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Due diligence measures to carry out before entering into any toll manufacturing transaction.
How a company can strategically structure a toll manufacturing arrangement?
Practical and contractual protective measures and controls to secure trade secrets and
technological assets.
An overview of other key contractual provisions to include in a toll manufacturing
agreement.
In a toll manufacturing arrangement, a company provides its raw materials or semifinished goods to a third-party service provider. The service provider, who often has specialized
equipment or infrastructure, provides a subset of manufacturing processes on behalf of the company
using those materials or goods for a fee.
Some toll manufacturing related important terms Plant: A manufacturing site.
Bonded Warehouse: A warehouse where goods are physically stored in country, but have not yet
been imported. (the custom charges or duties have not been paid) Once the goods are released for
sale, the customs duties will be paid.
Affiliate: Company commercial legal entity within a country that distributes goods to third party
distributors and end customers within its country borders.
Third Party: An entity external to your company. This term may reference both third party suppliers
and third party customers.
Toll manufacturer: A company manufacturing site that processes raw materials or semi-finished
goods. Company maintains ownership of some or all of the raw material or semi-finished inputs, as
well as the finished goods inventory. The toll manufacturer will charge a fee for processing (toll) to
the company.
Contract manufacturer: A companys manufacturing site that processes raw materials or semifinished goods, and sells the finished goods output to another companys legal entity. The contract
manufacturer regularly procures the components which are required for producing the final product.
Subcontract manufacturer: A third party manufacturing site that processes raw materials or semifinished goods for the company. The company maintains ownership of some or all of the raw material
or semi-finished inputs, as well as the finished goods inventory. The subcontract manufacturer will
charge to the company a fee for processing (subcontracting charge).
Direct Ship: Refers to the inter-company delivery scenario where the manufacturing site physically
ships the goods directly to the final inter-company recipient, while the logical delivery (funds flow) is
routed via the trading company.
Inter-company contract manufacturing: Refers to scenarios where material is procured from
another legal entity of your company. The process will trigger inter-company invoicing in the
background.
Inter-company toll manufacturing: Refers to scenarios where a service is performed on a
customer's process, for a fee. In these scenarios, the Customer and Supplier are two different
company legal entities. After the service is completed, the process will trigger inter-company
invoicing in the background.
Third Party contract manufacturing: Refers to scenarios where material is procured from an
external Supplier.
Third Party subcontract manufacturing: Refers to scenarios where a service is performed on a
customer's process, for a fee. In these scenarios, the Customer is a legal entity, and the Supplier is
an external entity.
Supply from another division: Refers to scenarios where material is procured from another
companys division.
Supply from another affiliate: Refers to scenarios where material is procured from another
companys affiliate. Today this process is referred to as re-positioning.
Trading Terms / INCOTERMS: INCOTERMS refer to globally recognized standard agreements for
the purchase and shipping of goods internationally. There are 11 different official terms, governed by
the International Chamber of Commerce, and provide internationally accepted definitions and rules
of interpretation for common commercial terms. INCOTERMS regulate responsibility for the costs,
transition of the risks, and delivery place in international shipping transactions.
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The Components net requirement is sent to another packager or Vendor when Component is
sourced from an outside vendor
Then vendor purchases the component from another inter-company vendor or 3rd party
vendor
Upon shipment (mostly direct delivery from the vendor), vendor posts the total quantity to the
vendor stock and does not bill Toll Manufacturer for the shipped goods
Company runs PO Adjustment Report to clear the difference between the planned and actual
consumption per batch / order.
Source List
BOM
BOM information maintained in Companys PO: If BOM is not available in Company profile, PO
will not be created!
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6: SAP Toll Reconciliation
Here are some of the crucial steps that one should carry out to have Toll Reconciliation verification
in SAP ERP.
At least monthly reconciliation of logical component stock vs. physical component stock is required.
All process orders related to the shipped orders must have Final Delivery Flag on.
After PO adjustment is done, Component stock at company level is recalculated.
*Write-offs include all cases related to physical destruction of the goods at Toll Manufacturer. All
such cases must be approved by Owner of the FoC Components as per defined Write-Off Approval
Process. Destruction can be done only after it is approved by the Owner of the Components.
As soon as PO Adjustments and Other Usage Consumption are booked, Toll Reconciliation is
complete.
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7: External Subcontracting Bird View
Heres pictorial view of high level events for an external subcontracting scenario.
Events
1. Warehouse clerk does stock transfer for respective subcontractor. (subcontracting material is
procured and posted)
2. Buyer creates subcontracting purchase order.
3. Subcontracting PO gets approval and same PO information is transmitted to Vendor.
4. Warehouse clerk created delivery request with respect to subcontracting purchase order
created on step 2.
5. Warehouse clerk picks up the delivery list and confirms the same.
6. Delivery confirmation initiates PGI (post goods issue) and hence a delivery note is sent by a
vendor.
7. Once material is received at docking location, good receipt is done and then it goes for a
quality inspection.
8. Quality inspection is done and result records updated with a digital signature.
9. Same time during goods receipt respective inventory GR/IR subcontracting is done.
10. Once invoice receipt is done in finance it will be sent to a respective vendor.
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8: Internal Subcontracting Bird View
Heres pictorial view of high level events for an internal subcontracting scenario.
Events
1. Production order created.
2. MRP (material requirement planning) is done and MRP list is generated and saved in SAP.
3. Sales order entry is maintained by sales administration when product is bought. Customer can
confirm or reject order that has been placed by sales administration team.
4. This information goes back and updates MRP planning data.
5. Planned orders converted to process orders.
6. ATP (available to promise) check is carried out and ATP quantities are updated.
7. After process order the confirmation is sent to sales administration team, who follow the
delivery creation request.
8. Warehouse updates picking and inventory consumption cost along with stock quantities.
9. PGI (post goods issue) triggers delivery note to customer and same time updates inventory
COGS (cost of goods sold).
10. Sales team carries out finance posting and hence a final billing statement is sent to a
respective customer.
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9: Summary
In this article, we understood the various aspects of Toll Manufacturing covering basic concepts, explanation of
common toll manufacturing terms, benefits, risks, due diligence, roles and responsibilities at different
organizational levels. Also we have covered the most critical pieces of Toll Manufacturing i.e. Toll reconciliation,
allied SAP checkpoints and configurations, internal and external toll manufacturing important events and related
interaction with different business stakeholders.
Hope you found this document relevant and useful!!!
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