Traps of the Trade: 5 things CPG Companies Need to Know About Managing Trade Spend

5 Things CPG Companies Need to Know About Managing Trade Spend

In CPG companies of every size, trade deductions are often the second largest line item on the P&L, as well as the most difficult area to manage. Yet their impact as a profit drain on the company is commonly both overlooked and underestimated by management. Recognizing and planning for the complexities of trade spend and revenue deductions are necessary first steps in establishing processes to manage this critical area of the business.

Over the years, we have seen CPG clients experience a number of challenges, including tracking ongoing trade activity. Another challenge is clearly understanding ROI on trade spend and how it compares to projected lift in sales. We have also seen CPG companies fail to hold adequate reserves to deal with deductions accruing from the prior year. Many also experience difficulty keeping up with large distributors and retailers that have robust accounting and buyer teams.

The following five insights can help you avoid the traps of trade spending:

  1. Make training central to your processManage trade spend from the ground up, by making sure that individual employees understand the company’s systems and processes. To that end, invest in staff training on accounting, ERP and trade promotional management (TPM) systems. Require cross-functional teams to use systems of record, and set clear expectations for each user’s role. Finally, provide employees with documented processes so they understand how to consistently apply policy and workflows.
  2. Bridge the gaps between sales, accounting and financeWithout clear communication and a common goal, departments can unwittingly work at cross-purposes. Encourage collaboration by clearly identifying and explaining each cross-functional department’s role in the success of the business, and explain why it matters. Make leadership responsible for communicating the importance of teamwork between sales, accounting and finance when calculating accruals and managing deductions. To help build appropriate insight on spending expectations, create a framework of trade deals, promotional calendars and forecasting models, and share it across the organization.
  3. Understand the big picture with trade and other deductionsIn order to spend wisely, you need to be able to anticipate deductions coming in from every possible avenue, from the deals made by sales reps and brokers, to deductions taken for prior-year events.
    • Understand what your sales organization is committing to and the rates associated with typical promotions. Forecast the targeted spend on base sales and incremental lift, and track deductions against actuals.

    Based on those deals, you will see deductions occur from accounts receivable payments, sometimes without authorization. Expect your sales reps to acknowledge, review and understand any deductions that come through. Rely on IRI data and other sources to validate retailer volume.

    • Brokers. Brokers also play a significant role in executing trade deals with customers. Be cautious, as brokers may agree to spend that is not authorized by internal teams or aligned with trade rates set forth by finance. Educate your brokers and establish clear communication and expectations between sales and brokerage firms. Hold your brokers accountable.
    • Trade deductions are taken by customers months after the trade events occur and can be very difficult to validate. Rely on the broker as much as needed to obtain necessary documentation.
    • Prior-year events. Post-audit deductions will occur up to two years after a promotional event. Keep a reserve on the balance sheet to account for prior-year events that may not be fully expensed.

    Other important deductions to keep an eye on:

    • Cash discounts for early pay: Most distributors and large retailers take systematic deductions based on payment terms vs trade terms. But customers may start counting toward the early pay deadline on the day goods were received into inventory, not your invoice/ship date – a difference of up to ten days. Customers commonly take the early pay discount as late as 30 to 60 days after the early pay date.
    • Shortages: Customers also take deductions off payment if they determine a shortage has occurred on receipt of inventory. The best defense is to require a signed bill of lading (BOL) and proof of delivery (POD) for each shipment. Cash discounts also occur in the case of shortage deductions. When the customer later “finds” and accounts for product, they may still take the cash discount even though it is outside of terms.

    Certain retailers’ inventory acceptance practices lead to numerous shortages and shortage reversals, and following the ins and outs of these deductions is time-consuming and costly. Engage your broker in helping manage this process and hold customers accountable.

    If your customer is responsible for picking up and transporting product, be diligent about creating processes and procedures that avoid “missing” inventory claims.

    • Damages and Spoils: These deductions are difficult for customers to justify without proof. Assign an internal team to validate them as they come through.
  4. Validate Deductions & Supporting DocumentationThe validation process ensures that all deductions are legitimately based on agreed-upon trade deals and terms with customers. But for this process to work, you need to make sure everyone in your organization is playing their part.

    Set internal policy to establish what documentation the sales organization needs to provide accounting for promotional events. This may include:

    • Signed trade agreements that define promotion type, event dates, products included and discount amounts
    • Trade calendar showing planned events with each retailer or distributor
    • Be aware of your responsibilities if a PO cannot be fulfilled due to lack of inventory. Distributors will come back and deduct a year later (they hire audit firms to research this type of deduction)

    Set internal policy to establish what documentation you require from customer service, distribution facilities or copackers, and freight carriers in order to prevent shortage claims. Include the following:

    • Signed BOL from the driver including shipment details (quantity, item, etc.)
    • Signed POD from the customer including shipment details or packing list
    • Any other paperwork required at time of receiving by your customer agreement

    Disputing deductions. It’s important be both diligent and timely with any disputes. Start with your sales reps and brokers, and then contact the customer’s AP department for proper routing directions. Remember to keep detailed records of all your communications.

  5. Staff to manage data validationDeduction support provided by the customer can include overwhelming amounts of product data that must be reconciled against certain promotional events and contracts. This mountain of information can create a challenge for deduction teams tasked with sorting and validating the data. This activity can be extremely time-consuming and includes filtering hundreds of line items to extract meaningful financial intelligence for sales and finance teams. Be sure to adequately staff your accounts receivable and deductions teams, so they can provide timely and relevant data that enables management to effectively evaluate trade spend.

    While there is no magic bullet for these common problems, simply staying ahead of them can minimize challenges to the P&L and keep trade spend from spiraling out of control. Here are a few real-world examples.

    • You offer a trade deal in September at the retail level, and the distributor orders a higher quantity than usual to take advantage of the deal. However, because of production constraints, you are unable to fulfill the whole order. Shorting the distributor PO during a deal period will result in an audit deduction in one to two years for the difference you could not fulfill. Accounting should be aware of these shorted POs to accrue for the inevitable chargeback.
    • A customer orders more product than usual to take advantage of a trade deal. If the customer cannot sell all of the product and it ages in their system, a deduction may occur.
    • A customer orders a given quantity of product using master case as the unit of measure (UOM), but you ship the product on a mixed pallet. The customer checks the item in to their warehouse as a different UOM, which results in a “shortage” of product received. To avoid this problem, use labeling that clearly identifies the pallet as individual saleable items, forcing the receiver to break down the pallet to the ordered product level.

Bringing It All Together

CPG companies face fierce competition and razor-thin margins into today’s rapidly changing market. By putting the right processes and practices in place, you can empower cross-functional teams and departments to work together across your organization to proactively oversee trade spend.

If you have questions about your trade spend approach or need some support with your financial operations, we’re happy to chat. Explore our Financial Consulting service offerings and contact us to get started today.