A/R Deductions

The Different Types of A/R Deductions

An A/R deduction can take several forms depending on its origin:

Claims deductions: When a portion of payment is withheld due to a dispute
Earned deductions: Typically observed as discounts given to customers for various marketing or promotional purposes

While earned deductions are worked into a company’s broader marketing strategy (and thus remain predictable), claims deductions and dispute management are where most companies will want to focus their attention.

At its most basic, any invoice dispute made by a customer can be considered a potential A/R deduction, and as such, companies benefit from setting up a repeatable (and ideally, automated) process for managing disputes.

What Is Dispute Management?

In a perfect world, businesses wouldn’t need dispute management. In reality, dispute management planning acknowledges the fact that clients will, at some point, refuse payment for one reason or another. When they do, companies need to know how to react in order to preserve the customer relationship and keep cash flows as predictable as possible.

A customer may dispute an invoice for a variety of reasons:

Pricing disputes over payment terms
Disputes over service quality or failed expectations
Administrative errors on the business’s end, including invoicing errors or double billing
Disputes for products that were never received

The Dispute Management Process

Dispute management incorporates a set of practices to allow businesses to handle these claims in a way that minimizes variability in cash flow. Here’s how the process typically works:

The dispute ticket is received from the accounting department or customer
The ticket is logged into accounting software and prioritized based on importance
Analysts pull relevant data from the issue, including documentation, proof-of-delivery, receipts, and any other pertinent details
If necessary, additional data may be requested from the customer regarding their complaint
The analyst reviews documentation and determines an appropriate action across cancellation, write-off, or refunding
This recommendation is sent up to executives to make the final call on resolution
The analyst corresponds with the client informing them of the decision
Updates to the invoice and associated documentation are made in customer relationship management (CRM) and enterprise resource planning (ERP) systems
Reports are generated to bring visibility to the issue and offer concrete information for future improvements to services or the A/R process itself

Keep in mind that this process would work great in a perfect world with clear communication among all parties. Disputes aren’t always resolved so easily, and the longer a company goes without collecting on the payments they’re owed, the more problems begin to appear.

Understanding Days Deductions Outstanding (DDO)

Accounts receivable deductions may not seem like they’d substantially impact operations, and in many cases, they won’t. A deduction here and a dispute there won’t materially affect an otherwise successful business. The problems come when a company starts to experience these disputes as a common occurrence, which is a clear sign that something’s wrong.

A simple metric for tracking disputes and A/R deductions is DDO – Days Deductions Outstanding. The formula for DDO is easy to calculate:

DDO = Number of Open Deductions / (Average Deduction Value * Periods)

This metric is a broad measure of a company’s ability to investigate claims, manage disputes, and collect on invoices. High DDO rates mean you aren’t collecting what you should and are losing money because of it. On the flip side, low DDO rates suggest an efficient dispute management process that minimizes the amount of time each invoice is open.

Although simple enough on paper, dispute management in application becomes a bit more complicated. The conventional deduction management process relies on manual data entry and report generation.

Every time a dispute is opened, an analyst needs to pull up documentation and manage communications by hand, inevitably leading to a cost-intensive, time-consuming process that makes it even harder to mitigate the impact of the dispute. For companies in this position, automated deductions management software is the best way forward.

Apply Automation and Deductions Management Software to Your Process

Those familiar with A/R know that automation is one of the single biggest improvements a company can make to its conventional accounting practices. Solutions like Gaviti’s automated A/R platform offer a variety of new ways to personalize collection strategies, deploy automated communications, and identify invoice disputes early in the process.

By doing so, companies minimize DDO and gain confidence knowing that their A/R system will be proactively monitoring for potential complications. Combined with the centralized nature of these platforms that makes data aggregation and reporting easy, it’s no wonder why 89% of businesses get paid on time when leveraging automated accounts receivable.

Do you have more questions about applying automation to accounts receivables and understanding additional deduction concerns—such as AR deductions on a paycheck? Gaviti can walk you through the details. Contact our team today to learn more about what our platform can do for your accounting workflow.