Ecommerce businesses deserve to get what they’re owed each time they make a sale—but that doesn’t always happen. For one reason or another, revenue that should go into your pocket sometimes ends up missing. This is known as revenue leakage, and plugging holes in your systems to prevent it can bolster your cash flow and profit.
To combat revenue leakage, you’ll need to pinpoint its source and cause. Various factors lead to revenue leaks, and there are a few ways to identify them, calculate their impact, and implement strategies to ensure they don’t happen again.
What is revenue leakage?
Revenue leakage occurs when a company fails to collect money it earned from sales due to human error, inadequate revenue management, fraud, and other inefficiencies. Even a very small amount of revenue leakage can hurt the financial health of your business by decreasing cash flow and lowering profitability.
For example, a business-to-business (B2B) software company using manual data entry for invoicing could accidentally underbill a client. If this happens once, it may not even be noticeable. If you don’t catch it for months, it could severely impact the company’s bottom line. It’s the difference between plugging up a hole in a ship as soon as it opens up and waiting until the entire vessel is half underwater.
Common causes of revenue leakage
- Billing inefficiencies
- Price inaccuracies
- Contract mismanagement
- Data entry errors
- Fraudulent activity
A wide range of factors can result in revenue leakage within your company. The more you’re aware of, the better—so here are some of the most common causes:
Billing inefficiencies
One of the main causes of revenue leakage is operational inefficiencies in a company’s billing process. Billing errors, like inaccurate prices or incorrect product quantities, can result in underbilling or missed customer payments. Outdated systems, software glitches, and human error can also contribute to incorrect billing and revenue leaks.
This type of revenue leakage is especially problematic for companies accepting recurring payments because invoicing errors can pile up without a company realizing it. For example, suppose an ecommerce business uses a subscription model to sell monthly shipments of personal-care products. If this business has inaccurate information in its subscription billing process for even 10% of clients, it could contribute to a major amount of revenue leakage. It would lose money with each payment.
Price inaccuracies
Pricing errors, meaning lost revenue from selling products or services for less than intended, are another major cause of revenue leakage. For example, a company running a promotional pricing campaign with a promo code for a holiday season discount could fail to switch off that code after the set time period and accidentally give unauthorized discounts.
If you use discounts, coupons, or promo codes for your products or services, manage them properly, communicate updates with your team, and deactivate pricing promotions as soon as they expire to avoid revenue leakage.
Contract mismanagement
Companies that enter long-term customer contracts can experience revenue leakage if they fail to manage contract terms and conditions properly, especially during contract renewal or renegotiation. Businesses without proper administrative processes can experience revenue leakage by failing to bill for the full price of a good or service, overlooking pricing increases, or forgetting to collect fees like penalties for late payment.
Data entry errors
Inaccurate data can lead to administrative errors in inventory management, order fulfillment, or payment processing. For example, manual processes for inputting customer data into a customer relationship management (CRM) system could lead to revenue leakage by failing to collect payments and not sending billing reminders. Similarly, inputting inaccurate data about your inventory levels can lead to unsold stock, another source of revenue leakage.
Fraudulent activity
Fraud is another cause of revenue leakage. Maybe customers are using improper payment methods, clients are submitting fake or misleading invoices, or employees are engaging in theft. No matter what the source, it can have a detrimental impact on your business.
For example, a business selling tech accessories could face chargeback fraud from a customer who purchases a smartwatch and disputes the charge while still keeping the watch. Companies can implement a variety of fraud prevention strategies to help avoid chargebacks, including fraud prevention software, limited order quantities, and clear return policies.
How to identify and calculate revenue leakage
- Conduct an audit
- Calculate your company’s revenue leakage
- Monitor relevant KPIs
- Perform a root cause analysis
Before you can reduce revenue leakage, you first need to identify the source of leaks in your business and determine the total amount of money you’re losing. Here are a few best practices for identifying and calculating your business’s revenue leakage:
Conduct an audit
One of the most effective ways to identify revenue gaps is by conducting a financial audit of your business. Review your sales records and compare them to your revenue—does your total revenue match the amount of product sold? Conduct an inventory audit. Do your inventory records match sales reports? Review all recent promotions, and double-check your online pricing for accuracy.
Calculate your company’s revenue leakage
Compare your expected income with your actual revenue to identify any discrepancies. Here’s the simple formula for this:
Potential revenue - Actual revenue = Revenue leakage
Monitor relevant KPIs
After calculating your company’s overall revenue leakage, home in on where those leaks occur based on key performance indicators (KPIs)—meaning quantifiable metrics that show where the revenue is being lost. Here are some of the KPIs to consider tracking to prevent revenue leakage:
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Quote-to-cash cycle time. This measures the average amount of time it takes for your business to complete the sales process, from providing an initial quote through to collecting payments.
