Receivables, also commonly known as collections, are often the most challenging part of working capital management. After all, it is hard to control your customers' payment behaviors. For treasurers, receivables reconciliation can be a challenge due to incomplete information on incoming payments, missing remittance advices, and inadequate technological support.
At the working capital level, receivables management requires a holistic effort across sales and logistics functions to ensure that the following objectives are achieved:
- Realistic and consistent payment terms,
- Minimum invoicing errors, and
- Cashflow incentives to ensure optimal collection and credit management.
Working capital studies have shown that invoicing errors, in particular, are a major source of overdue receivables. This is because customers commonly leverage on invoicing errors, for example, by waiting until the invoice due date to communicate the error, and then start the payment term from receipt of corrected invoices, resulting in a delay.
Bank account reconciliation is an important part of operational effectiveness and an internal control to mitigate operational risk. Often, bank accounts are reconciled manually. This increases costs and often delays reconciliation which can substantially increases operational risk.
Normally, the reconciliation of payments is less of a challenge, since treasurers normally know what payments have been executed. Reconciling receivables is more challenging. Few treasurers receive adequate and timely remittance advices. Bank statements often show minimal information about collections. While manual reconciliation is one of the solutions, it is not a preferred operational process in treasury and finance.
The goal of most treasurers is to achieve 90% or better auto-reconciliation of receivables. Machine reconciliation benefits the company by automating and speeding up reconciliation, thereby reducing operational risk due to manual processes, and freeing up people's time to focus on the most difficult outstanding items (the 10% or less that is not auto reconciled).
To achieve 90% or better auto-reconciliation requires adequate technological support. Reconciliation technology is provided by ERP and TMS vendors, as well as various cloud providers as a service. Many banks also provide reconciliation services directly, as well as various aids to reconciliation.
Incomplete collection data may have multiple causes. Some payment systems carry only minimal data, but the paying party name and some kind of comment field are normally available. Banks sometimes exacerbate the problem when collection data is lost within their own systems. Treasurers must ensure that they receive all available data from the payment systems in their bank statements.
Educating customers about the benefits of having good payment discipline and remittance advices can be helpful. The benefits for the customer include: faster clearing of their accounts which frees up their credit limits and speeds up shipment, reduced effort in dealing with vendors via follow-up calls, and better vendor relationships.
Some banks provide enriched collection data as a value-added service, often in separate reports other than their bank statements and these reports come at an extra cost.
Some older e-banking formats have limited data capacity, but generally, the problem lies in the bank's systems rather than in the clearing systems. In cross border payments, the bank's correspondent is sometimes responsible for loss of payment data.
As an example, SWIFT's FIN service (i.e. the MT940 statement message) dates back 40 years to the time of telex. Nonetheless, it has several fields of 4 x 35 characters that can carry information from the payer to the beneficiary. The MT940 is certainly capable of showing who the payer is.
SWIFT offers a more recent (only ten years old) XML format which is capable of handling megabytes of data and has fields for most conceivable needs. It is called the ISO 20022 camt message. This has been well received as a preferred formatto banks' proprietary non-standard messaging formats.
In addition to enriched data, many banks offer further reconciliation services. One venerable service is the lockbox, which was developed to help with cheque processing. Others include virtual accounts and reconciliation services.
Lockbox is a bank service whereby cheque collections are sent directly to a bank's processing centre, rather than to the corporate itself. The bank then opens and scans the cheques, as well as any other supporting documents. In some variants of the lockbox service, the bank also captures key details of both cheque and supporting documents. Because the cheque was sent directly to the bank, the corporate does not have to physically bank the cheque, which saves time and money and speeds up the process of money being credited to their respective bank accounts.
Any data captured by the bank is sent to the corporate via e-banking or SWIFT. This generally improves auto reconciliation rates as well as accelerating credit to the account. The cheque deposit acceleration part of lockbox is irrelevant for electronic payments. The reconciliation part is offered by many banks in their reconciliation service.
Virtual accounts have become a standard tool for treasurers seeking to increase auto reconciliation rates. The original idea was to break account numbers into two segments
<Company> & <Customer>
This ensures that the originator of incoming payments is known, which helps with reconciliation to accounts receivable. Some use the second segment to encode the invoice number, but since this forces customers to change the account number to which they are paying for every invoice (causing operational risk and costs), the latter method is not widely adopted for business to business payments.
Virtual accounts can be combined with other reconciliation tools to greatly improve auto reconciliation rates on customer collections to accounts receivable ledgers.
Accounts receivable reconciliation adds value beyond finance function costs by increasing customer satisfaction and reducing sales and collection management effort in identifying collections and responding to customer account queries.
Virtual accounts can also be extended to encode for group and legal entity or business unit and customer in three segments:
<Group> & <LegalEntity/BusinessUnit> & <Customer>
This enables bank account rationalization. If without virtual accounts, the group has separate bank accounts for each legal entity or business unit, then virtual account technologies allows groups to reduce the number of bank accounts to one per country per currency. In fact, following the IHB methodology, this can be reduced to one bank account per currency. This requires on behalf of (OBO) processing.
Taking this one step further, virtual accounts can be an enabler for IHB, where each legal entity has a virtual bank account within a single legal bank account for both collections and payments. In this configuration, the virtual account structure will be
- For payments: <Group> & <LegalEntity>
- For collections: <Group> & <LegalEntity> & <Customer>
In this configuration, the legal entity holding the account executes payments and collections on behalf of its peer entities. Combined with payment factory and / or IHB software, this provides a powerful enabler for IHB implementation.
Bank reconciliation services
Bank reconciliation services essentially refers to the outsourcing of reconciliation (that can be done by corporate ERP and TMS services) to the bank.
Many banks offer different reconciliation services for receivables, payables, and statement reconciliation. This can be summarised as:
- Receivable reconciliation: reconciles collection (credits) on the bank statement to the accounts receivable sub ledger
- Payable reconciliation: reconciles payments (debits) on the bank statement to the accounts payable sub ledger
- Statement reconciliation: reconciles the bank statement to the bank account in the general ledger.
Many corporates chose bank reconciliation services because they lack the systems or other resources internally to do it themselves. Since the bank is,in any case, handling collection information for the corporate, it makes a natural partner for receivable reconciliation.
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