Grappling with the Deduction Monster:

Eight Ways to Keep Deductions Under Control

by David Schmidt

The biggest problem with deductions is that they take time.  That time can be expensive, especially if sales people end up helping resolve deduction issues.  Furthermore, by cluttering up the receivables, deductions take valuable time from the collection process and slow the payment cycle.

What makes it worse is that most deductions are credited or otherwise charged off.  The rule of thumb says over 80 percent of all customer payment deductions will be legitimate.  Even so, the five or ten percent of deductions your customers might eventually pay can add up to a substantial amount over time, so simply charging off all deductions does not make economic sense.

Deductions require an efficient systems solution.  The key is minimizing the number of deductions that occur.  The root causes of most deductions lie in your internal processes, therefore any systems solution must center around the identification of deduction types.  Being able to quantify deductions by type provides corporate intelligence that can be used to expose the root causes, and thereby leverage system improvements to eliminate, or at least minimize, the recurrence of particular types of deductions.

With this in mind, here are eight ways to curtail deductions:

1.         Automate the deduction management process -- Deduction management software or collection software with problem tracking capabilities will keep you on top of the deduction management process.  Once deductions have been coded, the software should quantify the different types and track their progress through the resolution process following a programmed sequence of activities to ensure efficiency.   In addition, deductions can then be isolated from the unaffected receivables to prevent interference with routine collections.  The bottom line benefit is the corporate intelligence to effectively address the root causes of deductions while also efficiently processing those deductions that remain.

2.         Outsource deduction resolution -- If making the capital outlay to implement a software solution is not possible or staffing resources are very tight, outsourcing provides an effective alternative.  You are not just hiring bodies, but also the systems and expertise of the outsourcing firm.  Very probably they are already dealing with some of your major customers, especially if you are selling consumer goods, and so already know how to maximize your return with these accounts.  Often, the outsourcing firm will work for a percentage of what they recover for you.  Lastly, make sure the outsourcing firm supplies you with reports and other feedback that will help you address your root causes.

Not every credit department has recourse to these two options, especially when deductions are not a major problem (at least in management’s perception).  Many credit departments are left to work with the resources at hand.

3.         Use a spreadsheet to identify and track deductions -- This enables you to quantify open deductions by customer and deduction type, and then readily communicate the data both internally and externally.  Compiling deduction data on a spreadsheet is not as efficient as an automated system, but it still improves identification and resolution.  In particular, emailing deduction spreadsheets to customers facilitates the research and resolution process.

4.         Identify deductions when cash is applied -- The best place to identify deductions is when they first show up -- when cash is being applied.  This enables the resolution process to begin sooner and keeps deductions from interfering with routine collections.

5.         Accept only written purchase orders -- Many deductions reflect differences between the customer’s P.O. and your invoice.  Checking the pricing, terms of sale, and shipping requirements found on your customer’s purchase orders will prevent these types of deductions from occurring.

6.         Conduct deduction compliance audits -- Many customers only take deductions for legitimate reasons.  If an audit of your customer’s deductions confirms this, there is no need to research their deductions -- just clear them off with a credit.  Follow-up audits should be conducted every six to twelve months.

7.         Make sure credits and adjustments are issued promptly -- The older they get, the harder deductions are to resolve.  Open deductions also cloud your receivables, interfering with routine collections and sending a message to your customers that your company is disorganized.

8.         Get management support for reducing deductions -- If management does not understand the extent and ill-effects of your deduction problems, permanent solutions are hard to come by.  This is an education process that is made easier when you can produce hard evidence describing the situation. 

In the end, you want to make it easy for your customers to do business with you.  Too many deductions are evidence that this is not the case.  Correspondingly, improving systems to reduce the number of deductions and to accelerate resolution will pay dividends in terms of customer satisfaction.