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Blog: Finance and Procurement

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. at Aditya Birla Minacs
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.
Minacs Solution: If you are a Factor, learn more about Minacs’ trade finance solutions suite, especially TradeFree™ Factor, a Web-based factoring solution that automates your business end-to-end and allows your clients to work online with you for their needs.

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