Collection factories: considerations for the practical treasurer

Maturing technologies and efficiencies experienced via operating shared service centres (SSCs) have driven many corporate treasuries to centralise payables and enjoy the foreign exchange (FX) and liquidity management benefits. These have typically included costs savings from operating a reduced number of bank accounts and improvements in visibility over cash movements.

Most treasurers have left receivables in the hands of local business units, thus foregoing the further cost savings offered by a collection factory. Corporate treasurers who are reviewing the case for their company should consider the practicalities in building a centralised collections roadmap – or justify focusing elsewhere.

Many companies have successfully implemented – or are implementing – a pay-on-behalf-of (POBO) model, where payments are made on behalf of other entities and funded by accounts in the name of, for example, regional treasury. Optimal models minimise idle cash balances, as funding is centralised to the treasury entity that handles the operational aspects of disbursements and manages transactional activity through its own account rather than those of the business units. A high degree of automation minimises costs, and many corporates have managed to rationalise accounts used for disbursements.

Receivables, with their unpredictable nature, are a different story and often decentralised. An entity that collects payments on behalf of other entities through a centrally managed account structure or indeed a single account (COBO) operates as a collection factory. Due to the unpredictable and data-poor nature of receipts, these are complex structures that require special tools – such as virtual accounts – to ensure a net benefit to working capital. Cost reduction and simplification must be measured against a significant positive impact on processing costs and improved days sales outStanding (DSO), so the ability to effectively manage returns and rejections alongside the straight-through-receivables (STR) is critical to success.

Key Considerations for Collection Factories:

Benefits:
• Reduced number of bank accounts, reducing bank fees.
• Control over company-wide collections process and data.
• Time savings due to harmonised processes
• Improved reconciliation for all incoming credits – not just direct debit collections.
• “Virtual accounts” can identify payors, payees, or both.
• Credit cards per entity can settle to a virtual account.
• Improved data quality from a single approach to issuing invoices to suppliers.
• STR allows settled account receivables entries to move to cash quicker improving working capital.

Challenges:
• Collection methods can vary from customer to customer. Achieving economies of scale across these varying methods can often present an operational challenge.
• Some receivables processes (disputes, credit, or mandate management) may be too complex to incorporate. The scope may need to be refined to realize greatest benefit
• A single enterprise resource planning (ERP) system (for the entities served) is a key building block, although improved reconciliation tools can help those entities not on central ERP platforms.
• Entities domiciled in most locations will have to retain their regulatory and tax reporting obligations, and complex withholding tax requirements.

Example: Collection factory using “virtual accounts”
At the outset of collection factory design is the willingness to improve customer relationships. The concept of a virtual account is transparent to the customer but of high value to the payee, as this can be prescribed on a highly customised basis. Outside of the on-behalf-of model, virtual accounts typically identified a payor but in a collection factory can also be used to identify the entity being paid.

Virtual accounts

Implementation checklist: Virtual accounts
Standard receivables packages may need to be modified to operate at the level of international collections. A master customer data table should be stored in a single location, alongside payment terms, real and virtual bank accounts.
1. Agree with your bank the allocation rules for virtual accounts; Example – a range of international bank account numbers (IBANs) you freely assign.
2. Associate virtual accounts to your clients and/or business units, mapped to your internal system references.
3. Test transaction reporting with your bank to ensure a high straight-through-reconciliation rate.
For example, load an MT940 with appropriate data, to be used for reconciliation by your ERP.
4. Communicate virtual accounts to your suppliers and, going forward, all invoices will feature the virtual account.
5. Monitor improvements to reconciliation and cash flow.

Reconciliation
Virtual accounts can significantly improve the ease of identifying the remitter of a transaction, but this is only the start of the reconciliation and efficiency story. Each receipt has to then be loaded to your ERP/ AR system, reconciled and thereby completed before the funds move to being a recognised cash balance.

It is recommended that companies complete a data reconciliation model to ensure a high STR rate. Consider the main transaction types used to settle invoices and their use with virtual accounts.

Reconciliation

Click image to enlarge.

The above shows that direct debits are the best for creditors, but may be more complex for debtors. This is due to possible costs if individual debits are passed per invoice or reconciliation /efficiency if any form of netting is used. Netting is a tool that allows counterparties to net invoice amounts due and send a single settlement entry. Where netting is used – rather than payment at individual invoice, monthly account or refund level – it is worth considering using virtual accounts to confirm paying party and structured reference fields to ensure the net amount received is easy to reconcile through a structured reference or text block.

Credit cards often settle with merchant ID numbers to identify the credit party.By settling certain merchant IDs to a specific virtual account, this activity can also form part of a collection factory to more fully service the collecting entity.

For those entities receiving cheques, using lodgement or lockbox slips with valued receiving notes (VRNs) can assist to ensure credit allocation and reconciliation to the correct entity.

Next Steps:
– Get practical about your candidate subsidiaries. Target quick gains; for example removing duplicate collection efforts for any given single currency.
Service providers: Talk to banking and technology providers about their experience with entities across your footprint.
Technology foundation: Insist banks deliver and process data in ISO20022 XML – the richest data standard available.
Credit cards:Review reconciliation problems including dispute debits to streamline allocation to correct entity.
Ambitions: Ensure reconciliation rules can be built by business unit – and grow to adapt.
Build a data model tying virtual accounts together with reference/numbering within your ERP system.
Analyse payment types used by your clients versus bank and internal reconciliation costs, identify preferred payment methods and encourage greater use.

Summary

Tools such as virtual accounts are helpful in addressing the unpredictable and data-poor nature of receipts. Like POBO, efficiencies are gained through automation and simplification of bank accounts.Using virtual accounts to strengthen your reconciliation model may be enough to give your collection factory roadmap some promise, but the efficiency gains will depend on your specific implementation. Any collection factory that considers the practicalities above can improve days sales outstanding (DSO), improve your ability to manage rejects and returns, and deliver STR benefits from day one.

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