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Managing deductions.

We all have more things to do than time allows, so our level 3 priority items seem to be perpetually stuck at the bottom of our "to do" lists. It's not that these are unimportant tasks. We know they should be done, but something more urgent always squeezes in ahead of them on the list.

Straightening out deductions is usually one of these items way down the list. It's a headache. The longer it is left undone, the harder it becomes. The paper trail gets cold, people change jobs, intervening shipments complicate the issues and documentation becomes more complicated. In sum, it is a task that takes a lot of time for an uncertain reward.

Another reason deduction issues are not taken care of more promptly is that most people do not realize their financial impact. According to ChiCor Information Management, Inc., the dollar volume of deductions in the consumer goods industry averages 5 percent to 9 percent of total annual revenues. For many companies, this is greater than their net profit margin percentages. Furthermore, industry studies show that the dollar volume of deductions is growing faster than revenues.

If company financial officers, credit managers and sales personnel understood that deductions can be as much as or more than their company's net profit margins, deduction management would have a higher priority than it does currently. However, because deductions are done order by order, the aggregate total is seldom known.

* Customer Settlement Problems

Deductions are accounted for in the settlement of a transaction. Problems with deductions can result in settlement problems such as not getting paid on time, not getting paid in full or not getting paid at all.

There are many masons customer settlement problems occur. Two main causes of settlement problems are shipping errors and pricing errors. These types of errors are characteristic of deduction nonmanagement.

* Where does your company stand?

Rick Effgen of ChiCor sees deduction management as a continuum of three phases: the "chaos" (nonmanagement) phase, the management phase and the quality phase.

* Nonmanagement Phase

As you might expect, in the chaos or nonmanaged phase, deductions are treated haphazardly. Follow up is inconsistent, and salespersons and brokers are not really held accountable for resolving settlement problems. Rather than being handled as they arise, deductions are usually grouped and handled according to customer, which lets the settlement issues stagnate and adds to the confusion. Chargebacks are left on accounts receivable. Finally, no historical data are kept, and there are neither standard operating procedures nor performance goals.

* Management Phase

In this phase, many of the shortcomings identified above have been addressed. Consistent procedures have been established and are used for deduction follow up. Deduction "portfolio" "objectives, such as deduction days outstanding (DDO), have been set and are monitored. Deductions are handled as they arise instead of being accumulated and dealt with at the customer level. Everyone is held truly accountable. Chargebacks are removed from accounts receivable and are now posted to a deduction database. Deductions are now being managed, and this means that a file of historical data can now be developed.

* Quality Phase

Operations in the quality phase build upon the improvements put in place during the previous phase. The file of historical data is used for performance analysis, and deduction patterns are also analyzed. The performance and the costs of salespersons and brokers can be measured. In addition, deduction costs can be figured into customer profitability calculations. It is now possible to determine the cost of deduction follow up. Finally, the results of the data gathering and analysis are used to correct business problems.

* Getting Organized

There are a number of steps required to get a company from a state of deduction nonmanagement to deduction management and quality. One of the first things required is establishing a deduction database to consolidate and organize all deduction information about customers. In order to be effective, the deduction database must be able to receive from and send information to accounts receivable, invoicing, trade funds and general ledger. Without this integration, it will be very difficult to maintain accurate records and keep accounts current.

The next step is to establish standard operating procedures for each type of business, deduction and each deduction reason. The procedures must also spell out the prescribed series of actions to be taken in order to resolve a deduction. Once the procedures are in place, a program of systematic follow up for deduction resolution must be implemented. This can be done with specialized software that automatically tracks accounts receivable, or it can be done in a low-tech fashion with a tickler file. The risk with the low-tech system is the human element; someone has to act on the reminders in the tickler file. However, if a daily routine can be put in place, this system will work. The other part of the follow-up process is the correspondence with customers. The same kind of high-tech and low tech options apply - software or individual human action. In either case, it is a set of predetermined memos, letters and notices that are sent to the customer.

The last step is continuous monitoring and analysis. As the deduction function is organized, a file of deduction history must be started. By looking at this information and analyzing it in different ways - by customer, product, sales representative or by promotion - a company can see what deductions and customers are profitable, where changes might be made and if there are business problems to correct. Here, the two aspects are both important - collecting the deduction history and analyzing it frequently.

* Options

There are three ways of managing deductions once the process has been organized. You may choose a manual system, outsourcing or specialized software.

* Manual system

This way is most likely to be effective in a small company where the volumes and types of deductions will not overwhelm the person handling them. The organizational steps outlined above can be adapted to a small company environment. The important thing is to follow these steps. Without standard operating procedures even a small system will fall apart. The automatic follow-up step can be handled manually with a tickler file, as long as it is done on a regular basis. A series of form letters, memos and other notices can be developed to send to customers as needed. The critical factor is the human one. The whole deduction management organization rests on people handling this task conscientiously.

