Returns are a problem for many organizations. Often returns are dumped in a pile to be “sorted out when time permits.” Dust and dirt cover this material as workers have more important tasks to perform. During a physical inventory or warehouse cleanup, the entire heap of returned merchandise may be thrown out while management vows to process returned merchandise in a timely manner in the future.
We have found that the root of many organizations’ problems with returns lies in the lack of a specific set of procedures related to these transactions. In this article we’d like to present a three-step process that you might be able to utilize in designing an effective returns program.
Step #1: Determine What Can Be Returned.
Most organizations limit returns to goods that are currently stocked. Any special order or discontinued products usually are not eligible for return. Customers should be told what items cannot be returned as they order or buy the products. This information should also be noted on all packing slips and invoices. Only designated members of management can override this policy. These decisions should be based on the specific customer’s contributions to your company’s profitability.
Step #2: Process Returns Like Any Other Stock Receipts.
Returned material should not be dumped and forgotten. If possible, require and issue return material authorizations (RMA’s) to customers. These documents list the items (and quantities of those items) that you have authorized to be returned by the customer. A copy of the RMA should accompany the physical return of the material. The RMA can serve as a packing slip to be utilized by your receiving people. All material received should be divided into one of four categories:
- Item can be resold or used in its present condition. Like any other stock receipt, this material should be put away in its normal stock location within 24 hours of delivery.
- The item must be repackaged or repaired before being returned to stock. The item should immediately be sent to the department that will perform whatever is necessary to prepare the item for resale or use. In many organizations the cost of repairing or repackaging the item will be deducted from the credit issued to the customer.
- The item will be returned to the supplier. The item should immediately be sent to the vendor or staged (with appropriate paperwork prepared) to be sent to the vendor at a later date.
- The item will be thrown out or scrapped. The product should immediately be sent to the dumpster, the “scrap pile,” or a disassembly area so that any salvageable parts can be removed.
Step #3: Calculate What It Costs to Process a Return.
How much time does it take a receiving person to check in a line item on a material return? How much time does it take to return the material to its normal storage location? How much time does it take the clerical person to issue the credit memo? You can divide an employee’s hourly wage (plus benefits) by the average number of line items he or she can process or put away in an hour. For example:
Receiver’s Time
Hourly Wage = $20 per hour
Line Items Processed per Hour = 30
Cost per Line = $0.67
Stocker’s Time
Hourly Wage = $15 per hour
Line Items Put Away per Hour = 20
Cost per Line = $0.75
Administrative Time to Issue Credit Memo
Hourly Wage = $18
Line Items Processed per Hour = 6
Cost per Line = $3.00
The total cost per line is $4.42 ($0.67 + $0.75 + $3.00). If we picked up the material or provided freight we would add an additional amount to the total cost.
Note that we calculate the cost of a return per line item. Why? Because it costs a lot more to process a return containing 18 line items (regardless of the actual quantity returned of each item) than a return with only one item. If a customer returned 18 different products and it cost us $4.42 per line to process the credit, the total cost to issue the credit would be $79.56! Also note the relatively high administrative cost. This includes the time necessary to research if and when the customer actually bought the product from us and the price-per-unit they actually paid.
Many organizations try to recover the cost of processing returns by assessing a handling charge on the credit memo. Unfortunately it is not often practical to express this charge as a dollar amount. After all, if the customer returned a relatively inexpensive $2.00 item and it cost $4.42 to process the credit, we would end up charging the customer $2.42 to accept the material back into our inventory.
For this reason, handling charges are usually expressed as a percentage of the price the customer originally paid for the material. To determine the proper percentage for your company, divide the total cost of handling receipts for a specific time period (e.g. a month) by the value of the goods returned (at the sales price) during this time period. Let’s look at an example:
Line Items Returned = 120
Cost per Line Item = $4.42
Total Sales Price of Goods Returned = $14,220.00
$530.40 ÷ $14,220.00 = 3.7%
The cost of processing the return of an item is approximately 3.7% of its sales price. Note that the cost of repackaging or repairing a specific line item should be added to this cost. Even if you do not charge this fee to the customer, it should be considered in determining the customer’s overall profitability.
Handling returns is not a pleasant task. But it can be kept under control by establishing some basic policies and procedures. By minimizing the time and effort necessary to perform this task, we can devote more effort to those activities that produce profits.