Financing Through Factoring? Don't Let Chargebacks and Deductions Affect Your Dilution Rate
| Authors: | Keith Alphonso | Director of Business Development at Aditya Birla Minacs |
| Jeffrey Knopman | Cofounder and Principal at Profit Solutions Group Inc. |
If you are financing your business by Factoring, you had better factor in the possibility of being hit by chargebacks and deductions issued by major retailers, specialty stores and catalogues.
WHAT IS FACTORING?
So what IS factoring? Well, it’s been around for quite some time—4,000 years to be precise. Legend has it that it is the brainchild of King Hammurabi of Mesopotamia, credited with having established the world’s first metropolis, Babylon. Factoring can be defined as a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (the Factor) at a discount.
A typical factoring transaction is when a Factor advances funds to a Seller based on accounts receivable. The amount advanced could vary and is typically between 70–85% of the purchase price of the invoices, with the balance being paid, net of the Factor's commission and other charges, upon collection.
MINIMIZE CHARGEBACKS AND DEDUCTIONS TO REDUCE FACTORING RISK
All Factors manage their risk by, among other things, assessing the dilution rate of the seller of the invoices. Simply stated, the dilution rate is the loss associated with the collection of the accounts receivable. The dilution rate is comprised of chargebacks/deductions such as returns, damages, markdown allowances, compliance infractions, trade allowances, slow pay, bad debt and other negative issues.
To ensure a reliable cash flow, it is therefore important that chargebacks and deductions are constantly monitored and kept at a minimum. Factors should feel confident of being able to recover their funds when they provide you, the Seller, an advance.
While legitimate or authorized chargebacks can be easily taken into consideration when planning cash flow, unauthorized or erroneous chargebacks issued by retailers could be very damaging. Given that 25 to 30% of all chargebacks issued by major retailers, specialty stores and catalogues are either unauthorized or erroneous; this needs to be taken seriously.
In order to survive in this tenuous economy and garner a true understanding of the modern dynamics of deductions, it is imperative to re-evaluate the internal organizational structure of the order to cash cycle. One also needs to have the same meticulous focus and attention to detail as one would with merchandising, sourcing, production, etc.
It helps to be aware of some of the top compliance deduction reasons including concealed shortages, freight and routing errors, early/late deliveries, EDI violations and carton shortages. Every deduction, whether alleged or valid, has a history. This point is critical when disputing or accepting deductions. Furthermore, retailers have been known on occasion to be “in error” when assessing chargebacks against their suppliers.
MASTER THE FUNDAMENTALS IN DEDUCTION MANAGEMENT
The end game is to reduce the draconian flow of deductions, reduce days sales outstanding and turn a reactive environment into a proactive one. Companies can and should at least pay strict attention to the basics. Just like in football, where success is based on mastering the fundamentals such as BLOCKING, TACKLING, RUNNING and CATCHING, there are fundamentals in deduction management that must be mastered as well.
We have come a long way from the time of King Hammurabi. Let’s do him proud by mastering the deduction management process to ensure that the factor/client relationship is greatly enhanced by both the reduction in the dilution rate and the increase in cash flow.
How the Grinch Stole Christmas... From Suppliers: The Chargebacks and Deductions Nightmare
| Authors: | Keith Alphonso | Director of Business Development at Aditya Birla Minacs |
| Jeffrey Knopman | Cofounder and Principal at Profit Solutions Group Inc. |
It's the season to be jolly and there is no reason to be sorry if you know how to save your money from the...Grinch. Like the story of how the Grinch stole Christmas, chargebacks and deductions can be a similarly harrowing experience for consumer products suppliers.
UNAUTHORIZED DEDUCTIONS AND CHARGEBACKS ADD UP
But is the deductions issue fictitious? Is there really a problem? There sure is! Quite like the loss of water dripping from a faulty faucet, chargebacks and deductions that are unauthorized or not agreed to by a supplier, reduce the amount they get paid on their invoices - for no fault of theirs. It is always a challenge trying to keep up with a retailer's list of compliances. When looking at a single deduction made by a retailer, it may not seem like a lot and quite often it is ignored. However, when deductions are added up at the end of the year it can significantly impact the bottom line. The problem is with unauthorized deductions or chargebacks that are not legitimate. Chargebacks could be of various types including freight and handling charges, terms of payment, short shipments, advertising and markdown allowance claims.
Our experience has shown that 25 to 30% of all chargebacks issued by major retailers, specialty stores and catalogues are either unauthorized or erroneous. Yet, only about 20% of these deductions are on average recovered from retailers, with the overwhelming balance being written off. Tens of millions of dollars are therefore being left uncollected!
Chargebacks and deductions affect manufacturers and suppliers across a wide spectrum of industries, including consumer product manufacturers, pharmaceutical companies and the apparel industry. In short, any manufacturer or supplier dealing with retailers has a chargeback problem. A problem that they may sometimes be unaware of.
RETAILERS CREATING A NEW PROFIT CENTER - AT THE EXPENSE OF SUPPLIERS?
With the changing paradigms of the retail industry, suppliers are now dealing with a limited pool of retailers and the "rules of engagement" have changed dramatically. Retailers have created a new "profit center." Suppliers to a larger extent can now no longer ship bulk to distribution centers. Shipments need to be floor-ready. In the apparel industry, suppliers are now tasked with a multitude of responsibilities such as hangers, labels, ASN notices, packing goods for individual branches and many other new demands expected from them and driven by the retailers' new found leverage. All one has to do is pick up a routing guide/compliance manual and the message is conveyed loud and clear: "We dare you to ship correctly!"
Chargebacks and deductions play a significant role in the financial performance of suppliers as they siphon away profits. It is therefore imperative to re-evaluate the way deductions are handled and apply the same meticulous focus and attention to detail that is given to merchandising, sourcing, production, marketing and sales, to garner a true understanding of the modern dynamics of deductions.
Don't wait for a change of heart a top Mount Crumpit! Be proactive and enjoy the holidays!
For more information and details call Profit Solutions Group, Inc. at (212) 779-0907. Profit Solutions Group, Inc. is located at 1120 Avenue of the Americas, 4th Floor, New York, NY 10036