Developing Payables Policies

Policies formalize decisions on the disbursement of company funds for payables. In addition to the inventory rules listed in Chapter 7, guidelines should be thoughtfully developed on several issues, including the following:

• Should we pay our vendors on or after established terms, e.g., if the terms are net 30, should we pay on day 30 or a specified number of days after day 30 (which is the practice in many companies)?
• If cash discounts are offered, should we take the discount?
• Should we attempt to negotiate prorated discounts (dynamic discounting) for any payment made before the net period ends?
• How should we handle situations when documentation is missing from a bill, such as a PO, a receiving report, an authorization (whether by signature or voucher), and/or budget codes?
• If a vendor requests special treatment (such as an occasional early payment), should we comply?
• Should we allow vendors to buy lunches, drinks, or similar entertainment for our payables staff? If this is allowed, what limits are appropriate?
• Should we operate our own payables cycle, or should we outsource payment activities to a bank or other provider?

Policies establish required practice for all parties that cannot be modified except by senior management. This is important when vendor representatives approach payables clerks with early payment requests or offers of entertainment. Any violation should trigger appropriate responses by management.

Organizing for Payables Management

Many companies have an accounts payable manager responsible for the payment of bills from vendors. There are large float and cost implications of payables, and inappropriate decisions or inefficient procedures can add significant costs, adversely impacting working capital. Because of these considerations, the payables manager should meet frequently with finance and other relevant functions.

Payables Metrics

Various metrics can be used to measure a company's performance in managing payables.

• Issuance of accounts payable disbursements. Payables practice may be at variance with predetermined target dates. Such targets can be the discount date, the due date, or an established number of days after the due date. It is useful to determine industry practice by referring to industry ratios or statistics provided by trade associations, or at least to establish the parameters for payment so that the decision is not left to the discretion of payables clerks. For example, if our competitors pay an average of 10 days after the due date, when should we pay?
• Cash discounts taken/not taken. Although only about 10 percent of vendors offer discounts, any such opportunities should be individually evaluated and either explicitly taken or passed. Many companies either take all or none of the discounts offered, which is suboptimal practice. In addition, it may be possible to negotiate dynamic discounting with vendors offering prorated discounts based on days paid prior to the due date.
• Use of bank disbursement products. Although many companies prefer to use check disbursement systems to pay vendors to either extend float or have a paper trail proving the payment, there are attractive and cost-effective bank products that should be considered. A metric logging the review and use of these alternatives to traditional disbursing should be developed.
• Positive pay and account reconcilement. Certain bank services are primarily used for control to assure that payments are not altered and fraudulently diverted; see Chapter 3. Logs should be maintained to indicate company compliance with appropriate audit controls.

Active versus Passive Payables Management

Companies often do not actively manage the payables function and merely pay bills as presented if the necessary authorizations and accounting codes are provided and supporting documentation is attached. In these situations, there is little concern for the appropriateness of the expense, for the value of float, or for variances among vendors as to their need for timely payment. In fact, a vendor payment may be made before the due date if a formal diarying system does not exist. Each vendor must be individually examined to determine optimal practice.

Float Costs of Mismanaged Payables

Here's a situation involving mismanaged payables. The business of The World of Animals is to stock zoos and circuses. Working capital was a continuing problem, and a study of payable practices seemed appropriate. Disbursements were made by check, with two major payables runs on the 5th and 20th of each month. The results for its largest vendors are displayed as follows, showing an annual value of float costing nearly $30,000. Investigation into two of the vendors that were paid early determined the following:

• Charlie's was paid early because his sister-in-law worked at the company and saw no harm in issuing payments once the payables cycle was completed.
• Claire's was paid early because its salesperson had once asked for an early check to make her monthly sales goal. The payables clerk embedded the check release date as an ongoing system instruction.

The company immediately researched other vendor transactions, and found similar problems. The total cost to The World of Animals from all vendors in lost payables float was determined to be about $40,000 a year (see Exhibit 8.1).

Other companies actively manage payables to maximize float while maintaining good vendor relations. Decisions are made regarding the importance of each supplier, and markers in the payables system indicate whether cash discounts should be taken or if an invoice should be paid on or after the due date. These “pay fast/pay slow” alternatives require accounts payable managers to emerge from their clerical function of paying invoices as presented, and manage the process against such constraints as vendor sensitivity and the time value of money.

Regardless of the payables approach chosen by companies, many now use integrated purchasing/payables systems. These products offer various analytics, including controls on purchasing and payment decisions, limits on access to lists of approved vendors, file maintenance of all relevant vendor data, and interfaces with disbursement systems. Later generations of purchasing/payables (known as enterprise resource planning or ERP systems) are integrated with various business applications.² We'll discuss ERP systems in Chapter 10.

