What does deduction mean in the context of accounts receivables? Deduction denotes the amount reduced by the customer from the invoice amount due. Deductions can occur due to many reasons; both genuine and controversial. For instance, quantity, quality, or timeliness of delivery is a common reason. In other cases, there could be additional factors.
Deduction in accounts receivables is not new. However, businesses in the manufacturing, food, wholesale, and distribution industries encounter these frequently. A customer may opt for a ‘deduction’ when paying an invoice for a variety of reasons. Sometimes customers also take the deduction based on their own business policy and procedures. Deductions are the most difficult type of open item in accounts receivable to resolve because of their cross-departmental dependency.
Deductions resolution is a critical process in the accounts receivable process because it directly impacts the organization's revenue. When customers pay their bills partially, it becomes challenging to forecast revenue. Recent research shows that customer deductions incorporate 5% to 20% of the company’s gross revenues. Even if 10% of these AR deductions are unauthorized, a $1 billion company will be losing millions of dollars of profit.
The process of deduction resolution may sometimes involve communication with teams in the sales, accounting, operations, shipping, or logistics departments. In addition to the time spent by your own AR team, customers also get frustrated by incorrect invoices, and the time taken to handle the negotiations by their own teams. An inefficient deductions management process severely impacts customer satisfaction. Hence, identification and resolution of valid deduction should be attended to at the earliest and with utmost efficiency.
Earned deductions are provided by the supplier to the customer based on certain parameters. For example, trade promotion, ‘early pay discount’ or sales discount. These deductions are a part of the normal course of business and are the most common deductions.
Claims deductions are when the customers pay a portion of the invoice and raise a dispute (for example damaged goods or shortage in shipment). The organization then takes up the deduction on its payment if found to be valid.
Last, but one of the most common reasons for deductions is simply because of an innocent mistake. This happens, especially when organizations follow manual deduction management processes. The types of deductions in this case include:
As mentioned earlier, the deduction identification and resolution is a crucial process since it has a direct impact on an organization’s cash flow. Disputes in account receivables aren’t merely an inconvenience but damaging to functional costs and company time. Thus, they must be identified and resolved in an efficient manner. Research conducted by Genpact showed that 14-16% of deductions are invalid. The research also stated that 5% of deductions are unresolved and written off. Dispute management eats up 25-35% of the total order to cash effort, which has a considerable impact on the cash flow.
There is no doubt that manual deduction management is time-consuming and tedious. It requires a lot of analysts to go through the task of aggregating backup documents such as claims, PODs from carrier portals, customer’s accounts payable (AP) portals, Trade Promotion Management (TPMs). A chunk of the analyst’s productivity gets used up even before they start to research and validate the deduction. It not only delays the overall deduction resolution cycle but also hampers the analyst’s productivity.
According to an Attain Consulting survey, a $1bn+ organization potentially loses out on $4m annually from invalid disputes which are not recovered on time. Since the entire process is manual, a large number of open deductions go unnoticed and are eventually written off.
Manual deduction processes are error-prone since the team needs to manually identify the invalid disputes from 1000+ deductions every day which is equivalent to finding a needle in the haystack.
Lack of structured collaboration, multiple communications with customers, and longer approval cycles for deduction resolution leads to a dent in customer experience. Eventually, this will result in the downfall of a business.
To overcome these problems, switching over to a modern deduction management process will benefit the organization. It will improve workflow, bring visibility, and ensure efficient usage of the analyst’s time.
Once you have conducted a thorough analysis of your current deduction mechanism process and identified areas of improvement, you can level up by leveraging a smart platform. Integrating an automation solution with your ERP (Enterprise resource planning) and TPM (Trade promotions management) helps shorten the time taken to identify and resolve deductions. Consider a platform that offers:
It is a solution that automatically extracts data (promotions and commitment data from TPM); claims and POD documents from EDIs, emails, paper-based copies, or customer portals and links them to the relevant documents to reduce the research time.
Once the data is collected and auto-matched to the deduction, they can be validated with the help of AI reducing the analyst’s intervention (unless there is a case of exception). The deductions are then either approved or denied.
A prioritized worklist contains the open deductions along with the recommended steps to be taken to help the analyst focus on high-priority tasks. The deductions analyst can then validate them to ensure faster resolution cycles and faster recovery.
Integrate your ERP with Highradius Deduction Management Software, and proactively manage your deductions. The software standardizes and automates processes by:
The result is a hassle-free deduction management operation that helps recover revenue normally lost due to invalid deductions.
It’s quite natural for accounting teams working on thousands of deductions every day to miss the lower value deductions. There is a significant investment of time involved to research, follow up, and close deductions, even for low-value amounts. The longer and more time-consuming the deduction process is, the less steady and inconsistent the cash flow of that company will be. The longer it takes to resolve, the higher chances of not recovering the full invoice amount leading to an increase in DSO (Days Sales Outstanding), which can become a burden to grow a business and invest further.
There’s a famous saying in business: “Revenue is vanity, profit is sanity, cash is king.” Who doesn’t desire a positive cash flow in a business? But, failure to recover your invoice amount on time will have a negative impact on your business and over time, this will lead to the business incurring huge losses.
HighRadius Integrated Receivables Software Platform is the world’s only end-to-end accounts receivable software platform to lower DSO and bad-debt, automate cash posting, speed-up collections, and dispute resolution, and improve team productivity. It leverages RivanaTM Artificial Intelligence for Accounts Receivable to convert receivables faster and more effectively by using machine learning for accurate decision making across both credit and receivable processes and also enables suppliers to digitally connect with buyers via the radiusOneTM network, closing the loop from the supplier accounts receivable process to the buyer accounts payable process. Integrated Receivables have been divided into 6 distinct applications: Credit Software, EIPP Software, Cash Application Software, Deductions Software, Collections Software, and ERP Payment Gateway – covering the entire gamut of credit-to-cash.
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