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How banks can work together
Building good relationships with suppliers is important to every corporate. It definitely helps a company receive better service, delivery schedules, as well as pricing, if the supplier treats the company as a preferred customer. For the supplier, timely payment by the customer is key to reinforcing an excellent business relationship. with companies to ensure a more efficient and cost-effective supplier payment and financing system that benefits all parties.
Most companies use a variety of payment mechanisms to pay their suppliers; by electronic means such as local wire, or paper based such as cheques and promissory notes. Sometimes, a mix of multiple forms of payment instruments is used by the same company, depending on the payment infrastructure available, as well as the need and location of the supplier. The amount of the payment and the value date could also influence the mode of payment.
Companies also typically use multiple banks through which to route these payments. This is done to maintain multiple banking relationships from a strategic banking perspective, and also because different banks have different payment processing capabilities and geographic reach. This requires the corporate to use multiple and varied payment and Electronic Banking systems to issue payment instructions.
The above are issues and complexities faced by most corporates in processing supplier payments, and a great deal of time and energy is expended in meeting these basic challenges.
From the supplier's perspective, a key objective is converting the receivable from the corporate customer into ready cash. This usually takes longer if the payment is paper-based. Vagaries of outstation cheque collections in some countries could introduce further delays.
The most significant aspect in lengthening the payment cycle, is the credit period that suppliers provide their larger customers, typically ranging from 30 to 120 days. The credit period might be mandatory for the supplier to provide because of the negotiating strength of the corporate customer. It could also be a norm in that industry. The payment made by the corporate customer might also be broken into part-payments over the entire period.
While the supplier might have built some financial cost for the credit period into the cost of goods supplied, the crucial problem facing the supplier is that of obtaining alternative sources of funding for working capital. Lack of sufficient liquidity could prevent the supplier from expanding or meeting required expenses in time. This business risk could indirectly affect customers too.
Most suppliers therefore see this funding need as key to their business. Supplier financing provided by a bank can meet this need very effectively, and provide substantial benefits to the entire supply chain. While the suppliers might be small companies without much known credit history, the payment being from a large corporate greatly reduces financing risks.
A bank having an established relationship with the corporate is therefore ideally poised to perform the key role of providing an integrated service of payment processing and supplier financing. It is perfectly placed to link the flow of funds from the corporate to the supplier, as well as provide credit based on the need, as well as credit strengths of both parties.
Payments are also generated from ERP or back-office systems of the corporate. These payments would be initiated at the time of receipt of goods, or on acceptance of an invoice from the supplier. The payment instructions generated by the ERP system can then be automatically up-loaded into the payment platform, where they can be verified and authorised.
The payments would be dependent on credit periods agreed upon. The credit period could vary for different suppliers, and also for different invoices of the same supplier. Payment dates would need to be specific to each credit period defined, and for variations of part-payment.
Payment instructions with a future value-date would then be issued by the corporate to the supplier, for the supplier to in turn use these for financing purposes.
Cost effectiveness - An electronic workflow within the office, or between multiple offices, coupled with suitable payment infrastructure, is important in controlling costs. Savings can be realised both from requiring less effort within the company for processing payments, as well as requiring less time from senior staff for authorisation of the payments. Aspects such as an authorisation matrix are important to ensure that large payments are authorised and monitored by senior management.
Traditionally, future value dated payments have been issued on paper in the form of Promissory Notes. These are typically prepared in the Account Payable department of the corporate, authorised and signed by senior management. The entire process takes up valuable time, and also results in large costs for the corporate. The supplier through banks or finance companies then discounts these to obtain financing, but at high interest cost.
Paper-based payments can be outsourced to the bank, which can process these payments on a larger scale using automation to achieve cost effectiveness. Taking the further step of converting these paper payments into electronic payments - that can then be discounted by the relationship bank of the corporate - could be significantly cost effective for both the corporate as well as the supplier.
Addressing suppliers' concerns - Anxiety is also generated when the supplier does not know whether the corporate customer has released a payment, and its current status. This results in the supplier frequently calling the corporate customer to request the payment.
Beneficiary reports that provide information to the supplier on payments that have been released, as well as which invoices the payment is for, help the supplier plan liquidity based on the incoming funds flow, as well reconciling the payments received.
Prompt payment to suppliers - Reputation for prompt payment is key to help the company get better prices in negotiations with its suppliers. It also helps in improving relationships with suppliers leading to better service, and positioning of the company as a preferred customer for the suppliers.
The bank's role
The bank needs to provide the following capabilities to facilitate the flow of payment processing and supplier financing:
Payment initiation system for the corporate -The bank needs to provide an electronic system to the corporate customer that can be used for all payment initiation, authorisation and reporting needs.
The system should be able to accept payment instructions well in advance of the actual payment date. It should be able to communicate with the corporate's ERP systems as well as provide the corporate an option to manually enter payments. It should also support an authorisation matrix that is flexible enough to fit the workflow of the corporate.
An added benefit would be the ability to support a beneficiary library, so that payments to suppliers that are normally repetitive in nature can be used in a controlled manner, and supplier bank details do not need to be entered each time. The company should also be able to view all reports and status of each payment on the same system.
processing systems for banks
Some of the payments to be processed for suppliers of the company might be future dated payments, while others might be immediate payments requiring the company's account to be debited and supplier payment issued immediately. The payment processing system of the bank must support all such workflow cases, as each customer's needs could be different, as well as individual transactions could vary.
