I. Details of bottlenecks in the management of trade receivables and liabilities before TSU:

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1 Standardised confirmation of receivables: TSU a new (bank) solution with plenty of potential By Herbert Broens, Head of Export Department Bayer AG Contact: Herbert.broens@bayer-ag.de or Herbert.broens@t-online.de The management of trade receivables and liabilities remains a difficult process for any company. It affects firstly delayed payment, secondly financing, thirdly credit management of the receivables, fourthly the costs of operative collection and accounting management and fifthly the optimisation of stock-keeping. A new banking development called the Trade Services Utility (TSU) allows significant improvements in these areas. The introduction of TSU is perfectly timed to coincide with German Chancellor Angela Merkel s slogan for the Cebit computer trade fair in Hanover 2010, Connecting the world. I. Details of bottlenecks in the management of trade receivables and liabilities before TSU: 1. Delayed payment: The supplier does not always receive payment on time. Companies which produce and sell consumer goods for B2B are affected most significantly. The overdue rate for these is often over 15% of the total receivables. A look at published consolidated financial statements shows that such defaults are also a large factor in liquidity planning. For B2C trade, on the other hand, the majority of turnover is made up of cash transactions and the producers of capital goods receive milestone payments even before completion. Up to now, companies have planned receipt of payment from trade transactions on the basis of experience and mathematical models. However, on the one hand, the exact delay in payment is unknown ex-ante, and on the other hand, liquidity planning becomes increasingly more important due to worsened ratings and poor economic prognoses. For corporate groups with a central treasury, this is only possible with good software and plenty of support from the local units. Even then, such a system has limitations, since the payers alter their methods over time. Suppliers attempt to avoid delays in payment using bank products, such as direct debit (Abbuchungsverfahren in Germany), bank debt collection (Inkasso) and letters of credit (Akkreditiv). Since the debtor does not like to reveal his payment history to third parties, and this is necessary for a direct debit, there is no consent for this for many B2B transactions. Bank 1 / 8

2 debt collection and especially letters of credit are also associated with high handling costs. Further measures for the avoidance of delays in payment include the early evaluation of days overdue and verbal or written warnings based on this. Warning measures can begin even before payment becomes overdue in the form of reminders, and end in judicial debt recovery proceedings. The unit responsible for organising this is the business or a collection centre, which can be in-house or an external provider. 2. Financing: In B2B trade, and also sometimes in B2C, the buyers of the goods often receive a contractually agreed payment date. In B2B for consumer goods, this is usually around 30 days for domestic deliveries and around 60 to 90 days for exports. For capital goods, the payment date can be significantly further away. In B2B, the difference between consumer and capital goods is due to the fact that the cash flow revenue from capital goods investments occurs significantly more slowly than for trade transactions or production for short-term use. The agreed payment date is based on this. In principle, the payment date can be freely negotiated between the buyer and seller. In such negotiations, both sides take the financing costs into consideration. There are also variations across regions and sectors, which form the framework for the payment date. As well as the payment date, delay in payment is also a strong influence on the company s credit supply, the company s rating and the interest paid. Additional interest costs become payable when payment is overdue, and are not usually included in cost calculations. The interest costs do not just affect the calculation of profit and loss, but also the company s credit rating. This becomes more important during economic downturns, if a downgrading of the credit rating is threatened and the financing framework is urgently needed for other functions. 3. Credit management of receivables Credit management of receivables can be done in-house or using external hedges. 2 / 8

3 B2B in-house credit management currently occurs via the evaluation of inhouse data, data exchange with credit agencies and payment pools, and finally with credit scoring. Only a small number of cases involve the active cooperation of the debtor. Once the contract is signed, the credit management today receives no information from the debtor until payment. The alternative, the external hedging of B2B receivables against defaulted payment, has changed significantly in recent years. Until around the year 2000, domestic receivables were credit-insured and exports subject to documentary credit from banks. The state export agencies completed the range of security instruments by assuming the risk for countries and the public sector. Around the turn of the millennium, the number of credits fell. The main reason for this was that the relative handling costs for banks and companies had become too high. The costs were justified, due to the manual handling of numerous papers. But improvements in in-house credit management, up-to-date information about the creditworthiness of business partners irrespective of their location, and especially the expansion in credit insurance providers, created good-value alternatives, which the companies use. The picture changed again with the financial crisis of 2007/08. The largest US insurer, AIG, had to be supported by the state and sold foreign branches. The three largest European providers (EulerHermes, Coface and Atradius), which were and continue to be positioned globally, refused credit risks more frequently than before. There were several reasons for this: Firstly, the insurance volume had increased significantly as a result of the expansion and the change in customer behaviour described above (LC to credit insurance). The few global insurance providers, however, were not in a position to deal with the discontinuation of all LC securities, which had previously been divided among many banks. Secondly, the financial crisis very quickly caused credit limits to be allocated much more restrictively. Thirdly, European credit insurers received worse ratings, so that refinancing became more difficult for them. Finally, many new policies were too expensive for the customers. In general, it would also be advantageous for credit management to receive invoice recognition before it becomes due. This would make delayed payment more difficult both psychologically and in terms of argument. The faster payment is received, the lower the danger of default on payment. Secondly, a delay in payment always begs the question of why it has happened. In the case of invoice recognition before payment becomes due, 3 / 8

