Why Accurate Cash Application of Trade Spend Is Critical for Emerging CPG Brands
Trade spend is a big line item in any CPG brand's budget, and it can be one of the largest expenses for emerging CPG companies. Mismanaged cash application of trade spend can skew financial data, making it difficult to analyze profits, handle cash flow, or create accurate financial forecasts.
Tools for managing trade spend often focus more on promotion planning and boosting effectiveness, but the nitty-gritty details matter, especially when it's time to review your balance sheet or make capital investment decisions. You can't get a true picture of trade spend lift if you don't tie deductions to the correct sales invoice.
Let me walk you through the basics of trade spend cash application and offer best practices for this accounting task.
The Basics of Cash Application and Trade Spend
Cash application involves posting customer payments to the right invoices and line items.
Let's look at some basic examples:
Restaurant A pays an invoice for the wine it ordered. You must apply that payment to Restaurant A's account. Otherwise, it looks like the customer still owes money.
A retailer receives shipments every month on Net 30 terms. According to your agreement, late payments incur a 10% fee. The store receives shipments on February 5 and March 3 and pays the February invoice on March 4. It's important to match the payment to the right account and invoice. Otherwise, you might credit the March 3 invoice and charge a 10% late fee on the February invoice.
Throw in trade spend management for CPGs, and cash application gets more complex. Trade spend is the money spent on special incentives to drive more sales, including promotions and discounts, such as volume rebates and coupons, as well as allowances for issues such as spoiled product.
Retailers may deduct those amounts upfront when they pay invoices, reducing their payments below the amounts initially invoiced. If you don't apply trade spend deductions correctly, you leave line items open in your accounts receivable, making it hard to truly understand your accounting KPIs.
Some common mistakes I've seen in trade spend and cash application include:
Not validating deductions. Verify deductions to ensure they align with your agreements, or you might apply unauthorized or duplicate deductions.
Letting trade-spend-related cash applications pile up. Keep up with trade spend to reduce opportunities for error and ensure your financial landscape is always accurate.
Manual data entry errors. Leverage automation where possible to streamline cash applications and detect potential errors.
Not having a standardized process. Create a consistent process and communicate it to your customers. For example, if you already account for trade spend deductions on invoices, make sure they aren't subtracting it again when they make payments.
The Hidden Costs of Misapplying Trade Spend
Obviously, there's a link between trade spend and profitability. CPG brands sacrifice immediate profit margins for future growth, and those strategies can work well. But if you're misapplying trade spend, you may not have a big-picture understanding of your AR and cash flow, which can negatively impact financial decision-making and put growth at risk.
One of the main risks is a poor understanding of open collections and accounts receivable. If you misapply trade spend deductions, it can look like you have outstanding AR where you don't, or it might hide AR that's actually outstanding. This can create situations where company decision-makers have a skewed sense of what's owed or future potential cash flow.
At best, you waste time following up with distributors who you think owe money, only to eventually discover the error. At worst, company owners or leaders make spending decisions based on inaccurate AR forecasts, leading to cash flow challenges later.
Another common risk is an inflated trade spend accrual liability on your balance sheet. If you don't regularly apply trade spend deductions and offset this account, you may end up with a rather large false liability.
Best Practices for Accurate Cash Application
You can save your company time and money by following a few best practices for cash application.
Use a Consistent Approach
Accurate cash application for CPG brands starts with consistency. Reconcile trade spend deductions at least weekly so you can catch and address discrepancies before accounts become convoluted. This reconciliation should include matching deductions to agreements.
Employ Automation
Invest in automated processes to match payments to invoices and account for trade spend and other deductions. Blockchain software, OCR tools, and machine-learning algorithms make these processes easier for accounting teams across all industries.
Set Expectations for the Team
Develop strong communication and collaboration between sales and accounting teams to reduce friction across the entire process. When Sales knows trade spend deductions are applied regularly, account reps are more confident speaking to customers about their balances. If Sales is upfront about trade spend negotiations and agreements, Accounting can ensure invoicing procedures align with those discussions.
Get Professional Help
Consider working with an accountant with CPG experience to set up processes that support best practices or consult on discussions about how much to spend on trade spend.
Cash Application vs. Trade Spend: Understanding the Differences
While they're related, cash application and trade spend aren't the same. Cash application involves matching payments and other credits to invoices. Trade spend refers to certain types of promotional expenses. Cash application is a ledger process, while trade spend management is a growth marketing strategy.
Accurate reconciliation of ledger deductions related to trade spend ensures you have a better understanding of:
How your cash may flow in the future
How much money you're owed
How trade spend may be impacting each account and your overall AR
Profitability that accounts for trade spend and provides a better understanding of critical metrics, such as your break-even point
The Role of Accurate Cash Application in Optimizing Cash Flow
Accurate cash application, including trade spend deductions, lets you understand where cash is coming from. If you know what you're owed and when to expect it, and you can trust those figures, you know what type of working capital you have and when you can reinvest for growth.
Optimized cash flow also improves your understanding of your company's actual liquidity. I've seen brands ignore trade spend reconciliation for so long that their trade-spend-related balance sheet liabilities get out of hand. They literally throw off the balance with fake liabilities. Or it may tip the other way, and they have false assets on the books as open AR when it's really a promotional discount.
Improve Profitability and Growth With Accurate Trade Spend Management
Managing trade deductions may be a tedious accounting job, but if you don't do it, you never have an accurate understanding of your CPG brand's profitability. You also have a skewed understanding of cash flow, which can lead to poor financial decisions that put growth and your brand's survival at risk.
Cultivar can provide customized solutions to help emerging CPG brands optimize trade spend and cash application processes. Get in touch today to find out about personalized support.
FAQs
Want to learn more about cash application of trade spend? These FAQs can help.
What Are Examples of Trade Spend That Need to Be Deducted?
Trade spend includes any reduction in cost to the retailer to help increase sales. Examples include percentage discounts on the invoice, scan-based discounts based on the number of units sold, free inventory for new placements, shortages on shipments, spoiled or damaged product, and display allowances to get your product in a prominent spot.
What Is Working vs. Nonworking Trade Spend?
Working trade spend includes discounts that help increase consumer purchases, such as special promotional displays, rebates, and temporary price reductions. Nonworking trade spend covers all the support activities that don't directly drive consumer purchases but are still crucial to sales, such as invoice reductions for spoiled or damaged items and slotting fees.
Is the Cash Application Process the Same for Working vs. Nonworking Trade Spend?
For both types, you need to ensure you apply the payment to the correct invoice. However, nonworking trade spend is often more time-consuming to validate because those expenses are unplanned and aren't approved in advance. The amounts might also be recorded under different categories.
What Type of Professional Help Is Available?
At Cultivar, we offer a wide range of trade spend management services, including software integrations, deduction validation, and dispute management. By syncing your accounting and sales systems, we make it easier to track trade spend.
