Deductions Management: unlock trapped working capital, eliminate root causes, and reduce workload of OTC team.

Deductions and “short pays” happen when the amount remitted against the invoice is less than the balance due. They can also occur when debits are taken against multiple invoices and/or related to an altogether different invoice.

Deductions can be the most difficult open items to resolve because they often involve different departments and difference deduction reasons within an organization. When a deduction is created by the customer, it is incumbent upon the Accounts Receivables (AR) team, and others within the organization, to validate or invalidate the customer’s deduction.



Deductions are broadly divided into three categories:

Intentional Deductions (Trade promotion)
Trade promotions include things like promotional pricing, marketing, advertising allowances, rebates, mark-downs, return of unsold seasonal or excess product, freight charges, bank fees, price protection programs, etc. These deductions are generally considered a “cost of doing business” and the chance of recovering these deductions are slim.

Preventable Deductions
Preventable deductions include things like poorly communicated, incorrect or outdated pricing data, slow credit memo issuance, misinterpreted promotional programs, conflicting terms and conditions, order entry processing and edit errors, rush orders sent without shipping notifications, billing errors, incorrect taxes, compliance problems, electronic data interchange issues, etc. It is comparatively easy to reduce these recurring deductions and a root cause analysis can typically identify and fix the operational errors at the source.

Unauthorized (Erroneous) Deductions
Unauthorized deductions occur when customers “short pays” their invoices due to the following reasons: unearned or duplicate discounts, clerical errors, processing errors, misinterpreted pricing, etc. It is possible to prevent these deductions with proper oversight and process controls.

Key Challenges Faced by Deduction Teams

Time consuming and Manual processing: Despite the strides made by many businesses, the management of customer deductions remains a largely manual, paper-based affair, along with lacking accountability for resolving the various types of deductions To perform deductions research and resolution, most Deduction Analysts are forced to manually aggregate backup documents (Claims, PODs and BOLs) from different sources like paper claims, emails, carrier websites, and customer portals, etc. This leads to a significant delay in deduction resolution timelines resulting in a higher Days Deductions Outstanding (DDO). Most companies also utilize Deduction Analysts to conduct these low value, mundane tasks.

Due to the multiple stakeholders (e.g. Sales, Marketing, Finance, Distribution and Pricing) required to be involved in the resolution process, it becomes very difficult to track the status, provide proper resolution assignment, manage the process, and account for the cost associated with the deductions. Additionally, the use of third-party sales partners, or brokers, makes it even more difficult to access the information necessary to resolve deductions.

Processing Cost: The cost to research and investigate low dollar deductions represent a substantial impact to a company’s net operating margins. For many companies, these smaller value deductions often make up a major chunk of their deductions volume, and they represent a substantial loss each year due to often being written off.
Preventable and erroneous deductions significantly impact a company’s profit margin and bottom-line, so this is where strategic thinking must be applied. If not properly managed and controlled, deductions can decrease gross margins by 2-3%. Not to mention, the cost of labor expended on this potentially low value activity.

Further complications can happen when deductions are not cleared from the AR Ledger on a timely basis, such as an overstatement of revenue. Corrections of these overstatements are generally achieved only when a painful write-off is taken. This correction process can, and does, negatively impact an organization’s profit, cash flow and overall financial health.

For most companies, deduction processing means high volumes, high cost, and time away from more value-added activities by Sales, Customer Service, Credit, Collections, etc. The time has arrived for a solution that encompasses best practice processes, automation, policy adherence, detailed metrics, and customer education.

Solution Measures

Deductions can be the result of one or many problems in the organization’s processes. So, it is important to analyze and categorize deductions by type, size, frequency, and customer. These details enable organizations to focus their efforts in the right direction. Additionally, root cause analysis should be conducted to find the errors and initiate the corrective actions required to resolve and hopefully eliminate the deduction from reoccurring.

Automated Reason Code Assignment
Assigning reason codes, either by the customer on a Customer Portal, or during the Cash Application stage, ensures that reason codes are correctly fed into the accounts receivable ledger when posting cash. For example, RTV = Return, SHRT = Shortage. If a particular text reference is provided in a ‘note’ field on the EDI file, this may also be used to identify deduction types and assign a code to further expedite the deduction process. This eliminates the need for credit, collections, or deductions team to manually work the deductions.

Deduction Owner Assignment
Once a deduction has been coded with the appropriate reason code, the next step is to assign the deduction to an Owner. The Owner can be an individual within a functional area based on customer account and invoicing information, or the deduction can be routed to an assigned team for investigation and resolution. The process for assigning ownership removes the risk of having aged and unresolved deductions. Ownership also establishes responsibility and accountability for resolution and is a critical input into the root cause eradication process.

Deduction Bundling Replacing Smaller, Low Value Deductions
Deductions that fall within a criterion can be bundled into a single deduction. This creates one large deduction that is posted to the customer account, thereby replacing the need to post a large number of low value deductions. Given the fact that most larger companies do not re-pay low value deductions, this allows companies to capture previously lost capital. This, recouped revenue, has a significant impact on a company’s cashflow and their bottom line.

Effective Deduction Management includes the following:

  • Develop concise and accurate reason codes along with expected resolution time frames.
  • Establish clear ownership of all reason codes that carry escalation timeframes for unresolved items.
  • Promptly write-off justified customer claims.
  • Recoup the full invoice amount for deductions taken erroneously by your customers.
  • Promptly supply customers with accurate details and the documentation required to make corrective adjustments in a reasonable amount of time.
  • Eliminate the organizational process flaws and ill-informed decision making.

To achieve breakthrough deduction resolution efficiency, streamlined and standardized resolution processes, and enhanced customer relationships, companies should focus on the following:

  • Automate, collaborate, and drive resolution in real-time – best practice should focus on high value, higher-probability-of-recovery deductions. They should also drastically reduce the time spent on a low value, lower-probability-of- recovery deductions.
  • Automatically identify invalid deductions and write-off valid, low-dollar deductions.
  • Implement a configurable workflow-based resolution process using Line of Approval (LOP).
  • Improve inter-departmental collaboration between Deductions, Sales and other departments to expedite recovery.
  • Provide detailed root cause analysis, to drive internal efforts to reduce self-inflicted deductions (e.g. compliance deductions).
  • Implement a smart policy to reduce the volume of deductions. For example, by negotiating a “damages and shortages” price discount, all deductions of that type can be eliminated.

When deductions are processed efficiently, it directly impacts a company’s profit margin and customer satisfaction. Further, proactively managing deductions, can change customer behavior leading to a reduction in the total volume of deductions incurred.

Deductions are a business reality, but those that do it well, proactively manage the process and have preventative tools in place to reduce deductions. Doing so also delights their customers.