New Perspectives on Cards
As consumers, we now routinely use payment cards and other types of electronic payment more often than we use checks or cash. But as managers in charge of corporate payments and receipts, many of us continue to depend on the paper check. That was one of the principal findings of the Association of Financial Professionals (AFP) 2004 Electronic Payments Survey. Published in October 2004, this study found that 51 per cent of the corporations surveyed make more than 80 per cent of their business-to-business (B2B) payments by check, while 43 per cent receive more than 80 per cent of B2B payments by check.
If your company is one of the many that continue to rely on checks, you’re certainly aware of the obstacles that impede moving from paper to electronic payments. Lack of integration between accounting and electronic payment systems, a shortage of in-house IT resources, no industry standards for communicating remittance detail, trading partners that can’t send or receive remittance information with electronic payments – these factors are among the biggest roadblocks you may be facing.
For a growing number of corporations, using a commercial card has become one of the best ways to overcome these paper-to-electronic barriers. Not long ago, most of us viewed corporate credit cards as a niche payment vehicle only useful for small-dollar procurement, travel and entertainment, and fleet expenses. Not any more. The AFP survey found that one-third of respondents are already using commercial cards to make payments for capital goods and high-value indirect goods and services. One-quarter reported plans to start using commercial cards in this way within the next two years.
At Bank of America, we’re seeing a virtual reinvention of the commercial card. Our clients are now starting to realize that the commercial card is an electronic payment alternative that can be used cost-effectively and efficiently for a wide range of accounts payable transactions. In this white paper, we take an in-depth look at some of the key issues you should understand if you want to make and/or receive B2B card payments.
Using commercial card for B2B payments delivers significant benefits on both the payments and receipts sides. Here are some of the key reasons why corporations are paying trading partners more often by card:
Low costs and financial incentives for card usage – Making payments by commercial card costs less than making payments by check, ACH, or wire transfer. Corporate credit card accounts don’t incur transaction fees except in the case of cash advances. Since these accounts are non-revolving, there is never any interest expense unless payments are late. Competition for large commercial card accounts is fierce. To attract new card business, issuing financial institutions may waive annual fees and offer rebates based on transaction volume thresholds. Corporate rewards programs are also available and provide financial incentives to stimulate card usage.
Fast implementation – A commercial card program can be implemented quickly and easily. Your business can start taking advantage of electronic payments immediately without re-engineering interfaces between enterprise/accounting and electronic payment systems.
Stronger controls over payments – Since the passage of the Sarbanes-Oxley Act, corporate governance has become a major focus for all US corporations. A commercial card program provides excellent controls over purchasing activities through individual cardholder limits, online statements and statement approvals, and customizable program-level reporting. Restrictions on where cards can be used are easily implemented through merchant category code (MCC) blocks. In addition, more data can be passed with card transactions, which provides your department managers with better information about what has been purchased. Together, these controls bring great transparency and visibility to payments and drive accountability down to the individual cardholder level.
Better accounting, cost allocation, and leverage for discounts – Commercial cards can be coded with general ledger numbers and other internal identifiers so that payment information can be automatically applied to your accounts payable system. Today’s card systems permit highly complex accounting strings to be included in the card transaction information. Because mapping to your chart of accounts can be automated in this way, you’ll be able to allocate costs more accurately. It will also be easier for you to see which vendors you’re doing the most business with and to use this information to negotiate volume discounts.
Improved tax law compliance – A corporation that uses a payment card to purchase services from a vendor is required to file a Form 1099-MISC, which must include the merchant’s name and its taxpayer identification number (TIN). In 2004, the IRS approved the use of MCCs for determining whether a merchant should be considered a 1099 vendor. The IRS also instituted a new rule that allows a qualified payment card agent (QPCA) to verify merchant names and TINs on behalf of cardholders. It is expected that the card associations will offer QPCA services. Visa and MasterCard have already applied for QPCA certification.
The value proposition for receiving commercial card payments is equally compelling. Reasons why corporations want to be paid by commercial card include:
Faster payment – Commercial card payments provide good funds often within 24 hours from the moment the card transaction is initiated, within two days at the most. Compare that with the usual net 30-day terms for payments made by check. Plus there’s no manual deposit preparation, no trips to the bank to make deposits, and no waiting for checks to clear. This represents a huge difference in the time-value of money.
Lower processing costs – Card payments eliminate all the man-hours and expenses associated with handling check deposits. Think about your total costs for check deposit preparation, delivery of deposits to the bank, and deposit reconciliation. The processing fees for merchants accepting commercial card payments are typically in the neighborhood of 2-3 per cent of the payment amount. That compares favorably with early payment discounts you might give to trading partners that pay by check (for example, 2 per cent net 10). But instead of getting a check in the mail in 10 days and then having to make a deposit and wait for the check to clear, a commercial card payment puts good funds in your account in one to two days. (If you need an introduction to pricing for commercial card acceptance, see “Accepting Commercial Card Payments” below.)
