Returns and RMAs

Every distributor takes goods back. A customer ordered the wrong part, we shipped the wrong part, the item arrived damaged or a project ended with stock left over. A return merchandise authorization (RMA) is the approval that makes the return controlled. It records why the goods are coming back, what the customer gets and what happens to each unit once it arrives. Without that control, returns overstate inventory, understate costs and hide the errors that caused them.

At a glance

Step	Question it answers	Who usually owns it
Request and authorize	Will we accept this return, and why is it coming back?	Customer service or inside sales
Decide the remedy	Credit, replacement or repair? Is there a restocking fee?	Customer service, with sales for exceptions
Receive and inspect	What actually arrived, and in what condition?	Warehouse
Disposition	Restock, scrap or return to vendor?	Warehouse and purchasing
Credit or ship	Issue the credit memo or ship the replacement	Accounting or order entry
Recover from the vendor	Can we get our cost back?	Purchasing

Why the authorization step matters

An RMA exists so that nothing comes through the dock unannounced. When goods arrive without one, receiving does not know which order they came from, what price to credit or whether we agreed to take them. The usual result is a pile of unidentified returns in a corner of the warehouse, customers waiting for credits and inventory that is on the shelf but not in the system.

Most distributors set a few rules before authorizing:

• A time window. For example, returns accepted within 30 or 90 days of the invoice, stated in the terms of sale.
• Item eligibility. Special orders, cut lengths, custom assemblies and items with a shelf life are often non-returnable, or returnable only with a larger fee.
• Reference to the original sale. The RMA should point to the invoice line, so the credit uses the price the customer paid and the cost we recorded.

Reason codes

A reason code on every RMA line is what turns returns from a cost into a source of information. Keep the list short enough that people pick the right one, and split it by who caused the return.

Reason	Caused by	Usually leads to
Ordered in error	Customer	Credit less restocking fee
No longer needed, project overage	Customer	Credit less restocking fee, if the item is stock
Wrong item shipped	Us (picking)	Full credit or replacement, no fee
Entered wrong on the order	Us (order entry)	Full credit or replacement, no fee
Damaged in transit	Carrier or us	Replacement, freight claim
Defective	Manufacturer	Replacement or credit, then vendor return
Shipped late, no longer wanted	Us	Full credit, often no fee

Report returns by reason every month. A rising count of "wrong item shipped" is a picking problem, and it also shows up as lower order accuracy on the fill rate and OTIF page. A rising count of "entered wrong" points at order entry training or at confusing units of measure.

Keep "other" rare

If more than a small share of returns land in "other", the list is wrong or people are not being asked. Review the free-text notes on "other" returns each quarter and add the codes they suggest.

Credit, replacement or repair

The remedy is a separate decision from the reason.

Remedy	When it fits	What the ERP records
Credit memo	The customer does not want the item again	A credit against the original invoice, reducing revenue and receivables
Replacement	The customer still needs the item	A no-charge or even-exchange order, plus the return receipt
Repair	Serviceable equipment, often under warranty	A repair order, sometimes routed to the manufacturer

A replacement shipped before the original comes back is an advance replacement. It keeps the customer running, but it puts two units in the customer's hands at once. Track open advance replacements and follow up when the original does not arrive.

Restocking fees

A restocking fee is a charge for taking back goods the customer no longer wants. It covers the cost of receiving, inspecting, repackaging and putting the item away, and it discourages casual over-ordering. Fees of 15% to 25% of the line value are common as a rule of thumb, higher for special orders, but set yours from your own handling cost and your market.

Apply the fee only to customer-caused returns. Charging a restocking fee when we shipped the wrong part is a fast way to lose an account. Most ERP systems let the fee sit as a separate line on the credit memo so it can be waived line by line with a reason.

Receive, inspect and disposition

Receiving a return differs from receiving a purchase order. The goods need an inspection before they are available to sell, so most distributors receive returns into a holding or inspection location first.

Dispositions

Disposition	Condition	Inventory effect
Restock	New, in original packaging, current item	Back into available stock at the cost recorded on the original sale
Return to vendor	Defective, or overstock the vendor will take back	Held for vendor return, then removed when shipped
Scrap	Damaged, expired, opened or obsolete	Written off, which is a cost of the return
Repair or refurbish	Serviceable but not saleable as new	Moved to a separate item or location at a reduced value

Restock at the right cost

Returned goods should come back at the cost that left inventory on the original sale, not at today's replacement or average cost. Using a different cost moves margin between periods and makes the return look better or worse than it was.

For items with lot or serial numbers, the return must come back under the same lot or serial that shipped. See lot and serial traceability.

