141124 cash management payment systems

BA FINC 46 TREASURY MANAGEMENT
By: KLIEF T. AMORES, 2014
2. CASH MANAGEMENT

Cash is King, And, risk management helps you realize that cash is King. Cash is your best insurance policy.
- Amy B. Kweskin, Treasurer, Washington University in St. Louis

Cash Management
-Is the art – and increasingly the science – of managing a company’s short-term resources to sustain its ongoing activities, mobilized funds, and optimize liquidity. - Michelle Allman-Ward, James Sagner, Essentials of Managing Corporate Cash
-Is a critical component of liquidity management, without which most organizations have serious difficulty operating. - Karen A. Horcher, Essentials of Managing Treasury

Cash Management Model

2.1. Cash Transfer Methods
/ Payment Systems

1.Understand the basic terminology used in making payments
2.Evaluate the principal payment methods
3.Determine the benefit, costs, and risks associated with each payment methods
4.Appreciate payment system risk
Objectives

Case Study
At the request of the treasurer, Bill Ford, Ann I. Shade, the cash manager, is undertaking a complete review of GETDOE’s cash management systems. One of the areas that has been highlighted for attention is how the company manages its cash transfers. While many companies in the industry have already moved to electronic payments, GETDOE is still decentralized, hence, disbursement are through many different banks, primarily by check. There has been no opportunity to take advantage of the economies of scale and efficiencies that centralization can provide. Ann’s research revealed that some of the traditional float advantage of paying by check have been eroded by lower interest rates and the collection techniques offered by banks. In addition, the actual cost of issuing and processing checks has been greatly underestimated, especially when all associated costs are considered, including disbursement equipment, check clearing and reconciliation, and postage. The company is experiencing competitive and supplier pressure to move to electronic payments. Ann and Bill will have to evaluate the implications, trade-offs, and expenses prior to making a decision.

Clearing and Settlement Systems
Clearing is the process of recording transactions between members of clearing channel, such as the Clearing House Interbank Payments System (CHIPS). CHIPS acts as a clearing house for its members but settlement occurs across the member’ accounts with the Federal Reserve Bank.
Settlement refers to the act of transferring funds from a payer’s account to a beneficiary’s account.
Important Concepts

Immediate Settlement Systems
The Fed wire, operated by the Federal Reserve System (the Fed), is an example of a real-time gross settlement (RTGS) system. Transactions settle singly of bilaterally with a simultaneous debit to the sender’s bank and credit to the receiver’s bank.
Important Concepts

Delayed Settlement Systems
With a net settlement systems (NSS), multiple payments and receipts between participants are settled at the end of a period on a net basis, resulting in a single debit or credit to each member’s settlement account. i.e. Automated Clearing House (ACH) that settles one or two business days forward.
Important Concepts

Hybrid Systems
NSS systems are being redesigned to reduce the time between origination and settlement to reduce risk.
Important Concepts

Transaction Types
Credit Transactions. The person making the payment (the buyer) initiates a payment transaction to credit the account of a beneficiary.
Debit Transactions. The beneficiary initiates a transaction to debit a buyer’s account. These transactions are usually preauthorized.
Important Concepts

Methods of Payment
Electronic Payment Method
The Fedwire System
Clearing House Interbank Payment System (CHIPS)
Automated Clearing House (ACH)
Manual Checks
Other Payment Mechanisms
Trade Drafts
Bank Drafts (Cashier’s Checks)
Cash
Credit and Charge Cards
Procurement Cards

The Fedwire System
- Is an RTGS payment system that processes on a same-day basis without settlement risk to the participants, as the Federal Reserve Guarantees Payment.

The Fedwire System

The Fedwire System
Advantages:
Value. Immediate, same-day value.
Settlement. No Settlement Risk.
Finality. Funds cannot be recalled without the beneficiary’s permission once the payment has been sent by the sending bank and is confirmed by the Federal Reserve Bank.
Guaranteed Payment. The Fed guarantees payment should the sending bank fail.
Speed. Very fast.
Security. Reliable and Secure

The Fedwire System
Major Disadvantages:
Cost. Expensive to use relative to other payment types.
Credits only. Does not process debit transfers.
Limited Automation Linkage. As not all financial institutions are online with the Fed, some have to make alternative arrangements, either through member banks or over the telephone. This can slow the process and introduce errors.