In the case of electronic payments, the bank will need to send the payment to the electronic payment network, and debit the corporates account in the bank's General Ledger system.
Discounting by the bank - Based on the credit terms provided to the company by the suppliers, the company needs to make available funds for payment only on the agreed date. The supplier can secure financing if required through discounting facilities, enabling receipt of funds in advance of the actual payment.
Such funding or discounting is typically based on paper-based payments issued up front, where the instrument is then kept in custody by the bank or financial institution providing the discounting.
However in the case of supplier financing, the bank providing the service to the corporate customer can also provide financing to the suppliers; irrespective of whether the payment is electronic or paper-based. The supplier would need to enter into a business relationship with the bank, but not necessarily open an account with the bank.
The bank should have the capability of providing discounting to suppliers based on their individual needs. Some suppliers would require funding, while others may not. The discounting service will also need to be payment item specific; a supplier might need funding only for certain payments. The bank can inform the supplier of pending payments through fax or e-mail, and provide the supplier the option of informing the bank whether the payments need to be discounted or not.
Information reporting - The bank can provide information reporting to both the corporate, as well as to the suppliers. The corporate customer will get updated information on the total number and amount of payments, as well as details on the status of each payment. This will assist the company in reconciling payments made. Keeping the corporate informed of when the payments issued will actually be debited from its account will enable its liquidity to be managed effectively.
In the case of the suppliers, the bank can provide information on when a payment instrument has been issued by the company in the form of a beneficiary advice, as well as information on the funds discounted by the bank. Additional reporting benefits would be on invoice details against each payment, which would help the supplier in reconciliation.
Discounting terms - The discounting provided could be on the entire payment due to the supplier, or a part of it, depending on the needs of the supplier.
Similarly, the supplier can request that the discounting be provided only during a specific period when funds are required. This is likely in case of large payments, where the supplier might not want to discount the entire payment for a long period of time. In such cases, the supplier might request for discounting for a part period only.
An interest based charging mechanism has to be used for the discounting. Based on the number of days for which funding is required, the interest rate used by the bank to provide the discounting would vary.
Maturity buckets such as 30 days, 60 days, used for the discounting charges would depend on the bank, as well as the country where the services are being offered. The interest rate used for each maturity bucket would vary, depending primarily on the supplier being discounted. Typically, the supplier will be credited with the payment amount less the discounting charges.
The credit can be made to the preferred account of the supplier, which can be with the same or with another bank. If the credit is to be made to an account of the supplier in another bank, funds will need to be transferred electronically or through a paper instrument.
Risk monitoring - In the traditional discounting model, the bank would discount receipts of the supplier across all its customers. In the new financing model, the bank is discounting only payments being made to the supplier from one single corporate customer - with which the bank already has a strong relationship. Hence the risk of default (and therefore cost) is lower.
Ensuring that the corporate customer has accepted the goods received from the supplier, - before the bank releases any financing to the supplier - can control the risk of the corporate not agreeing to the payment later. To control the risk of the corporate customer defaulting, the bank needs to have a periodic credit appraisal of the customer, and maintain a credit line that can be shared by all the suppliers being financed against payments issued by that customer. This is to ensure that financing across multiple suppliers for the same corporate does not exceed the level of risk acceptable to the bank.
The bank also has to maintain a credit line for each supplier. This is an additional safeguard, to ensure that risk is spread across multiple suppliers, and not concentrated on one or a few suppliers. This should be monitored over the long term, when multiple corporate customers of the bank might be using the same supplier.
Benefits to the
relationship with the corporate customer.
In addition to the business generated, the bank will also be in a position to know the company's business needs as well as financial health.
Access to supplier network for cross-selling - With a supplier financing arrangement, the bank gets the opportunity to build up a complete banking relationship with the various suppliers of the corporate, opening up many other opportunities.
Fee-based business - The bank can charge fees to both the company as well as suppliers for all the services rendered. This would be a recurring fee, which would lead to regular fee-based income for the bank.
A viable business
Companies would embrace this service as it provides a means for them to cut down on the manual effort involved in payment issuance. Suppliers would find the service beneficial as the payment process is more efficient, and they are also able to secure financing for their working capital needs through discounting arrangements.
In addition to both the fee-based as well as fund-based business generated, the bank can also use the platform to quickly offer similar services to multiple corporate clients providing economies of scale.
Automation would help to reduce variable processing costs, and minimise the incremental cost of supporting each additional corporate or supplier.
Raj Subramaniam is the visionary for CashTech Solutions, Raj assists in the charting of the direction and development of the next-generation cash management products and solutions. Raj is highly respected for his innovative ideas and concepts coupled with a profound knowledge and understanding of cash management, his professional opinion is widely sought after across Asia Pacific.
Prior to joining CashTech, Raj worked with Citicorp Overseas Software Ltd., a software development subsidiary of Citibank, where he designed and developed corporate banking and cash management applications.
Raj holds an MBA from the Indian Institute of Management, Ahmedabad, and a Bachelor of Science from St. Stephens College, Delhi.
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