Checks, ACH, and Fedwire

Checks, ACH, and Fedwire are the most usual methods of disbursement for payables. A regular bank checking account receives activity during normal business hours, which means that any holder of a check can request funds from the account (or “cash” the check) at any time. The account owner must either leave balances or transfer funds into the account to cover such activity, or risk the embarrassment and expense of checks returned to depositors (such as vendors) for non-sufficient funds (NSF).

A better alternative is a controlled disbursement account, which is funded once during the business day to cover daily check presentments, eliminating the need for companies to leave balances to cover clearing items. Early notification of that day's clearings allows funding of the account and helps the finance manager determine the company's cash position. The funding is by intrabank transfer, through an interbank ACH, or by Fedwire.

The company completes the payables activity by releasing the payment in satisfaction of an outstanding invoice. However, the bank will require resolution of any mismatches of issued file data compared to clearing data if positive pay is used. When the payment is by ACH, the rules of the clearinghouse (NACHA) require that a prenotification ACH be satisfactorily completed before the ACH can be completed. Due to their cost, Fedwires are infrequently used for disbursements and are final once released.

Costs of Check Issuance

Companies that issue disbursements for payables should carefully examine the all-in cost, not just the bank check clearing charge. Exhibit 8.2 lists a company's charges for 3,000 vendor checks a month, with the cost of nearly $7 per payment totaling almost $250,000 a year. Using another disbursement method would result in significant savings: per item bank charges range from about 15 cents for ACH to about 75 cents for comprehensive payables. If the latter were used, avoidable costs are about two-thirds of the charges in italics and all of the charges in CAPITAL LETTERS (see Exhibit 8.2). The potential savings are almost $140,000 ($247,500 less $108,967).

Procurement Cards

Procurement cards (also known as purchasing cards) are corporate cards issued to designated employees to make local purchases on behalf of the company. These cards differ from credit cards in the following respects:

• The company (rather than the employee) receives the bill and is responsible for payment.
• Codes are embedded in the card to restrict purchases to eligible types of products and services, and to limit the total amount spent.
• Automated data capture enables the company to receive next-day summaries of purchasing activities for company review and the determination of appropriateness and accuracy.

Purchasing can be simplified through the use of the cards for routine items. A major procurement card benefit is the elimination of the paperwork inherent in creating a PO and other documentation. In addition, volume discounts may be arranged with vendors frequently used, and employees can be encouraged or instructed to use those suppliers. Many national and regional banks now have procurement card programs.

Savings arising from procurement card programs can be 80 percent to 90 percent of the cost of the traditional PO cycle. Opposition to card programs has been primarily from purchasing departments that see these cards as a threat to their position in the company. However, widespread card usage has minimized this problem, particularly as management is generally pleased with the savings typically achieved. Furthermore, the use of cards for small items allows purchasing managers to concentrate on major buying decisions and to negotiate with vendors for volume discounts when cards are presented.

Electronic Disbursements

In an actual situation, a large hospital and medical center received a high percentage of invoices in paper form requiring extensive manual handling including validation, review, and approval. A vendor-maintained electronic settlement process allowed the hospital to involve all of its suppliers, including medical, pharmaceutical, office supplies, food service, and construction; such other vendors as legal services and printing companies were later added.

As a result, savings were developed throughout the payables cycle:

• Comprehensive payables grew to three-fourths of all disbursements.
• The cycle to complete payables was compressed from 80 to 20 days.
• Exceptions and adjustments were reduced by one-sixth.
• The percent of cash discounts increased to three times the amount offered to the typical buying company.

Freight Bills

Numerous organizations offer comprehensive freight and logistics services, including the auditing and payment of bills from transportation carriers.³ Freight invoices are reviewed for excessive charges such as misclassifications, incorrect discount levels, incorrect mileage calculations, extension mistakes, and other errors. Overcharge claims can be filed and tracked to request refunds of fees overpaid.

Other services offered include verification of shipper liability, rate negotiation, review of contracts, classification and routing assistance, customized transportation and distribution systems, carrier selection, and contract negotiations. These freight payment services audit both large freight movements and small parcel services such as UPS, FedEx, and DHL. A particular concern is on-time performance and the filing of claims for refunds if delivery does not occur within the time guarantee.

Here's the typical data flow: based on company instructions, carriers submit freight invoices to the designated freight payment provider. The firm will verify the freight movement by reviewing bills of lading⁴ and signed proof of delivery, and accuracy of the invoice will be determined by examination of freight rates, freight discounts, misapplied charges, and other sources of potential errors. In addition, recommendations are made regarding carriers used, transportation and logistics systems used, packaging and container labels, and payment alternatives.