* Outsourcing

Where a manual system is the most labor intensive way for a company to handle customer deductions, outsourcing is the least. The work of contacting customers and straightening out discounts is done by a third party. Sometimes the third party works onsite at the client company's facility. Sometimes everything, including all documentation, is shipped offsite to the outsource facility.

Although much of the laborious tasks are outsourced, the company still must organize its procedures, set parameters, prepare or approve communications to be used with its customers, supply all the invoicing and other information necessary to do the job, and review and monitor the results. In other words, there's still a great deal of preparation work involved for a company before it turns over the deduction function to a third party. This is very important because in most cases the customer will be under the impression that he is communicating directly with the company, not with a third party. The thirdparty outsourcer will "invisible" to the customer. Any telephone contact or written communications will appear to be directly from the company. Thus, it is vital that all methods of customer contact be approved beforehand by the company.

Often a company outsources deduction management along with other receivables. Deduction management can also be outsourced as a stand alone arrangement. For instance, Dun & Bradstreet (D&B), which provides receivables management services, has one customer - a manufacturer of electronic games - that uses D&B only for deductions. At the end of a life cycle of a particular game, the company ships all invoicing, deduction documentation and files for the covered products to D&B, where a team is dedicated to that one account. Its job is to clear up and resolve all the deductions for the products covered.

One of the ways this saves so much time for the company is that the D&B team is tied into the manufacturer electronically. It can feed information directly into the company's accounts receivable and other systems. This gives the company up-to-the-minute financials and reports without having to re-enter data. It should be noted that because a third party, such as D&B, will have access to company systems, the company must have confidence in the integrity and reliability of its outsourcing partner.

* Software

There are a variety of software applications available that can be used for deduction management. In fact, collection management software packages, such as GetPAID and AStar's QuickFlow, include a deduction management function. The same is true of credit software programs with a larger scope, such as QSP's Credit Manager. Other collections applications can be used for deduction management with some minor modification.

ChiCor Information Management, Inc. has a software package, DMS, that is specifically for deduction management. It is designed to work with accounts receivable packages and can be integrated with enterprise resource planning (ERP) software.

The main benefit of using software is that the deduction resolution process is streamlined and shortened through automated customer communications and follow up. This results in faster collections, reduced DDO as well as reduced DSO (days sales outstanding), and the ability for a company to do more with less staff.

Additional benefits are better record keeping and the ability to generate reports and analyses. Ultimately, of course, the goal is to use this information to make changes that improve the business and increase profitability.

ChiCor's DMS follow up and resolution process is controlled by what it terms "action profiles." The action profiles are set by type of deduction, the reason for the deduction, and the dollar amount of the deduction. The action profile specific to a deduction then guides the software user through the resolution process, prompting calls to the customer, letters, memos or any other step included in that action profile.

During the resolution process, DMS can age a deduction, generate action messages and reminders for the user, and create internal memos. It also can report on the number of deductions and the dollar volume in dispute by customer, by type and reason of deduction. ChiCor also has other products that work in tandem with DMS. One is called e-TradeFunds, an Internet-enabled trade funds management system. The other is CashApply, which can apply cash received via lockbox, ACH' or EDI to a company's accounts receivable system and create debit memos that are immediately passed through to DMS.

However, as with the other options, the use of software won't work unless the company has established its standard operating procedures. With ChiCor's DMS, that is actually a part of the implementation process. During the implementation process the classification of deductions occurs and the various action profiles are established - ith as many as 14 different steps.

The dollar impact of improperly taken deductions is usually all it takes to make companies realize that ignoring deduction management puts them at some financial risk. The process of organization takes some determination, but can be achieved in several ways. Depending on its size and the relative importance of deductions in its industry, a company can opt to handle deductions internally with a manual system or with an automated system. Outsourcing is another possibility. Depending on the chaotic state of a company's deductions, the mandatory start-up work required may be daunting, but it is inevitable. However, the maintenance of the system will be relatively easy and the reward will be substantial.

ERRORS THAT CAUSE SETTLEMENT AND DEDUCTION PROBLEMS

Shipping errors

* Wrong product

* Short shipment

* Damaged product

* Shipment late/early

* Shipped to wrong location

Pricing errors

* Incorrect pricing

* Wrong terms

* Allowances not granted

* Freight charge errors

* Discount errors

Other errors

* Promotional deduction

* Trade spending claim

* Bill back deduction

* Post audit claims

Joyce R. Ochs is the senior editor of Business Credit(R).
COPYRIGHT 1999 National Association of Credit Management
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1999 Gale, Cengage Learning. All rights reserved.

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Author:Ochs, Joyce R.
Publication:Business Credit
Article Type:Cover Story
Date:Mar 1, 1999
Words:2018
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