Vendor returns and credit recovery

A return to vendor (RTV) sends goods back to the supplier for credit. Distributors use it for two reasons: defective goods under the manufacturer warranty, and stock rotation, where a supplier lets us send back slow items (often up to a share of the prior year's purchases, and often only with an offsetting order).

The steps mirror the customer side. Request a vendor authorization, ship with the vendor's reference on the paperwork and record a debit memo or expected credit. Then follow it until the vendor credit arrives. Vendor credits are frequently short, late or never issued, and each one that goes unchased is cost we absorbed.

Suppliers often charge their own restocking or handling fee on stock rotation returns. Put that fee on the RTV when it is agreed, so the expected credit matches what the vendor will pay.

What returns do to inventory, margin and fill rate

Inventory value

A restocked return adds units back to inventory. A scrapped return does not, and its cost becomes a loss. An RTV sits in inventory until it ships, and a receivable for the vendor credit replaces it. Returns received but not yet inspected are a common reason inventory and the general ledger disagree at month end, so clear the inspection location before the close.

Revenue and margin

A credit memo reverses revenue and, for restocked goods, reverses cost of goods sold. The margin you earned on the original sale disappears, and the costs of handling the return are added. Under U.S. GAAP, FASB ASC Topic 606 (added by ASU 2014-09) has sellers that grant a right of return recognize revenue only for the goods they expect to keep sold. Those sellers also carry a refund liability for expected returns and an asset for the goods they expect to get back. The estimate is an accounting policy question for your accountant. On the operations side, a reliable return rate by customer and product group is what makes the estimate possible.

Fill rate and service

A return caused by a picking or entry error means the original order line did not deliver what the customer wanted. Some distributors reduce the fill rate for such lines. At minimum, report error-caused returns next to fill rate so the two can be read together.

Worked example

These numbers are invented and round. A customer bought 20 units at $50.00 each, cost $36.00 each and returns all 20 because they ordered the wrong size. The terms carry a 15% restocking fee.

Step	Calculation	Amount
Original sale	20 × $50.00	$1,000.00 revenue
Original cost	20 × $36.00	$720.00
Original margin	$1,000.00 minus $720.00	$280.00
Restocking fee	15% × $1,000.00	$150.00
Credit memo	$1,000.00 minus $150.00	$850.00

On inspection, 16 units are resaleable, two are damaged and two go back to the supplier, which charges a 10% handling fee.

Disposition	Calculation	Cost recovered
Restock 16	16 × $36.00	$576.00
Return 2 to vendor	2 × $36.00 × 90%	$64.80
Scrap 2		$0.00
Total recovered		$640.80

• Cost not recovered: $720.00 minus $640.80 = $79.20
• What the business keeps: $150.00 fee minus $79.20 = $70.80, before the labor to receive and inspect, and before any freight we paid

A sale that earned $280.00 ended at $70.80, and probably below zero once handling is counted. Had the reason been "wrong item shipped", there would be no fee, and the same transaction would lose $79.20 plus handling.

Two KPIs to track

Return rate

What it measures: the share of sales that comes back.

Return rate

Value of returns credited in the period ÷ gross sales in the period

With invented numbers, $36,000 of returns credited against $2,000,000 of gross sales in a month is a 1.8% return rate.

How to read it: track it by reason code, customer, product group and salesperson rather than as one number. We could not find a reliable public benchmark for business-to-business distribution return rates, so compare against your own trend. A customer or product group well above your average is worth a conversation.

How it goes wrong: returns credited in one month for sales made in another make the monthly rate jumpy. A trailing 12-month rate is steadier. Counting units instead of value hides expensive returns behind cheap ones.

Credit memo cycle time

What it measures: how long a customer waits for their credit.

Credit memo cycle time

Average days from RMA issued to credit memo posted

How to read it: long cycle times usually mean returns sit uninspected. Customers short-pay invoices while they wait, which adds disputes to receivables. Split the time into its stages (RMA to receipt, receipt to inspection, inspection to credit) to see which one is slow.

How it goes wrong: issuing credits before the goods arrive shortens the cycle but gives credit for goods that may never come back. If you do this for good customers, track credits issued against goods still outstanding.

Setting up your returns process

1. Write down the return policy: window, non-returnable items and restocking fees by reason. Put it in the terms of sale.
2. Require an RMA for every return, and a reason code on every RMA line.
3. Receive returns into an inspection location, and give each unit a disposition within a set number of days.
4. Open an RTV for every defective or rotation-eligible item, and review open vendor credits monthly.
5. Report return rate by reason and credit memo cycle time monthly, and act on the error-caused reasons first.

For how the credits and vendor recoveries fit into the books, see the month-end close checklist.