4 it is even easier to act on the assumption that the debtor has difficulty paying. 4. Costs of operative collection and accounting management The traditional collection procedure and the allocation of incoming payments are largely manual processes. Depending on the number of unfilled posts, one collector can be responsible for 300 or more customers. As well as the staffing costs for these workers, further costs accrue for the allocation of the incoming payments in accounts receivable these may be minimal in the case of direct debit, for example; or be incumbent on outsourcing (lockboxes in the USA, boletos de cobranca in Brazil). Often, not all incoming payments can be allocated by machine a good allocation quota is over 80% - so that the remaining payments have to be processed manually. This can lead to costs of over 50, especially when the cost of the dunning process is added on. 5. Optimisation of stock-keeping At first glance, management of stock seems unconnected to the management of trade receivables and liabilities. Stock managers make decisions based on operational production processes, service agreements or capacity requirements. Corporate planning and optimum order quantities are the deciding factors for them. The implementation of their decisions influences company results, profit margins, working capital results and return on equity. In 2009, Professor Protopappa (European Business School, Dept. Logistic and Finance) found that close cooperation with the working capital department optimised results. Restrictions on each department should be solved across all departments. After all, trade receivables and liabilities only come about when the company s own stocks or those of the customer are kept full. Effective working capital allocation and making receivables and liabilities visible can bring about significant improvements in costs, highlight liquidity developments and reduce borrowings. II. The TSU Approach The banks role as payment processors, risk hedgers and liquidity providers is a special one. The changing requirements of customers cause many institutions to rethink and to realign their range of products and services in accordance with the customer s value chain. Transaction financing is becoming increasingly important, while traditional products (e.g. factoring) are being offered just as much as innovative forms of financing (e.g. supply chain finance). Furthermore, banks see themselves 4 / 8

5 increasingly as service providers, supporting their customers in data acquisition and analysis. International cash management, e-invoicing, the creation of trade documents and their settlement are just a few of the new services offered. For banks, too, the quality of data is of key importance. Alongside the credit standing, it provides the foundation for a successful relationship with the customer. Data acquisition is a particular challenge in international trade. The provision of paper documentation, such as for a credit or documentary collection, has become less important. There are no uniform electronic invoicing formats. Support via SWIFT the Trade Services Utility This is why SWIFT, an internationally-active company owned by banks, brought a new solution onto the market in 2007: Trade Services Utility (TSU). TSU is a notification-based bank-to-bank application which can be used for data exchange and the automatic comparison of purchase order, invoicing, transport documentation and certification data. The prerequisite for this is that the companies provide the relevant information. The format in which this is done depends on the agreement between the bank and customer in each case. TSU merely provides an inter-bank format which makes the exchange of data possible. TSU allows customers to recognise documentary discrepancies early on without individual checks, thus avoiding non-payment and reducing the processing time between delivery and payment. As well as the advantage in terms of time, expensive document creation and auditing processes become unnecessary (see Point 1). This allows banks to enter more strongly into risk assumption for trade credit again (see Point 3). However, many are becoming increasingly convinced that a uniform standard of bank communication is also necessary for customers, since many customers have to exchange TSU data with several banks. Furthermore, real cost avoidance is only achieved if the corporations ERP systems can exchange standardised data without separate programming. With TSU, it is possible to levy a standardised irrevocable declaration of payment obligation: the bank payment obligation (BPO). This BPO becomes due when the financial institution involved has performed a data comparison and accepted any discrepancies. This gives it a similar character to a letter of credit. SWIFT is currently in pre-negotiations with the International Chamber of Commerce in Paris, to obtain an endorsement for the TSU- Bank Payment Obligation. This will increase its usage as an alternative of the LC in future. Before ICC recognition, TSU will have other important functions: 5 / 8