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Billing accuracy rate. Companies can use this metric, expressed as a percentage, to evaluate the effectiveness of their billing process with the following formula: (Number of accurate bills / Total bills generated) x 100 = Billing accuracy rate.
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Customer acquisition cost. Customer acquisition cost (CAC) calculates how much it costs (in sales and marketing expenses) to acquire one new customer. Companies can compare CAC with other metrics like customer lifetime value (CLV) to evaluate whether the cost of acquiring a new customer outweighs the total revenue you expect to earn from that customer during their relationship with your business.
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Payment success rate. Payment success rate (PSR), also known as transaction success rate (TSR), is the percentage of attempted payments that are processed and approved successfully, which can help you identify where payment failures occur.
Perform a root cause analysis
Another strategy that you can use to identify revenue leakage points in your business is the root cause analysis framework. The analysis starts by defining your problem (in this case, revenue leakage), brainstorming potential causes (like inaccurate billing information or unauthorized discounts), analyzing each causal factor (using your KPIs), and determining which ones are to blame. This framework helps to identify discrepancies in your business processes and prioritize which causal factors to resolve to plug revenue leaks.
How to prevent revenue leakage
- Establish effective invoicing and billing systems
- Properly manage your long-term contracts
- Monitor and update your promotions
- Optimize your order-to-cash process
Once you’ve identified and calculated your business’s revenue leakage, you can begin taking steps to prevent lost revenue by doing the following:
Establish effective invoicing and billing systems
Optimize your invoicing and billing systems to avoid pricing errors and inaccurate billing. Establish a verification process for all invoices to double-check and confirm that customer data and order information are correct. Use business automation tools to automate billing and invoicing processes. This helps you avoid human error from manual data entry. Set up a revenue recognition process where your accounting team tracks sales and revenue accounts to avoid inaccurate financial statements.
Properly manage your long-term contracts
Implement a process for contract life cycle management, which involves creating, organizing, tracking, and maintaining business agreements. Businesses can use to establish systems for the seven stages of the contract life cycle: initiation, negotiation, approval, execution, compliance, renewal, and termination.
You can standardize contract templates and establish a contract approval and renewal process with specific task owners on your team. By centralizing your contract storage system, team members can reference and monitor contract accuracy to avoid accidental revenue leakage from outdated terms or incorrect contract information.
Monitor and update your promotions
If you use promotional codes, coupons, discounts, or flash sales, set clear limitations and expiration dates for those campaigns. For example, you could use a discount app to run a promotion and set clear boundaries for it: a specific discount code for one type of product that expires after six weeks, for example. By using tools that facilitate your promotions and automatically stop them once they’re over, you can reduce unauthorized discounts and minimize revenue leakage.
Optimize your order-to-cash process
The order-to-cash (O2C) process breaks down into eight steps, including:
1. Order management. A customer places an order for goods.
2. Order processing. Ensures that the purchase order is sent to the correct person or department for processing.
3. Credit management. Ensures repeat B2B customers’ credit is in good standing.
4. Order fulfillment. After processing payment, businesses prepare deliveries by picking and packing the correct items.
5. Shipping. Deliveries are shipped to customers, often via third-party logistics (3PL) providers or by working directly with shipping suppliers or courier services.
6. Invoicing and billing. Businesses generate invoices with the correct customer data and billing information for the order.
7. Accounts receivable. Companies work with their accounting teams to track overdue or near-overdue invoices.
8. Revenue recognition. Tracks when a customer’s payments are complete and properly recorded as earned revenue.
To optimize your O2C process, establish a set of standards in a simple guidebook that your employees can refer to throughout the process. In your guide, note areas where information needs to be double-checked to avoid revenue leaks—like confirming invoicing information and tracking when revenue is collected. Use accounting software tools to record all of your sales and expenses in one digital general ledger that you can use to identify overdue invoices or revenue discrepancies like billing errors.
Revenue leakage FAQ
What do you mean by revenue leakage?
Revenue leakage is the process by which a company fails to collect the revenue they’ve rightfully earned, whether because of billing inefficiencies, price inaccuracies, or a variety of other reasons.
How do you detect revenue leakage?
To detect revenue leakage in your business, conduct a comprehensive financial audit, monitor relevant key performance indicators related to your company’s revenue, and perform a root cause analysis to home in on the causal factors leading to revenue leaks.
How can you prevent revenue leakage?
Some of the best strategies to prevent revenue leakage include establishing an automated process to avoid billing errors, optimizing your order-to-cash process, implementing a strong contract management system, and setting clear end dates for any promotional strategies like discount codes or coupons.
How can you calculate revenue leakage?
Use a simple formula to determine revenue leakage: Potential revenue - Actual revenue = Revenue leakage.
