Bottomline Technologies – How Will SEPA Deliver Working Capital Benefits in Accounts Receivable?

In a recent reader survey on the single euro payments area (SEPA) and corporate accounts receivable processing (results article to be published next month), I responded that SEPA would eventually have a highly positive impact on the cash cycle and collection processes of corporates that trade cross border within the EU. In this article, I will explain the reasons behind my answer.
I should start by underlining the fact that I am focusing on the end game of ‘full on’ SEPA, rather than the transition period. We should definitely not underestimate the enormous challenges of migrating from today’s multi-faceted and fragmented EU payments environment to the new standardised world of SEPA. This is a period that people are now being realistic enough to admit will last longer than the originally proposed three-year transition period (January 2008 until December 2010). Indeed, there is growing opinion that it might be preferable to allow corporates a reasonable period to migrate so they can incorporate SEPA into their normal technology investment cycles, rather than being mandated to implement quickly (which would result in higher costs).

In the corporate world, a major unsolved challenge is how to persuade internationally active corporates that the new SEPA instruments should be adopted in place of existing in-country schemes, with all their diversity and complexity but also, importantly, their familiarity for experienced users. This is a challenge that the regulators have so far failed to address in any depth and which some banks will probably claim falls outside their immediate remit.
Taking the proposed SEPA compliant direct debits as an example, will large billers adopt them domestically? As long as domestic schemes are in place, corporates are likely to prefer to continue using products with which they are familiar and which are ‘tried and tested’ – warts and all. It may turn out that only the forced regulatory withdrawal of legacy schemes will finally push large corporates into adopting the new SEPA compliant schemes.
Looking beyond the daunting challenges of migrating from multiple legacy national payment and collection schemes to standardised SEPA schemes, it is exciting to explore the tremendous working capital benefits that SEPA will help unlock for corporates trading within the EU. With greater standardisation of payment and collection instruments and a general reduction in the number of bank accounts maintained, corporates will increasingly be able to centralise cash management and achieve improved visibility of inbound cash, along with easier reconciliation. This, in turn, will enable corporates to reduce their days sales outstanding (DSO), with valuable cash flow benefits, greatly enhancing the cash conversion cycle.

SEPA will allow a more holistic approach to both accounts payable (A/P) and accounts receivable (A/R) activities across the EU. Many corporates have already made some progress in streamlining and centralising their A/P activities. Accordingly, there have been growing numbers of payment factories and shared service centres (SSCs) created over recent years. While this work is by no means complete – and indeed SEPA will provide further opportunities for centralisation of A/P – it has to date proved harder to achieve such consolidation on the A/R side of a business. This is ironic bearing in mind that efficient collection processing is crucial to working capital management and, more importantly, cash flow into a business through an efficient A/R process is the very lifeblood of an organisation.
The slower progress in streamlining A/R is in part due to the diversity of collection products, including direct debits. They demonstrate a greater diversity than EU payment products, in terms of the wide variety of direct debit schemes, with disparate mandate, finality and clearing cycle requirements. However, the standardisation of SEPA compliant schemes should make it easier for corporates to consolidate their A/R units into shared service centres, perhaps even ‘collection factories’.
Significant efficiency gains and economies of scale should be achievable from the increasing centralisation of A/R activities as corporates improve their regional visibility across the EU, making cash flow forecasting easier and more reliable. This will facilitate a more proactive collection process, supported by improvements in the content quality and timeliness of invoice distribution. One obvious step to accelerate the collection cycle under SEPA is the standardisation of bank account information. Specifically, IBANS and BICS should be included on all invoices in order to make it easier for customers to settle their debts, improving the likelihood of funds reaching the correct bank account more quickly and without reject or error.

The idea of a ‘single euro account’ for the entire eurozone still seems rather ambitious, especially in view of the slow progress towards harmonising tax and legal regulations across the EU. No doubt tax and legal considerations will continue to affect the location of bank accounts but we can certainly anticipate a general reduction in the large number of bank accounts that large corporates still tend to maintain today. This is especially true for those currently used to manage specific in-country payments and collections, some of which are highly localised.
This general reduction in the number of bank accounts should result in considerable improvements in visibility of remaining accounts and reporting, supported by better multi-bank connectivity, which in turn will make liquidity management easier. Indeed, some of the complex liquidity management structures and in-country pooling mechanisms, which corporates have implemented to cope with large numbers of accounts across the EU, can be rationalised and migrated to simpler and less costly structures, and in some cases these will no longer be required.

