Profit Recovery is a way of recognizing revenue and income when payment against it has not been received in full. This method of recognizing revenue is typically used in cases where repayment of the sale is not certain. It defers gross profit until all cash relating to the sale is received, and it helps ensure that net income remains close to operating cash flow.
For example, suppose a web developer sells some software to a client on credit. The developer has heard from other developers that this client has a tendency to delay paying invoices. Therefore, the developer decides to use the cost recovery method in this instance. When the developer sells this software to the client, he records the sale as a receivable on his balance sheet and only recognizes the revenue earned when the sum of all cash payments received from the customer is equal to or exceeds the cost of goods sold.
This is an excellent method of recognizing revenue in the case of a credit sales that has a risk associated with it. However, it shouldn’t be employed for run-of-the-mill installment sales that have a high probability of being paid in full on time. Doing so would violate the accounting principle of recognition which states that revenues should be recognized when the product is transferred to the buyer. It’s also likely that auditors would not be happy if the company used this method to defer taxes.
One of the biggest problems with using the profit recovery method is that it can often be difficult to detect errors in this manner. Unless companies have the tools and staff to perform a complete review of all their transactions, these duplicate payments may go unnoticed for long periods of time. In order to be effective, these reviews should take place on a regular basis. The best time to perform these reviews is when a significant amount of new spend has been implemented, such as after systems changes or acquisitions.
Identifying potential duplicate payments early on can save a lot of money in terms of both dollars and the labor involved in recovering them. This can be achieved through a review of accounts payable data files, especially the invoice header file and invoice detail file. It is important to look for spending categories where the supplier is a sole source provider or has been awarded a fixed price contract. These are some of the most likely areas for finding cost savings. Investing in prevention methods is also crucial and can be as simple as eliminating the use of paper purchase orders to suppliers. This could dramatically cut credits to recover and fees paid. It is also worth considering a professional cost reduction firm that offers services like supply chain management, supplier communication, and procurement strategies that have resulted in more than $3 billion in client savings. Using these firms can help a company to uncover hidden opportunities that can make a major impact on the bottom line.