APEX Expert Blog

How to prevent millions from slipping through the cracks

by Jim Arnold, President of APEX Analytix

Contract overpayments are a little like a slow leak in your right rear tire. You don’t usually notice until it’s too late, and you find yourself fixing a flat by the side of the road. The good news: You can solve the problem and get back on the road to business as usual

No one sets out to routinely overpay on supplier contracts. But despite everyone’s best efforts, money gets wasted — a lot of money. Ironically, part of the blame rests on efforts to streamline paper-driven accounts payable processes and drive down manual error rates.

Using enterprise resource planning (ERP) systems or best-of-breed approaches, many companies have done well at automating the purchase-to-pay process. And some have gone a step further, to implement Evaluated Receipt Settlement (ERS), which automates invoice payment, eliminates traditional three-way matching and saves a lot of paper-shuffling.

But contract compliance has lagged behind. Few companies have a global contract repository or any easy way to match contract terms to purchase orders or invoices. Even companies that image documents may be exposed to above-average error rates. That’s because contract terms aren’t culled out and stored so they can easily be matched with transactions.

The bottom-line questions to ask: How can we make sure every invoice we pay is in compliance with the contract terms? If we pay $15.52 per unit for Part No. 1234 on the face of the invoice, was that the price negotiated on the contract?

Big discrepancies

Lack of contract compliance leads to some of the highest error rates, biggest disconnects and largest dollar amounts slipping through the cracks. Here are a few recent examples:

• A global entertainment company contracted with a temporary staffing service to fill 1,100 different positions in different countries. But the contract only established rates for 350 of those positions. At stake: Total contract payments of $40 million annually. Since most temporary service contracts are billed cost-plus, inability to know the true base rate drained away even more cash.
• An automotive manufacturer wound up paying $421,000 too much to a vendor because someone “fat-fingered” the price with a misplaced decimal point. The manufacturer’s ERS assumed both the purchase order and receipt were correct and automatically cut the checks.
• A large manufacturer that used industrial gases arranged for a contract price of 75 cents per cubic foot, but a data entry error turned that price into $75, and an invoice that should have been $1,150 added up to $115,000. Again, their ERS just paid the calculated amount on the check.

Other examples range from mistakes that hinge on incorrect units of measure (pounds to kilos is commonplace) to companies that buy at the correct contract price but get refunds for returned items at a lower price. The latter cost one plastics manufacturer $27,000.

What you can do to prevent errors

Most CFOs and other financial executives understand these things happen. They may not realize the scope of the problem, which tends to increase as companies grow, merge and build a global presence. Clearly, the larger the enterprise, the more likely you’ll find information silos, fiefdoms, little or no interface between Accounts Payable and Purchasing and other signals that overpayments need attention. To prevent these errors, companies can take two main approaches:

• Marry the contract master file and the transaction file, so you can more readily compare the two. For example, say the contract calls for Company A to pay Company B $16 per widget from January 1st to July 31st. When you run a transaction report, you see that you’ve been paying $18, or $2 more than you should. That gives you the data you need to take action and recover those overpayments.
• Look for anomalies in the data, and then chase down the contract to determine why the anomalies occurred. Let’s say you review the transactions over time and see that for Part X you’ve been paying $12 per invoice except for twice when you paid $18.50. In context, that $18.50 anomaly sticks out like a sore thumb. And if you’re talking about thousands of parts and invoices, some number of anomalies will surely turn into overpayments.

Flag exceptions early and often

Certainly, keeping exceptions to a minimum and flagging them as early as possible is a “best practice” well worth pursuing. You will not only put a stop to overpayments, but cut your overall processing costs as well. Fixing problems during invoice processing carries one cost; finding the problem later, when you have to reverse it out in accounting, carries an even higher price.

And of course, if your overpayment is out the door, you have to get it back from your supplier, and that creates another set of problems. What if you discover the overpayment is a year old or more? Is that supplier still in business? Are your contact people still in place? Can you get to the right people?

Relationship issues add yet another dimension. Hunting down $5,000 from a distant third-tier vendor is one thing, but asking a downstream supply chain partner to take a $250,000 hit is quite another. Yes, they’ve been billing you the wrong amount, and yes, you deserve to get your money back. But that’s still going to be a difficult conversation — and an adversarial situation.

Consider sending statements

Another recovery option that can pay handsome dividends is to send statement requests to vendors, in an effort to resolve open invoices or credits on their books. Often vendors have credits on their books that aren’t reflected in clients’ internal records. For example, say a plant across the country returned $50,000 worth of parts, but that credit never made it into the company’s ERP system.

At some point, the vendor will take that $50,000 into income, even though it’s money owed to you. And let’s be candid: Vendors have little or no incentive to tell you about credits on their books — in some cases Accounts Receivable departments are instructed to hide credits, to respond only if specifically asked about them, or not to respond at all.

For example, APEX Analytix has found that a series of two or three letters generates about a 40 percent response rate from the vendor master list. Calling the major vendors often brings the total to 50 percent. If that effort generates $2 million, you can bet there’s another $2 million held by vendors who didn’t respond.

It’s a safe bet that, if you have 50,000 vendors globally, some will be forthright about credits, and some won’t. Others will rationalize that those credits amount to a compensating balance or represent just payment because you made them wait 90 days to get paid.

A final word

The longer you wait to recover overpayments, the more effort and expense involved, and the more time needed to resolve the issues. Across thousands of payments and vendors, these dollars can be significant. As the late Sen. Everett Dirksen once said, “A million here, a million there, and pretty soon you are talking about real money.”

That’s why smart companies use technology solutions that will find overpayments or other errors as early in the procure-to-pay process as possible, when least costly to fix — and less likely to leave you stranded by the side of the financial road, wondering why the spare tire isn’t in the trunk.

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Jim Arnold is the president, founder and chief technology officer of APEX Analytix. A CPA, CMA, CFE, CISA and CAPP, Arnold previously worked in application development at Texaco Inc. and internal auditing at General Foods/Philip Morris, and for two years was manager of financial planning for the Maxwell House coffee division. He received a bachelor’s degree in accounting information systems from Pace University.