The so-called multi-purpose pan-European direct debit (M-PEDD) has at last been hatched as a hybrid and perhaps even a ‘lowest common denominator’ of a range of national schemes. For corporates that already make extensive use of in-country direct debits across the EU, migrating to the M-PEDD will undoubtedly demand considerable transition administration, such as signing new mandates. However, in the longer term, the M-PEDD should prove attractive, since set-up will be much simpler and cheaper, with only one set of rules across the EU. Standardisation of return procedures and reason codes should lead to significant efficiencies. And the M-PEDD should ultimately prove a growth area, especially in the business-to-consumer field.

Significant improvements should also be seen in reconciliation. The proper use of standardised routing codes, IBANS and BICS, will not only improve STP but also reconciliation. More remittance information (up to 140 characters) will be capable of being transported with the payments, again greatly facilitating reconciliation. Similarly, as bank charges can no longer be deducted from payments, it will be easier to identify incoming payments, whose value should more often coincide with the face value of invoices, rather than the net amount after deduction of bank charges. All these developments will improve the cash conversion cycle and enhance working capital management. The easier and more timely gathering of reliable information will speed up decision-making, which will accelerate inward funds application and help the management of bank debt and inventory, as well as credit limits. The release of credit capacity on clean reconciliation of trade creditors will also reduce A/R, a key objective in efficient working capital management.

These SEPA changes in EU payment and collection processing are not going to happen overnight, but the opportunity for unlocking considerable value is still evident even if this transition turns out to be an evolution, rather than revolution. It also looks like the introduction of SEPA is set to coincide with an important growth period for invoice discounting and supply chain finance.
Banks who see their traditional revenues for payments and cash management under threat from SEPA are increasingly looking for deeper integration into the financial supply chains of their corporate customers in order to deliver working capital solutions, such as enabling suppliers to get paid more quickly, hence delivering improvements in DSO. In broad terms, this specialist funding can be divided into two types:
1. Invoice discounting (biller centric), which is different from factoring in that the biller/borrower usually collects the invoice debt, in contrast to factoring where the factor manages the sales ledger and collection process for the borrower/biller.
2. Payables finance (payer centric) or supply chain finance, where the financier uses payer information, such as approved and matched invoices, in order to reduce the risk on making early payment of invoices to suppliers.
Both these mechanisms can be structured to enable the payer to extend their days payables outstanding (DPO) at the same time as reducing the suppliers DSO, providing valuable off balance sheet funding for suppliers. These benefits are enabled by recent improvements in risk management systems, as well as a growing focus on intercompany co-operation in the financial supply chain and improved visibility and efficiency in invoice processing, matching and approval.

The European Commission (EC) is encouraging the development of e-invoicing solutions by banks as a way of making the business case for SEPA more convincing (according to the EC Consultative Paper on SEPA Incentives, February 2006). The initial reaction appears to have been that, at present, banks and infrastructure providers do not want to widen the focus of SEPA, since this might increase the risk of not meeting the tight deadlines for SEPA implementation. However, there is a great deal of value to be unlocked if e-invoicing were to be adopted more widely. The European Association of Corporate Treasurers (EACT) has drawn up estimates that were included in the EC’s consultative paper. Based on these figures, the EC calculated that a conservative estimate of the saving easily exceeds €100bn a year:

Total annual EU invoices Exceeds 20 billion
Percentage of invoices which are B2B or B2G* Exceeds 50%
Current cost to manually process an invoice €30-80
Cost saving from electronic processing 60-90%
Conservative estimate of minimum saving per invoice €25
Conservative estimate of total annual saving More than €100bn a year

* B2G = business to government invoices.
In fact, the EACT itself estimates a potential saving of €243bn, whereas the EC estimates that only half of all EU invoices are the B2B and B2G invoices (i.e. five billion invoices) and that each one will produce a minimum saving of €25.

There is little doubt that enormous SEPA implementation challenges lie ahead, especially in terms of persuading large corporates to migrate to SEPA compliant schemes for not only their cross-border payments and collections but also their domestic traffic. In this context, we should bear in mind that it is estimated that 97-98% of all EU payments and collections are made in-country, rather than cross-border. However, as summarised above, there are considerable A/R benefits to look forward to once we cross the chasm, both in terms of improvements in working capital and liquidity management.
Similarly, SEPA will help drive A/P benefits, though these fall outside the remit of this article. The challenge in terms of A/R and A/P benefits for corporates lies in quantifying and communicating the business case, which can indeed deliver considerable benefits for buyers, suppliers and financiers.