Netting: From Payments to Process Engineering
For most organisations, inefficient internal processes make up the largest cost within cash management. When the netting system is well integrated in the business, the set-up enables clear structures, sophisticated techniques and efficient reporting. All of these areas are cornerstones in the cash positioning process. An individual company’s ability to make forecasts is a key indicator of the quality of their liquidity management. A reliable forecast is important from both an external and internal perspective:
Efficient payment procedures are dependent upon integration. The netting solution is an important component in this integration with connection to different enterprise resource planning (ERP) systems, treasury systems and different electronic banking (ebanking) systems.
Figure 1: A Holistic View of Netting: The Corporate Financial Value Chain
The Corporate Financial Value Chain is a structured methodology used by SEB to improve the customer?s internal processes. The value chain is built upon different customer business processes whereas cash positioning, cash flow forecasting and payments are the most relevant from a netting perspective even though the process touches other processes as well. |
Source: SEB
Netting as a process is very mature and in the past it has been a very profitable technique for minimising transaction costs; however, the focus has now shifted. Today, it is estimated that 40% of the costs saved by netting are from minimising transaction fees, the other 60% is from improved payment discipline and facilitation of other adjacent processes such as reconciliation and dispute handling, which can be realised if the company uses receivable-driven netting. Interestingly, many companies that do netting admit that although the tangible benefits, as outlined above, are significant savings in themselves, it is the intangible benefits of netting, such as improved payment discipline, that constitute the most important benefits.
In 2007 gtnews conducted a survey on cash management, which was answered by 339 readers including 270 companies. According to the findings, the use of inter-company netting as a payment reducing technique was dropping. The gtnews 2009 Cash Management Survey, however, predicts that the use of netting will increase in the coming years, showing that its value is about to be redefined. Netting vendors are aware of this and have adapted to this change. For example, SEB’s netting partner Coprocess has improved its offer by adding modules for matching, dispute handling, reconciliation and payment factory in their new netting system, Coprocess.Netting. Other important trends are:
How beneficial for a company can netting be in terms of savings? The total cost of processing an internal invoice is estimated as up to €50 (which includes issuing, printing, mailing, receiving and attesting). According to SEB’s findings, it can be shown that a well-organised netting will improve internal processes so that the cost can be reduced by approximately 30%, which leads to a saving of about €15 per invoice. For most companies this is a significant saving, particularly for company groups processing millions of internal invoices per month.
A netting process is typically implemented in companies with multiple production sites and sales companies in multiple countries. Such an organisation creates many inter-company invoices that need to be settled cross-border. As mentioned before, netting is one of the most important tools to minimise cash flows and foreign exchange (FX) transactions between the subsidiaries; also, it is evident that cash pools are important tools for minimising currency risk. But the remaining risk needs to be handled by the internal bank. International companies are usually exposed to different kinds of risks: settlement risk, as well as transaction, translation and economic exposure. This article will put focus on transaction risk, translation risk and support to adjacent processes.
By using the netting functionality to a larger extent than just a tool for settling internal invoices, it is possible to make use of netting to enhance cash pooling and forecasting. Without third-party payments, netting is a closed system where the group companies only transfer money to each other through the netting centre. Since the netting is centralised at the netting centre, the settlement process will, by default, trigger payments between accounts located in different countries and create imbalances between cash pools.
To optimise the liquidity process, it is easy to connect many different cash pools to the netting process. By so doing it is possible to make all transfers within each cash pool and there is no need at all for cross border transfers between the pools. With a set-up like this, the money never leaves the cash pool structure, i.e. the money is transferred from treasury’s account in each cash pool and the company is not exposed to bank floats and transfers within the cash pool is often free of charge.
A process where all internal invoices in different currencies can be netted off internally and all external invoices remains will by default lead to balances on currency accounts. Without the netting process it would have been possible for a subsidiary to net off internal income against external costs in the same currency. In this situation the company must handle the currency exposure derived from the external cash flows.
The netting process is a very smooth way to handle this. Subsidiaries can buy and sell all currency in the netting at the same time as the ordinary netting is settled. The group will achieve economies of scale and dramatically reduce the administration since the group’s currency deals will be made only on the netting day and only on one side of the spread. By doing this, the group’s currency accounts can have a balance close to zero at month end, which means that no risk is derived from a currency position and the internal balance sheet will not be exposed to translation risk.
When all the existing balances are cleared in the system, it is easy to take the next step – to link the netting to the short-term forecast. The netting’s ask/offer function (spot deals) can be used as a tool to secure the currency needs until the next netting.
For subsidiaries with incoming funds, it is easy to sell the excess cash in the netting and use it for the internal invoices. If the subsidiary is a net payer in a foreign currency, then the forecast can be used to identify the need for cash in the near future (e.g. the period between two netting dates). The net amount identified is then bought in the netting. By using this functionality, it’s easy to optimise the handling of foreign currencies without building balances on currency accounts.
Another area where netting can be implemented together with other processes is the integration between e-invoicing and netting. A company could net out e-invoices automatically and then electronically create payment instructions to the bank, which increases the straight-through processing (STP) ratio significantly.
As mentioned, we see that netting is facing a shift from a payment reducer to an integrated methodology for improving other adjacent processes such as forecasting, balancing of cash pools, matching, e-invoicing and dispute handling. The trend is that transaction fees are dropping, resulting in that netting will almost be a pure co-process to other treasury processes. We also see that most netting vendors are now moving in this direction, trying to find new competitive advantages for their products.
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