6 Supply chain financing is becoming significantly more important: The tight financing framework for companies led to a new product development in Spain a few years ago: so-called Confirming (what is known globally as supply chain financing), which is currently enjoying an increase in demand in many countries. The idea behind SCF is that the bank credit is based on the future payment of the debtor. This provides relief for the bank s balance-orientated customer financing. This makes additional credit possible for the supplier, and he receives financing with favourable interest rates when the buyer has a better credit rating. The prerequisite is that the buyer/debtor recognises the receivable again after receiving the invoice, regardless of his obligations in the purchase agreement. The bank can then support the SCF with less equity to fulfil Basel 2 and with an appropriately lower interest rate. The advantage of SCF is therefore shared between the bank, the supplier and the debtor. All parties benefit in the form of cash payments or new payment dates. Some banks have set up web portals to support the process of invoice recognition workflows. An interface with an ERP system is being set up for the initiator of SCF, who corresponds with many business partners via the portal of his chosen bank. However, corporate counterparts of SCF continue to manage their little data input manually. This text is only intended to point out the balance-orientated effects and possibilities. The SCF will achieve a real breakthrough when a matching standard is developed. Here, the TSU offers a data set independent of region and sector, which allows corporations to work together with multiple banks. SCF is especially suited to conducting supplier transactions with multiple banks, as long as the costs for manual handling do not exceed the advantages. To do this, the default data set is required. In this, internationally-active trading companies and industrial companies which export must also take many points of contact with external service providers (banks, logistics companies, insurers, authorities ), suppliers and customers into account in the global environment. To do so, production, goods and financial data must be integrated in order to get a complete online status. It is therefore especially important that the banks use the TSU data set uniformly with the customer. Otherwise, TSU will not become accepted by major customers, since the business case does not assume an increasing number of points of contact. In currency management, the TSU insight into the delivery and payment terms of the customers allows the banks to offer active management of currency risks. The TSU data set is even more important for B2B trade outside banking products: 6 / 8

7 Working Capital improvement: By matching trade receivables and liabilities, differences and outstanding payments can be recognised before they are due. Delay in payment is only authorised in exceptional cases. Matching before the due date thus brings significant advantages for interest and liquidity. Suppliers receive payment punctually even without direct debit and cheque payments, which have other implications. Manual work: A large part of the collection expenditure is dispensed with if confirmation is provided, before payment is due, that the customer has received and accepted the invoice and planned this position for his payment. A large proportion of the manual accounting tasks is also dispensed with, since due to the electronic data exchange, the debtor and creditor have a stronger interest in harmonising the data sets in such a way that as little manual input as possible remains on both sides. The advantages of this are for the debtor, to a large extent. The debtor will give his payment confirmation for marketing reasons in some cases. Sometimes he will only be prepared to do so if he is compensated. However, in realistic payment models, this will nevertheless lead to improvements for the debtor and the creditor. Annual accounts: Collecting confirmation from the debtor regarding the existence of the receivable is no longer necessary, since the position has been confirmed by matching. In this, matching is available not only for sample testing, as at present. Deliberate and accidental false representations of the balance are therefore avoided. Optimisation of stock-keeping: Data exchange via TSU starts when the order is made. This allows the supplier to take the demand into account quickly in the production process. TSU is therefore also the beginning of the new definition of order quantities and times, which can have a positive effect on prices. Smaller stocks are good for the environment, after all an increasingly important argument. III. Facts on TSU: To give an idea of TSU, here is a rough data set description for minimum matching: Order number, max. 35 characters, and date of invoice Buyer name, max 70 characters e.g. Global Location Number His address, city, ISO Code for the country Seller name, max 70 characters, e.g. Global Location Number His address, city, ISO Code for the country Product name/description, max 70 characters Payment date, max 40 characters 7 / 8

8 Sale price, ISO Code for currency and max 18 digits for the amount Buyer s bank BIC Seller s bank BIC Good s quantity TSU is already supported by over 100 banks. The leading international banks all use TSU. The task now is to roll out the standard across companies, in order to increase significant values. This article will be published in the September/October 2010 edition of the Business Credit Magazine. 8 / 8