Comprehensive Payables Concepts

Several banks offer a complete disbursement outsourcing service generically referred to as comprehensive payables. The company authorizing payments transmits a file in any of several formats containing the following payment data:

• Due date of payment (as payments can be warehoused by the bank)
• Dollar amount
• Payee and payee's address
• Mechanism (i.e., check, Fedwire, or ACH)
• Accompanying remittance detail

The bank creates payments as instructed and issues them on a specified date. Some banks determine the appropriate payment mechanism based on company-determined parameters. Electronic payments are issued as requested by the company, and transaction fees are based on the bank's standard pricing.

Benefits of Comprehensive Payables

There are significant benefits to companies using comprehensive payables:

• Consolidation of the payments function. Instead of having to maintain different systems for various types of payments, companies can use a single system for all disbursements.
• Outsourcing the entire disbursement function, including check printing, mailing, and the reconciliation process. Several internal company responsibilities can be entirely eliminated, and the risk of internal fraud is significantly diminished with the process managed by a bank.⁶
• Cost savings. Studies indicate that the all-in cost of creating and sending a payment is approximately $5, although fees vary by issuer. Banks are currently bidding the comprehensive payables service for about 75 cents for paper disbursements. Electronic disbursements are charged at the bank's price for ACH or Fedwire with an additional charge for managing the disbursement process. The company continues to have some expenses for general bank contact, including overall supervision and the daily “pay” or “no pay” positive pay decision. An estimate of the total cost of using a bank for outsourced payments is $1 per transaction plus postage.
• Vendor access to payment status. As the process is on a hosted web-based platform, vendors can log onto the system at any time and view the status of their invoices and payments pending. Some banks (e.g., Bank of America) allow vendors to factor these receivables to accelerate cash flow.

Mechanics of Direct Deposit

The employee provides a voided check to his or her employer at the time of employment or later enrollment. The transit routing and bank account data from the bottom of the check are used to build a file record. Depending on the arrangement with the disbursement bank, the ACH transfer is made one or two days before the pay date, assuring that good funds will be in the employee's account on the pay date. Alternatively, an outside payroll service calculates the amount of net pay and the various deductions (including tax and employee-paid benefits), and transmits a file of these data to the bank that is used.

The leading payroll services are ADP, Paychex, Administaff, and Trinet Group. The primary advantages of direct deposit are:

• Low cost to the employer, as the cost of an ACH is about 15 cents (vs. about $5 to issue and reconcile a payroll check).
• Reduced employee absence, as there is no reason to leave company premises to deposit or cash the payroll check.
• Convenience for the employee, as the pay is in the bank regardless of weather, vacation, business travel, or the loss of the payroll envelope.
• The funds are credited to the employee's account, the earnings on which, depending on the type of depository account, may or may not pay interest for his or her benefit. However, earnings on deposit accounts are fairly nominal, so this should be a minor consideration.
• Fraud prevention, as there is no need to verify the identification of an employee attempting to cash a payroll check.

Disadvantages include the following:

• The employer loses all use of the funds deposited for the payroll—the float—on pay date. Studies of payroll check clearing show that the average delay in check clearing is about three business days.
• The employer must manage a dual payroll system—check and direct deposit—unless all of payroll is converted to electronic. This is not a major concern for companies that use an outsource service.

Promoting Payroll Direct Deposit

Employees who resist direct deposit may want to hide pay from a spouse or significant other, may not have a bank account, or are simply uninformed about the mechanics of the program. Companies can require direct deposit as a condition of employment (but not after), but must allow employees to select the financial institution to which their pay is sent.

Consider involving the bank in providing an educational program to assist in overcoming resistance. Companies find that their financial institution will market their services to employees, and promotions often used are a year's free checking, a discounted mortgage or home loan program, free credit card programs, or other promotions. The current banking environment may be an excellent time to offer these services.

Sufficient employment at a single site may justify the bank installing an ATM for employee banking (which may have to be subsidized by the company). Corporate benefits include eliminating any petty cash maintained to accommodate check cashing and travel or expense reimbursement, and not having employees leave the premises during work hours to conduct banking activities. In addition to the management and replenishment of these funds, the company avoids the risk of theft.

Paycards

Employees may choose not to receive a direct deposit or a check for various reasons. Many banks and payroll services offer paycards, which are ATM cards specifically used for payroll. The employee need not have an account at the payroll bank. Instead, an ATM card is issued along with a PIN number, allowing access through any ATM machine or at merchants that accept the card family (e.g., Visa or MasterCard). The employee receives a monthly statement detailing withdrawals, payroll credits, and purchases.

Paycard is a convenient way of paying seasonal workers and other employees who may only be at a job for a short period of time. Other employer paycard advantages include:

• Elimination of stop-payment fees for lost or stolen paychecks.
• Minimizing exposure to paycheck fraud.
• No need for employer encashment of payroll checks.

Advantages for employees include:

• No time wasted waiting in lines at banks or check-cashing stores.
• No fees for check cashing (which can be a significant cost).
• No requirement for multiple forms of identification to cash checks.
• Access to funds anytime and virtually anywhere.