Simplified accounting – Merchants that accept commercial card payments can pass three different levels of data about what has been purchased. Level 1 includes only the most basic transaction data: merchant name, total purchase amount, and date. Level 2 adds a customer identifier, such as a purchase order or account number plus sales tax information. Level 3 adds line item detail for each item purchased, including item quantity, item unit of measure, item product descriptions, and item product codes (e.g., UPC or SKU numbers). If you’re a Level 3 merchant, you will probably pull this detail from your enterprise or electronic cash register system directly into your card processing system. If this is the case, when you apply card payment information to update your accounts receivable system, all you need to do is reverse your data flows. That means your receivables matching process for card payments can be highly automated and extremely accurate. In comparison, think about what happens when you have to key in data from the paper remittance advices that accompany your check payments. Beside your labor costs, how often do you run into reconciliation problems because those advices don’t have the internal identifiers you need?
Expanded business opportunities – More and more companies that use supply chain management software to manage the procurement-to-pay cycle are requiring suppliers to accept card payments. This is also true for federal government agencies that want their contractors and vendors to accept purchasing cards such as the GSA SmartPay® card. Commercial card is also the most common payment vehicle for online public and private-sector B2B market places, as well as for the electronic invoice presentment and payment systems corporations are now starting to use. If your company wants to take advantage of this wide range of new business opportunities, you need to accept commercial card.
On the B2B payment and receipts sides, commercial card delivers significant benefits that can produce a classic win-win situation for trading partners. In the following sections of this white paper, we’ll look at the some of the ways your business can derive maximum benefit from moving more of your accounts payable transactions to commercial card.
As consumers, most of us have made telephone or Internet credit card purchases. With these “card-not-present” transactions, you provide your credit card number and card expiration date to a merchant verbally over the phone or by keying this data into a secure website. Corporations are finding that a similar type of commercial card provides a powerful B2B electronic payment alternative for a wide range of accounts payable transactions. The unique feature of this form of card payment is that there is actually no card at all.
How does it work? You set up a “ghost” card account for each of your vendors or trading partners that accept credit card payments. To help you do this, your issuing bank should be able to accept a list of your payees and then tell you which ones are already accepting credit card payments. You can then notify these payees that you wish to make vendor or trade payments via card and send them the card account number and expiration date your payments will be charged to.
Each of your vendor accounts works like your other card accounts except that no plastic is issued, and account credit limits are set to zero by default. When you’re ready to pay an invoice or multiple invoices, you download the payment information from your enterprise or accounting system and transmit it to your bank. Your bank dynamically increases your vendor account credit limit to equal the total payment amount and simultaneously sends your trading partner an email instructing them to initiate payment on your account within a specified timeframe. This email also contains the remittance detail for the invoice or invoices you’re paying. Your payee then initiates the transaction by entering the amount, card number, and expiration date into its card processing system, and the transaction flows through the normal authorization and approval channels. Your payee receives good funds usually within 24 hours.
Benefits to Payers – As a vehicle for making B2B vendor or trade payments, commercial card provides numerous benefits. The service is easy to set up and requires no systems re-engineering. In fact, the file you send to your bank to initiate card payments is very much like the file you would submit for a check run. Card payments are also cost-effective, since there are no transaction fees. Furthermore, because this service lends itself to large-dollar payments, you have the potential to increase spend and earn higher rebates. Another advantage is lower exposure to fraud. There are no cards to be lost or stolen, and there is never any open liability on the vendor account because the credit limit is zero until you initiate a payment.
Benefits to Payees – On the receipts side, accepting card payments means you’ll enjoy the benefits of being paid electronically rather than by check. You’ll have good funds credited to your account usually within 24 hours, as opposed to the typical 30 days or more for a check payment. You’ll also receive your remittance information electronically, so you can eliminate the man-hours, costs, and errors of manually re-keying data from paper advices.
Commercial card for accounts payable represents a brand-new electronic alternative for paying vendors and trading partners and communicating remittance data electronically. But when considering how to optimize your use of commercial card, don’t overlook “traditional” purchasing card, travel and entertainment (T&E), and fleet programs. If your business is not already using these types of programs, take the time to analyze how you’re making payments for those types of expenses and what your costs are. Then talk to your banking partners about the costs for making these types of payments by card. If you already have commercial card programs in place, here are some key ways you can optimize them.
Purchasing Card – To improve your purchasing card program, look at how you’re using your card reporting and program management systems to help you meet expense control, corporate governance, tax compliance, and cost reduction goals. Here are some suggestions:
Multiple-Use Card Programs – If you already have multiple commercial card programs, you may want to look at the benefits of consolidating your programs with a single issuer or transitioning to a single multiple-use card program. Large corporations typically prefer to maintain separate programs for purchasing, T&E, and fleet because of the complexity of their accounting and reporting requirements. Multiple-use card programs are more widely used by middle market companies, which stand to benefit by aggregating transaction volumes and to qualify for rebates.
