Overcoming the Challenges Caused by Disputes and Deductions
The Necessity of Efficient Processing and Elimination of the Root Causes
It’s a good news / bad news situation. The good news is your customer has sent you a payment. The bad news is that it is not for the full amount.
Disputes and Deductions occur when a customer believes an order has not been satisfactorily fulfilled, or it has been invoiced incorrectly. They can raise havoc with your revenue, profit and cash flow.
Disputes occur when the customer withholds payment, in part or in full, because they disagree with the bill you have sent them. Prove to them the accuracy of your invoice, and you should get paid.
Deductions occur when a customer pays an invoice less than the full amount (short payment) with no intention of ever making up the balance. In fact, with deductions, repeated analysis has shown that 95 percent of the time the customer is correct.
No matter their cause, Disputes and Deductions:
Reduce your firm’s revenue and cash flow, often in small individual amounts. If numerous, they can add up to become “death by a thousand cuts.”
Utilize huge amounts of employee work time in Finance, Sales, Customer Service and Order Fulfillment in order to resolve.
Reduce your company’s net profit margin.
Annoy customers and earn you a sub-standard supplier quality rating.
Overstate your Accounts Receivable (AR) balance causing problems with auditors and reductions in its collateral value if pledged as security in a financing (borrowing) agreement.
With the sale of a product or service, you expend the full cost of production and you bill at the full price. Yet, with Disputes and Deductions, you receive less than a full payment, and possibly receive it well beyond payment terms.
Substantial volumes of unrecoverable Disputes and Deductions will cause a significant reduction in your profit and cash flow –- possibly enough to make you unprofitable and often enough to increase your borrowing. This is especially true if you sell to major retailers and/or other firms that take large volumes of deductions. We’ve seen large corporations incur profit dilution in excess of 2 percent because their Dispute and Deduction handling was inefficient.
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Get to the Root Cause
If you have a significant volume of Disputes and Deductions, or if the volume is steadily increasing, you need to get to the root cause. This is because upwards of 95 percent of short payments are self-inflicted wounds. Customers make short payments because the invoice they receive does not agree with their purchase order and receiving documents. Ultimately, Disputes and Deductions are an invoice accuracy problem.
You want to, therefore, identify the high frequency causes of Disputes and Deductions. Correct the causes and you will see a reduction in volume. One client discovered that their most frequent cause of deductions was billing incorrect sales tax. They acquired a leading sales tax application and saw sales tax deductions decrease by 84 percent within six months.
The American Productivity & Quality Center (APQC), a non-profit organization providing independent, unbiased, and validated research has accumulated data from over 1,700 companies on the time it take to make billing adjustments, as well as the cycle time from issuance of an invoice until receipt of payment. Their benchmarking shows efficient firms take on average just 7 days to correct an invoice and only 16 days from invoice to payment. At other end of the spectrum, less efficient firms take 20 days to correct billing errors while their bill-to-payment cycle time jumps to 35 days. The biggest factor in the difference in payment time (21 more days) is the 13 additional days - nearly twice as long - it takes to process an adjustment.
These metrics speak volumes about the importance of both invoice accuracy and the need for responsiveness in regard to customer disputes and deductions. Bill promptly, invoice accurately, and respond quickly to disputes and deductions and you will get paid sooner rather than later.
Please share this newsletter with your small business customers . . . it just might help them pay you sooner!
Dispute Resolution
While eliminating root causes and increasing invoice accuracy is the best defense against Disputes and Deductions, you are probably never going to be able to eliminate every discrepancy. There will always be customer Disputes, and here is what you should do when they occur:
When a customer is holding up payment due to a Dispute, request the customer pay the invoice ASAP less the amount disputed. In many cases this will recover a large portion of the total invoice amount. Inform the customer you will research their Dispute and settle the short payment promptly.
Research the customer’s claim. Ascertain the nature and specifics of the Dispute. If the customer is correct, issue a credit memo. If the customer is incorrect, provide documentation to support your position and request prompt payment. Of course, this step may be difficult and require several iterations. It’s only worth doing if the amount in dispute is significant and/or you have solid documentation for your charges.
Deduction Handling
Warning! Low Payback Ahead: Researching and resolving customer Deductions is generally a low return activity. It requires substantial time to determine if the customer is right or wrong, and if they are wrong, then significant effort over an extended time to prove they are wrong and collect the money owed. Deductions must be still be resolved, however, because taken together the accumulated value of all can be significant.
Resolving Deductions, however, is notoriously a low return activity because 95 percent of the time customers usually have a valid reason for the short payment. In addition, collecting the 5 percent of Deductions that are not valid takes considerable time and effort while typically successful only half the time. For these reasons, processing Deductions can consume huge amounts of time only to result in a low return on the investment.
To make the best of this difficult situation:
The first step is to screen out small value Deductions which cannot be economically researched and resolved. This is best handled through an Automatic Small Balance Write-off, which is just the cost of doing business. Of course, if a customer has a high volume of small Deductions, that needs to be addressed, and is best accomplished with periodic random audits of their deductions. In our experience, a high portion of total Deductions can be classified as small balance and immediately written off with no resource and expense dedicated to resolving them. For example, one client raised their automatic write of threshold to $600, eliminating the need to research 42 percent of total deductions whose aggregate value was only 2 percent of total deduction value. When you consider only 5 percent of deductions are valid, they were sacrificing the opportunity to recover one-tenth of one percent of total deduction value in return for reducing research volume by 42 percent. A good deal.
Ascertain the nature and specifics of the Deduction. The customer will often include an explanation or reason codes with their remittance advice.
Research the customer’s claim. If the customer is correct, issue a credit memo. If the customer is incorrect, provide documentation to support your position and request prompt payment. Of course, this step may require more than a little back and forth with the customer.
There are also other actions that can be taken to reduce the burden of Disputes and Deductions:
Negotiate a price allowance for specific types of Deductions. For example, a 0.4% price reduction, based on historical experience with short shipments, to cover product shortages in return for the customer not taking shortage deductions. This is an issue that often comes up with the shipment of bulk products where there is almost always an overage or shortage.
There are numerous Dispute and Deduction software solutions available that deliver huge productivity increases and speed up the resolution process. These reduce your processing costs.
Your Virtual Credit Manager can help you identify process improvements that will shorten your cash conversion cycle and improve collection efficiency.
Be Smart . . .
The Dispute and Deduction resolution steps outlined above, executed with streamlined processes and supported by easy access to information and documents, enable you to reduce your processing costs and maximize the return of your administrative efforts. The real key to efficiency, however, is reducing the number of Disputes and Deductions that occur.
In the final analysis, you need to be smart in your approach to Disputes and Deductions. Ignoring them only compounds the problems they create. When Disputes and Deductions occur they need to be addressed efficiently. When they keep recurring, the root cause needs to be eliminated.