Deductions are the burden of accounts receivables and are bound to happen. They are the residual invoice value resulting from payments which are less than the total invoice amount. After investigation, if the deduction is judged to be valid it needs to be removed from the AR ledger via credit memo or write-off. If deemed invalid, it should be collected from the customer.
Simple enough except when you multiply this by thousands of deductions per month, taken for a wide variety of reasons.
Deductions often have a serious financial impact:
- Up to 2-3% gross margin erosion
- Huge productivity penalties to Cash Application, Collections, Customer Service, Sales, Logistics resulting in higher cost and/or reduced performance
- Serious degradation of the Customer Experience
- Employee demotivation
- Elevated AR – total and past due
- Potential over-statement of financial results (net sales, profit, assets) and large one-time hits to earnings to clear backlog of aged deductions and disputes. This can be a serious internal control/audit issue
Deductions processing is necessary, but a low value activity. Over 95% of deductions are valid, resulting in issuing a credit to clear them from the Accounts Receivable ledger. The invalid deductions are difficult to collect from customers. A CFO’s reaction to this process is usually, “I don’t want to hire 6 people to issue credit memos”. However, if invalid deductions are not challenged, they will increase in frequency and value, significantly reducing gross profit margins.
Most of the operations in identifying, creating, investigating, resolving and clearing deductions is transactional in nature. Only the decision on the validity of a deduction requires substantial human participation.
The solution is to research and resolve deductions of significant value in a fast and efficient manner. There are steps that companies can take and tools that they engage to proactively predict and reduce certain kinds of deductions.
- Creating the deduction
- Extracting remittance data and reason code information from multiple customer sources (vendor portal, various documents) which are in a variety of formats
- Route the deduction to the designated resolver with full information and documents and route credit memo request through the approval hierarchy
- Track every deduction from creation to clearance from the AR ledger
- Perform dunning of resolvers who have exceeded the allowed time for resolution
- Compile reporting on deduction processing operations and status
- Automatically write off small balance deductions and match & clear credit memos to open deductions
- Provide analytics capability to drive improvements in order fulfillment and invoicing quality
These capabilities can increase the gross margin by 100-200 basis points and productivity by 70-80% in transactional operations. It will also reduce past due and total AR while avoiding internal control issues and large prior-period write-offs of AR. The result is a deduction processing function digitally and strategically transformed from a low value costly operation to a high value profit center.