The Fedwire System
Uniform Commercial Code Article 4A (UCC Article 4A) Security Procedures:
Securing the terminal and software at the company site;
Using passwords, test keys, and personal identification numbers (PINs) to access the system;
Multiple levels of entry and release;
Encryption to ensure the privacy of the message;
Authentication, digital signatures, and digital certificates to assure the identity of the sender;
Smart-key devices to secure systems against unauthorized access and use

CHIPS
-Is a bank-owned, computerized telecommunications network operated by the New York Automated Clearing House.
-It currently links 56 U.S. and foreign banks that have offices in New York City.
-Originally designed as an NSS with settlement at the end of the day, in 2011, CHIPS converted to a RTNS, thereby eliminating most of the daylight overdraft exposure and time delays in effecting payments.

CHIPS

Advantages:
Value. Immediate, same-day value.
Settlement. Settlement risk is virtually eliminated through special prefunded accounts held at the Federal Reserve.
Finality. Funds cannot be recalled after their release into the CHIPS system.
Speed. Very Fast, and may be more efficient in using a bank’s liquidity than the Fedwire due to the net settlement process.
Security. Reliable and Secure.
Information. Up to 9,000 characters of data.
CHIPS

Cost. Expensive to use relative to other payment types, such as ACH.
Credits Only. Does not process debit transactions.
Limited Direct Membership. Much more limited direct membership that with the Fedwire, although may financial institutions gain access to CHIPS through correspondent relationship with members banks.
CHIPS

-An electronic network for the processing of both credit and debit transaction within the United States and Canada.
-It includes direct deposit payroll, social security payments, tax refunds, and the direct payment of business-to-business and consumer bills.
Automated Clearing House (ACH)

Advantages:
Value. Can be made on precise settlement dates.
Cost. Provides a low-cost, electronic alternative to checks and wires.
Reliability and Efficiency. Compared with checks, ACH collections are far more predictable.
Electronic processing and interference. The system allows for automated inferences to reconciliation and cash application systems .

Advantages:
Payment Options. The ACH handles debit as well as credit transactions, providing opportunities for improved collection processes.
Accelerated inflows. By reducing float in the entire collection process, cash inflow are faster than check receipts.
Batch processing. The ACH handles repetitive bath transactions, such as payroll, pensions, and annuity payments (credits), and collection of insurance premiums, utility bills, and mortgage payments (debits)

Advantages:
Information. Large amounts of information can be transferred with the payment.
Security. The system is reliable and secure.
Fraud prevention. While not fraud proof, electronic systems are more secure than paper payments.

Delayed settlement. ACH payments settle one or two days later than Fedwire and CHIPS payment.
Finality. The ACH does not offer the same guarantee of finality as Fedwire or CHIPS payments, as debits can be returned unpaid.
Loss of Disbursement Float. ACH Transactions clear days faster than checks.
Initial Start-up Costs. In addition to development and systems costs, there are costs associated with ongoing support and maintenance of dual systems.

Change of procedures. Moving to the ACH requires a change of internal procedures and compliance by customers, vendors, and suppliers.
Concerns with Debit Transactions. Companies (and consumers) may be unwilling to authorize direct debits to their account due to apprehension concerning security and loss of control. Many banks offer systems that protects against unauthorized debit transactions over preapproved limits.

Uneven Capabilities. Not all financial institutions that claim they are ACH-Capable are able to process addenda records.
Security. Controls are not as extensive with the ACH as of Fedwire, making it risker to use for large-value payments.

A check payment is made on a paper document, which has traditionally been physically routed from the payer to the payee, to the payee’s bank, and then back to the payer’s bank. Bank Check
-Is a payment on behalf of the payer, which is guaranteed by the bank (and therefore of value to the payee).
Manual Checks

Payor
The person or company issuing the check
Payee
The person or company to whom the check is payable
Drawee Bank
The payor’s bank on which the check is drawn
Deposit Bank
The financial institution where the payee first deposits the check for crediting to the payee’s account.
“Pay to the Order of” the payee
Manual Checks

Manual Checks

The primary Clearing Channels:
The Federal Reserve System
Clearing House
Correspondent Banks
Direct Sends
On-Us Clearing
Manual Checks

Advantages:
Readily Available. A check book is provided with every demand deposit account (DDA).
Widely Used. Checks are widely accepted as a method of payment.
Disbursement float. The disburser gains float from the delay in mailing payments, processing the items, and check clearing.
Efficient. The check system is well established and the U.S. postal service works efficiently.
Limitless information. When information needs to accompany the payment, it is easy to do so using a remittance document.
Manual Checks

