Understanding The Deduction Process In The Order-To-Cash Cycle

In an ideal world, all B2B accounts receivable would be straightforward. Your customer asks you to provide something, you do it, and the customer pays you. However, it ends up a lot more complicated, especially when your customers are big-box retailers.

Deductions processing in the order-to-cash cycle can result in a significant loss of profits, including claims for returns, shortages, pricing, logistics and shipping, EDI errors, vendor compliance, On-Time In-Full (OTIF) penalties, as well as trade allowances and rebates. Trade allowances alone constitute up to 20% of revenues and many thousands of deductions in the CPG industry, providing a huge opportunity for errors.

Common Deduction Categories

1. Agreed-to Deductions. Trade promotion billback deals, cash discounts, markdowns, approved returns. The “agreed-to” category represents the largest percentage of deductions but has a very high error rate, ost customers take cash discount deductions even when they pay late, and errors on return quantities or pricing are more often the case than not.
2. Preventable Deductions. Self-inflicted deductions include confusing trade promotions, errors in billing, EDI errors, shortages, OTIF violations, and delivering late or early.  Many of these can be systemic and will continue happening forever unless the root causes are solved.
3. Unauthorized or Excessive Deductions, such as trade promotion deductions violating the deal parameters, double deductions, late discounts, customer returns errors, pricing, counting errors. Excessive amounts deducted on otherwise proper deductions are included here as well, including incorrect pricing and quantities charged back, etc.
4. “Post-Audit Deductions” are especially difficult,  as they are issued by commission A/P auditors up to a couple of years after the fact. 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.  Up to 50% of post-audit deductions are wrong, overstated, or sometimes duplicate deductions. See Managing Post Audit Deductions

Perhaps 80% of all deductions are approved, but even those that are part of the “Agreed to” classification contain errors that, in the aggregate, create huge losses for the manufacturer.

Read on to learn more about the deduction segment of the cycle and how deduction management automation can help you keep it in check.

How Deductions Fit In the Order-to-Cash Cycle

In the B2B realm, the order-to-cash cycle is the framework for converting orders into cash. It begins with your customer placing an order and mutual agreement on terms. After you ship the goods, you submit the invoice. Fifty years ago, your customers would have paid those invoices as submitted and, if the reason for a claim for a credit, they would submit it afterward, which you had time to investigate before issuing a credit memo to be later deducted.

Today, however, the process is to deduct first and leave it to the supplier to figure out, and it isn’t a simple procedure. After your customer receives an invoice, they may dispute certain terms, apply a discount, or issue a claim the order was not received as written. This leads to the issuance of a debit memo deduction and often delays in payment, more work for your A/R department, and a reduction in the revenue you will collect.

In some cases, deductions can be chalked up to mistakes made on either end of the transaction. Perhaps the customer entered the wrong SKU pricing, or you made an invoicing error, your fulfillment center short shipped the order, or shipped late (or early) by a couple of days. There are also cases of deductions taken by customers trying to take advantage of a deal that is no longer available.

Without modern technology/automation, customer deduction processing is difficult to keep up with, and backlogs and write-offs are the norms. For example, the complex returns reconciliation between customer debit memos and the supplier credit memos needs to be at the SKU/NDC and pricing level, which in any volume can only be accomplished by smart technology, automated processes, and workflows. The recent trend of CPG companies to offshore manual deduction management processing has exacerbated the profit costs. While driving down direct labor costs, offshoring has reduced the dollar amount of excessive deductions recaptured, which loss is arguably much greater than the labor savings.

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. This is why intelligent automation, starting with automatic recoding of deduction reason codes upon cash application, is an essential tool to mage this profit-draining operation.

Monitoring Your Deduction Performance -KPIs

Days Sales Outstanding (DSO), CEI, ADD, and ART are standard accounts receivable KPIs for cash flow and collection metrics. We are deduction management experts and feel strongly that deductions are unique and cannot be lumped with the other metrics. You need to measure deduction performance with modified accounts receivable KPIs. We believe four Deduction KPI tracking reports accomplish this.

1. We use the standard Deductions Days Outstanding (DDO) that tracks how quickly deductions are moving through the process.
2. We established perhaps the most important measure of effectiveness and set up the Deduction Efficiency Index (DEI) to track the amount of money you recover from incorrect deductions.
3. A monthly Root Cause discovery list to track the causes uncovered and hopefully prevent re-occurrence.
4. Monthly deductions numbers and amounts by category ( returns, damages, pricing, etc.) for your top ten customers.  This is important for management to see.

If you think about it, 1) finding and correcting deduction root causes and 2) collecting incorrect deductions are the only two reasons to do all this massive work.

Carixa Deduction Management Offerings

As a leader in accounts receivable automation and deduction outsourcing, Carixa offers automated tools for managing your deductions, invoice collections, auto cash application, and other order-to-cash processes. For example, our Carixa Cloud Deductions module utilizes best-practice deduction strategies, AI-and RPA-driven processes, and easy-to-understand performance reports, while automating and streamlining your operations for efficiency. With the help of this software solution, you can also, with a click, easily use third-party services to outsource problem categories – such as trade promotions and cash discounts to automatically audit and recover deductions and recapture your lost profits.

When you choose to automate deduction processing, you can more easily identify the root causes of preventable deductions, reduce the long time it takes to process deductions (Deduction Days Outstanding (DDO), increase your revenues, and more. If you’re ready to learn more about our A/R automation systems and get started, reach out to one of our experts today.