In an ideal world, your customer buys your goods, you ship them, and the customer pays you. However, the process is way more complicated when your customers are big box retailers.
Deductions result in a significant loss of profits, including claims for returns, shortages, pricing, logistics and shipping, EDI errors, vendor compliance, On-Time In-Full penalties, trade allowances and rebates. For example, trade allowances constitute up to 20% of revenues and many thousands of deductions in the CPG industry. This presents a massive opportunity for finding errors. Deduction categories include:
- Agreed-to Deductions. These include trade promotion bill-backs, cash discounts, markdowns and approved returns. This category represents the most significant percentage of deductions, but has a very high error rate. For example, most customers take cash discount deductions even when they pay late, and errors on returns are extremely common.
- Preventable Deductions. These self-inflicted deductions include confusing trade promotions, errors in billing, EDI errors, shortages, OTIF violations and late or early deliveries. Many of these are systemic and will continue happening forever unless you determine the root causes.
- Unauthorized Deductions. These include trade promotion deductions that violate the deal parameters, double deductions, late discounts, customer returns errors, pricing and counting errors. Excessive amounts deducted on otherwise proper deductions are included in this category, including incorrect pricing and quantities charged back.
- Post-Audit Deductions. More than 50% of post-audit deductions are wrong, overstated, or duplicated. However, they Post are hard to resolve, as they are issued by commission-paid A/P auditors who do not want to lose their percentage. Also, they are deducted two to three years after the shipment, making research difficult. They include claims from Categories 1, 2, and 3 and are often aggregated in hundreds of entries per post-audit claim, one line for each SKU transaction. See Managing Post Audit Deductions for more information.
Perhaps 80% of all deduction claims are approved, but even those that are part of the “Agreed to” classification contain errors. When added together, all these errors create enormous losses for the manufacturer.
Is there a Solution?
In B2B commerce, the order-to-cash cycle is the framework for converting orders into cash. It begins with your customer placing an order and mutually agreeing on terms. After you ship the goods, you submit the invoice. Fifty years ago, your customers would have paid those invoices as presented. If they had a reason to claim a credit, they would submit it after, which gave you time to investigate before issuing a credit memo for future deduction.
However, today’s process is to deduct first and leave it to the supplier to figure out. This isn’t a simple procedure. After receiving an invoice, your customers may dispute specific terms, apply a discount, or issue a claim that the order was not received as written. This leads to the issuance of a debit memo deduction, delays in payment, more work for your A/R department, and less revenue for you.
In some cases, deductions can be chalked up to mistakes made on either end of the transaction. For example:
- Your customer entered the wrong SKU pricing
- You made an invoicing error
- Your fulfillment center short-shipped the order
- You shipped late (or early) by a couple of days.
- Your customer tries to take advantage of a deal that expired
Without automation software, it’s challenging to keep up with deduction management and processing. Backlogs and write-offs become the norm. For example, you need to handle the complex returns reconciliation between customer debit memos and supplier credit memos at the SKU/NDC pricing level. This can only be accomplished by intelligent technology, automated processes, and workflows.
The recent trend of large CPG companies to offshore manual deduction management processing just exacerbates the losses. It drives down direct labor costs, but reduces the amount of deductions recaptured which is a much larger dollar amount.
Customer deductions are a drain on profits and a strain on resources. The time it takes to research deductions means you have less time to work on regular accounts receivable. Intelligent automation is essential to manage this profit-draining operation. It starts with software that automatically re-classifies deduction reason codes during cash application.
Monitoring Your Deduction Performance – KPIs
Days Sales Outstanding (DSO), CEI, ADD, and ART are standard performance metrics for cash flow and collection. As deduction management experts, we feel strongly that deductions are unique and need to be measured separately from other receivables metrics. Our expanded metrics help, including:
- Deductions Days Outstanding (DDO) tracks how quickly deductions are moving through the process.
- Deduction Efficiency Index (DEI) tracks the amount of money you recover from incorrect deductions.
- Root Cause discovery list – tracking the causes monthly prevents reoccurrence.
- Top Ten Customer deductions – tracking these numbers by category such as returns, damages and pricing provides critical reporting for management.
Action Plan
- Put someone in charge of deduction improvement, reporting to the “C” level.
- Establish a corporate deduction policy and distribute it to your customers.
- Figure out how you are doing relative to your industry. Contact us at info@smyyth.com.
- Establish a monthly reporting scheme using the selected metrics. Use your current experience as the baseline and measure improvement with DEI.
- Continuously track and report root causes for departmental accountability.
- Examine and engineer your processes and workflow to remove the impediments.
- Investigate how today’s software innovations can streamline your operations and better ensure success.
- Have a monthly management meeting to cover your progress and track the money you return to profit.
- Deal fairly with your customers, but enforce your policies consistently.
Deduction resolution represents a huge administrative expense. Remember that you are doing all this work to get your money back from excessive deductions and correct root causes.
This starts with a commitment to a businesslike policy statement and following through to consistently enforce your rules. You have negotiating power and don’t need to accept deductions as a “cost of doing business.” You can’t win them all, but you will be way ahead of many of your competitors that roll over.
Contact us for more information about optimizing your deduction process with advanced Carixa deduction automation software or services.
Interested in learning about more ways to enhance profits? Take a look at our post, Profit By Controlling Revenue and Profit Leakage
