization
- Billing, shipping and logistics errors or disputes
- Customer error or over-deduction on all categories of deductions
Consequently, instead of disappearing as predicted twenty-years ago, deductions are as difficult as ever. Revenue and profit dilution (we also call it “profit leakage”) caused by customer deductions and late payments continues to cost companies many millions of dollars every year. Most deductions cannot be avoided since they are the result of established business practice.
However, there remains plenty of profit leakage that can be recaptured, controlled and eliminated with a revamp of policy, strategy, advanced software, and expert staff.
¹ It’s interesting to note that we have seen instances where 50% or more of “post-audit” deductions are wrong.
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