Advantages:
Anyone, Anywhere. When the details of a payee’s bank account are not known, a check can be sent to the address on file.
Manual Checks

Fraud. Paper instruments are much more susceptible to fraud than electronic transfers.
Use for International payments. Checks are not always an acceptable payment method of payment outside the United States; they can involve a costly collection process, may incur mail delays, and require a currency conversion.
Cost. Due to the ancillary costs of storing, processing, reconciling, and special bank services, such as controlled disbursements and positive pay, the all-in costs of checks can be more expensive than using the ACH.
Manual Checks

Collection Float. A check delays availability of funds by two or three business days.
Finality. A check can be returned unpaid for a number of reasons, including insufficient funds, a closed account, or a stop-payment order.
Manual Checks

Check Process Flow:
•Mail Float
•Processing Float
•Presentation Float
•Availability Float
Manual Checks

Trade Drafts
-Are primarily used in international transactions, as supported by documentation attesting that the terms of trade have been met. Bank Drafts (Cashier’s Check)
-Is a check drawn by a bank on its own account. Procurement Cards
-Also known as purchasing cards. Used to reduce the costs and related administration of purchasing within the company.
Other Payment Mechanics

Credit and Charge Cards (PLASTIC)
-Allows the vendor to receive value on a transaction while the purchaser enjoys a grace period of up to 30 days before the bill is presented.
-Charge Cards. American Express Cards, the full amount is due when the bill is presented.
-Credit Cards. MasterCard and Visa, a minimum payment is due upon presentment of the bill, but the remaining cab be paid over a period of time, thereby extending credit.

Cash
-This eliminates the cost and time involved in making cash deposits.
-Advantages:
-Fungible. Small amounts of cash are nearly always accepted.
-Speed and Finality. Funds are assured as soon as cash changes hands.

Cash
-Disadvantages:
-Physical Nature. Cash has to be physically handles, and, if lost, cannot be replaced.
-Low dollar value. It is usually not acceptable for large dollar transactions.
-Fraud. Modern technology enables currency notes to be very convincingly reproduced.
-Nonearning asset. Cash is a nonearning asset until deposited or used.
-Security. Extra security and cost may involved.
-Audit Trail. Cash provides no audit trail.

Case Study
After consideration of the advantages and disadvantages of electronic payments. Ann has determined that GEDOE should begin to migrate its disbursements to the ACH. She fears that if the necessary changes are not initiated, GETDOE will eventually lose competitive advantage by not being as efficient as its peers in the industry. Ann realizes that the process will not be accomplished overnight and that much negotiation lies ahead with GETDOE’s employees, vendors, and suppliers.

The control system for check payments assumes that a fully documented packets of payables information has already been created, which contains receiving, purchase order, and supplier invoice information. The following controls should be used to create and monitor check payments:
Remove Check Stock From Locked Storage.
Restrict Access to Check-Signing Equipment.
Controls for Check Payments

The following controls should be used to create and monitor check payments:
Require a Manual signature on checks exceeding a predetermined amount.
Check signer compares voucher package to check.
Implement positive pay.

The following controls should be used to create and monitor check payments:
Use electronic payments.
Reconcile the checking accounts every day.

Electronic payments can involve large amounts of money, and so require a stringent set of controls to mitigate the risk of loss. The following controls may be implemented:
Restrict access to master vendor file.
Require signed approval document for manually initiated electronic payments.
Verify ACH debit filter with bank.
Require password access to payment software.
Require additional approvals.
Require an end-of-day payments review.
Controls for Electronic Payments

To address unauthorized accounts debits and the sheer size of potentially incorrect or fraudulent payments, the following additional controls may be implemented:
Impose an outright debit block on all company accounts.
Request a daily cumulative limit for authorized trading partner debits.
Request notification of duplicate debits.
Use a separate bank account as the source of electronic payments.
Controls for Electronic Payments

1.Electronic Data Interchange (EDI)
-Refers to the electronic exchange of information between trading partners using formatted messages.
2.NACHA Formats
-Standardized messages used by all banks and parties involved in originating, processing, and receiving ACH Payments.
Payment System Standardization

3.SWIFT
-Society for Worldwide Interbank Financial Telecommunications
-A bank-owned, global communications system. Developed in the early 1970s, it created a series of strictly standardized messages for the exchange of financial information between financial institutions.
Payment System Standardization

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141124 cash management payment systems

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