If your business already accepts commercial cards, you’ll be familiar with the content of this section. However, if your company doesn’t accept cards but wants to, and you need an explanation of how to get started, here’s an introduction to card acceptance.
Issuers, Acquirers, and Merchant Services Processors – Financial institutions that provide card services are divided into two broad categories. Issuers are banks that issue credit cards. Acquirers are banks that accept (or acquire) credit card transactions on behalf of merchants (the term used for any business that receives card payments). To start accepting card payments, you’ll work with an acquiring bank that will provide you with a merchant account and settlement services. You’ll also work with a merchant services processor, which may be your acquiring bank or a third-party provider that works with your acquirer.
Card Acceptance Software and Connectivity – To be set up as a merchant, your acquiring bank will require information about your business, a credit profile, and an estimate of the card transaction volumes you expect. If accepting card payments makes sense for your company based on this information, your acquirer will set up a merchant account for you and help you implement a card processing system. If your company plans to accept a moderate volume of commercial card payments, this system will most likely be a PC-based solution that uses a dial-up connection through an ordinary phone line. If your business will accept both commercial and consumer cards or expects high transaction volumes, you may need to use a DSL, cable, or T-1 line for greater processing speed.
Card Acceptance over the Internet – Once you have a merchant account, you can also be set up to accept online card payments. A simple way to do this is through an Internet Service Provider (ISP) that offers merchant services. If your company has its own website and wants to accept orders and card payments over the Internet, you can set up a more sophisticated online service using a payment gateway provider. A payment gateway will be able to provide you with shopping cart software, hosted order pages, or an application programming interface (API) to order pages you maintain on your own site.
Cardholder Data – When you accept card transactions, you’re responsible for protecting cardholder data on your system and must comply with payment card industry (PCI) data security standards. Your acquiring bank can provide consultative advice on how these standards apply to your business and what you need to do to be compliant. You will also periodically need to update cardholder data stored on your system such as card expiration dates. Some banks offer an automated account updater service to accomplish this.
Level 3 Transaction Data – As previously noted, merchants can be set up to pass three levels of card transaction data. If you plan to accept commercial card payments, you should be set up as a Level 3 merchant. Here’s why. First of all, your trading partners will want you to provide Level 3 line item detail for card purchases they make from you. Second, this line item detail can be uploaded from your enterprise system and passed into your PC-based card system. So when your card payments settle, you’ll be able to use your own internal identifiers to reconcile and update your receivables system. Finally, and most importantly, being a Level 3 merchant will lower your card processing costs. To understand why this is so, let’s look at how merchant services are priced.
Merchant Discount Rates and Interchange – Pricing for merchant services is handled as a merchant discount rate plus a flat per-transaction charge. The so-called discount rate is actually a percentage that your acquirer takes off the payment amount as a fee whenever it settles a card transaction on your behalf. For example, if your discount rate is 2 per cent and you receive a $1,000 card payment, your acquiring bank will take $20 off the top. When the transaction settles, you’ll receive $980 minus the per-transaction charge.
The merchant discount rate reflects your acquirer’s cost for accepting card payments. The principal component of this cost is the interchange fee, which is the fee acquirers pay to issuers whenever the acquirer accepts a transaction charged to the issuer’s card. Interchange fees, which are set by the card associations, are a percentage of the payment amount plus a flat per-transaction charge.
For commercial card, interchange fees are lower for Level 3 merchants than for Level 1 or 2 merchants. This is to encourage merchants to pass line item detail. Large-dollar purchases (roughly above $9,000) receive the lowest interchange rates, although the per-transaction fees are high compared with those for small-dollar purchases. This is to encourage greater use of commercial card for big-ticket items. Merchant discount rates for commercial card reflect these interchange rates.
The Bottom Line – For merchants accepting commercial card, probably the best generalization that can be made about the pricing for merchant services is this. Card acceptance fees are similar to early payment discounts for check payments, both in magnitude and in the way they’re applied. That’s the bottom line. When making your cost-benefit analysis to decide whether to accept card payments, talk to your potential acquiring banks about pricing and then take a really hard look at the time value of receivables you have tied up in checks.
Today, commercial card payments, while rapidly growing, still represent a very small percentage of the total volume of B2B payments. But more and more corporations are realizing how cost-effective and efficient card payments can be. As commercial card moves into the accounts payable mainstream, we believe you can expect numerous enhancements to existing card processing systems. Look for better integration of card reporting with traditional treasury management information reporting. More robust electronic invoice presentment and payment solutions will become available as commercial card usage grows. Imaging solutions that combine the electronic data attached to card transactions with digital images of paper invoices, purchase orders, and requisitions should also further streamline processing flows.
At Bank of America, we anticipate a tremendous increase in commercial card transaction volumes over the next few years, and we believe commercial card has the potential to revolutionize the B2B payments arena. If you’re ready to transform the way your business makes and receives payments, start talking to your banking partners now about the future of commercial card.