How can virtual accounts streamline your collections?

How can virtual accounts streamline your collections?

Virtual accounts have the potential to significantly improve cash collections through accelerated cash centralization and more efficient accounts receivable reconciliation. It is an innovative cash management structure that large corporates, in particular those with decentralized collections across Europe, can benefit from. A Zanders consultant explains.

Zanders has supported many corporates in strategic treasury projects on the accounts payable (AP) side. Only relatively recently, a larger number of corporates have started to look into means of streamlining their accounts receivable (AR) as well. Why do you think there is now an uptake of AR projects and where do virtual accounts fit into the picture?

“Centralization of incoming flows is more complex. You’re simply less in control of where and when you receive cash than where and from what account you pay. Corporates have built up experience and best practices by centralizing outgoing flows and potentially also the reconciliation of accounts payables first. On the incoming side, however, local entities typically manage customer relationships and also apply cash to open AR.

As a result, corporates that have centralized outgoing flows on a limited number of treasury accounts still collect cash on a dispersed set of local accounts. Cash is not king when you don’t have quick access to it. So why wouldn’t we just have one single bank account for collections? The complexity comes with the cash application to open AR. If all customers paid into the same account, an automated cash application process would heavily rely on the payment reference to match bank statement items with open AR. However, the payment reference is a free-format field that depends on the correct entry by the payee, and can also get (partially) cut off along the way through settlement and clearing systems. Getting the payment reference right is not required to transfer a payment. Getting the bank account number right, however, is.

This is where virtual accounts step in. Quintessentially, a virtual account increases the information value of the mandatory account number (i.e. IBAN) to a great degree so that it complements the free-format payment reference. Virtual bank accounts are like pass-through post-boxes – when a payment is sent to a virtual account, cash falls right through and gets accumulated on a centralized ‘real’ bank account. A virtual bank account thus does not hold value, while a real bank account holds value and represents an account in general ledger of banks. Because of their purely notional nature, virtual accounts can be created by banks in large numbers without incurring the accounting and regulatory workload tied to ordinary bank accounts. This creates an opportunity for corporates to use virtual accounts on a large scale for collections. Specifically, we see two models: replacing real bank accounts of subsidiaries with virtual accounts or creating virtual bank accounts on a per customer basis.”

Corporates have focused on reducing their number of bank accounts for years and now you propose to open new virtual accounts per subsidiary or even per customer. Where do you see the biggest benefits of such a structure and what are the main requirements?

“Difficulties in automating reconciliation processes are pronounced in the case of emerging markets and that is also where virtual accounts have existed for a while – although mainly on a domestic scale. The use of standardized payment formats and account numbers (i.e. SEPA, IBAN) has created an efficient scale for this new structure in Europe. Leading banks take up virtual accounts as a competitive differentiator within the commoditized cash management industry. Large corporates have already invested in treasury technology to virtualize internal transfers within an in-house bank structure. Hence, the market is ready now and the constant drive to innovation in cash management has triggered the first virtual account structures in Europe.

A payment factory with payments-on-behalf-of (POBO) facilitates the centralization of the underlying bank account structure for outgoing flows, while the payment and reconciliation process can remain decentralized. Virtual accounts can basically facilitate a similar structure for collections-on-behalf-of (COBO).

When replacing real accounts with virtual accounts per subsidiary, corporates accelerate the incoming side of the internal financial supply chain by pooling cash instantly and reducing costs associated with holding local bank accounts. In the age of integrated treasury technology and big data, the mere amount of data to process centrally is no longer a roadblock when it comes to centralizing cash and streamlining collection processes.

An application of virtual accounts on a per customer basis could require thousands of virtual accounts, yet it can enable an unprecedented automation of the AR reconciliation process. Quicker AR reconciliation also frees up customer credit limits which in turn enhances sales potential.

Receiving cash on a treasury bank account that legally belongs to a subsidiary creates a COBO structure. The ERP/TMS needs to support this architecture, which has to filter the incoming treasury bank account statement according to the virtual account identifiers and credit the respective in-house bank accounts. The implementation also requires a communication plan towards customers for them to update the supplier bank account number at their end.”

What steps should corporate treasury managers take?

“Treasury managers have taken a leading role in payment factory projects which often resulted in closer ties between treasury and AP departments. I see now a similar opportunity for treasury managers when it comes to collections and closer interaction between treasury and AR in the future. To investigate the benefits of a virtual account structure, they could start off with an assessment of the current cash management structure and AR processes. Define a scope (currencies, countries) of your ideal virtual accounts structure and define different application models (i.e. per subsidiary, or per customer) and determine the impact on the technology side.

Conduct a financial business case for the virtual accounts set up in different models and scenarios. Then conduct a bank RFP process on the defined scope to select your banking partner for virtual accounts. Decision factors include local capabilities of banks, intraday visibility, virtual IBAN management, pricing model, and more. Finally, the implementation of virtual accounts will also be a treasury technology project. We are ready to support your organization to make the most out of virtual accounts, from the initial assessment and business case up to the implementation in your treasury technology landscape.”