Reducing Mark Downs, Charge Backs, and Deductions through ERP

When you hear the term deduction, you may think of the HR Dept. which administers medical deductions or 401(k) contributions that are deducted from an employee’s paycheck, and remitted to third party administrators. But this article focuses on Accounts Receivable (AR) deductions, sometimes known as charge backs, and mark downs, for various B2B transactions, which can be a major drag on profitability.

These types of financial deductions are common among Manufacturers, Supplier/Distributors, and Consumer Packaged Goods (CPG) companies which develop, manufacture and supply products to retailers, who in turn sell to the end-user consumer. A deduction occurs when the retailer, for whatever reason, decides to short-pay the invoice from the supplier.

Generally, there are three types of deductions. Authorized deductions, often in the form of trade promotions from the supplier, can occur if the retailer meets certain incentives, such as ordering so many products by a certain date. The supplier then provides discounts in the form of authorized deductions. They’re authorized, welcomed, agreed to by both parties, and foster business partnership.

Penalty deductions occur when mistakes are made, and the supplier is penalized by the retailer for not correctly fulfilling the order, or meeting certain requirements. Some examples might include damaged goods, shipping the wrong Stock Keeping Unit (SKU), the wrong amount, or missing the deadline. As a penalty for non-compliance, the retailer extracts a deduction as a form of compensation for the mistake.

The third type is an unauthorized deduction. Often misrepresented as a supplier mistake, some retailers attempt to coerce better deals through trumped up charges, or exaggerations, faulting their suppliers for dubious mistakes. The supplier, thus, did not authorize the short pay, but their options may be limited unless their ERP system is up to the task.

Deductions dilute receivables but are generally a preventable leak, even as retailers regularly rely on them to bolster their own bottom lines. Particularly as more retail power is aggregated among big players like Walmart, Best Buy, and Home Depot, they are more apt to win bigger concessions from their suppliers, who dare not risk losing an important customer. In an economic downturn, retailers may use deductions aggressively. But in an upturn, the supplier may be more apt to ignore deductions because they need not jeopardize a relationship when times are good.

Trade promotions are often vulnerable to deductions because they can become too complex to administer or interpret. The sales rep may promise a deal to the customer, but fail to communicate it accurately to their finance department. The finance department may not have an easy way to track the promised promotion, which leads to errors, and more deductions. Without tight integration between marketing, sales and back-end accounting, and without clearly defined, easy to understand promotions, deductions will result.

Additionally, without an integrated system to create, administer and track promotions, it can be very challenging to research and contest deductions. The resolution process is often manual and paper-based, therefore time-consuming and prone to errors.

Suppliers and Manufactures will often automatically write-off deductions that are under a certain threshold, because the time and effort required to research the claim, and negotiate a settlement, can outweigh that effort. The sophisticated customer may also attempt to determine that threshold, so automatic write-offs occur, as another way to capitalize on potential cost savings.

To address this increasingly vulnerable profit leak, a company must align its people and processes, from better promotional planning, to order-to-cash execution. Sales & Marketing must align their promotions with finance, so discounts, delayed discounts, and accruals can be tracked and administered correctly. Demand forecasts must be communicated back to the supply chain, so they can deliver on promised timeframes. Information on customer pick, pack and shipping procedures must be captured in the ordering process to ensure error-free order fulfillment.

If and when a deduction does occur, despite these steps, Finance needs the flexibility to assign ownership for research and resolution to the most appropriate department, whether it’s sales, customer service, credit or collections. Finance, Sales and Marketing also need to be able to determine customer profitability, not only including deductions in that calculation, but the costs associated with resolving them as well, so they can better align their promotional efforts back toward their truly, most valuable clients.

Other important considerations would include a single, common, customer database shared among all the departments, with flexible workflow, and an integrated order to cash, and order fulfillment process. Flexible reporting, and profitability analytics, such as capturing important metrics like Days Sales Outstanding (DSO), preferably delivered in a real-time dashboard, are equally important, and critical to identifying deduction trends in order to ward off future dilutions. Deduction management is a critical step to elevating the profitability and competitiveness of the enterprise.

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