While senior financial executives are charged with squeezing even the smallest inefficiencies out of routine business processes, few have explored perhaps the final frontier in supply chain management -- the payment.
There is no single answer to the question, "How should I pay?" An important place to start is learning about the fundamental economics and benefits of each type of payment. Your mission is to achieve an optimum mix of electronic and paper payments.
The first rule of your payment strategy should be, "Think cards first."
The hard cost facts
Each payment option -- paper checks, ACH, credit card or wire -- has benefits as well as restrictions. Paper checks remain the reigning champion of payments when it comes to business-to-business transactions.
Annual business-to-business spending totals more than $7.8 trillion, as reported by Tower Group Commercial Payment Cards in the U.S. Product Overview December 2001, with 86 percent of those transactions paid by check, according to a survey by the Electronic Payments Network.
Yet, the days of paper checks as the dominant payment type may be numbered. Check 21, a law that became effective late in 2004, promotes the future electronic exchange of check images as part of the check-clearing process in order to reduce the distance that paper checks must be physically transported.
Many businesses previously benefited from the float, or lapse in time, between issuing the check and having the funds debited from their accounts. The reduction in this float benefit is expected to reduce the reliance of businesses on checks.
Those still clinging to this payment type may find increasing costs charged by their financial institutions to process the paper.
When Automated Clearing House (ACH) payments are combined with information or data within an electronic data interchange, there is significant value, especially when used to process invoice and payment information with your strategic trade partners. Of course, ACH is relatively inexpensive when used on its own, but you diminish your float benefit as ACH transactions typically settle within two days.
Wire is more costly but is the best payment tool to guarantee and expedite payments.
Purchasing cards are the fastest-growing payment tool in the marketplace. Card acceptance has become more widespread, and cards are used to purchase almost everything a business needs -- from office supplies and hardware to customer entertainment.
Cards allow you to make just one payment to the bank each month to cover all of your card transactions made with individual vendors. Cards can reduce soft costs of about $5 to $15 per invoice in accounts payable personnel and monthly check writing activity.
Most important, purchasing cards are one of the few cash management tools that can generate income for you through a revenue share program. Your revenue potential is based on the total volume spent on your purchasing cards.
Other factors that might impact your payment choice should be discussed with your financial adviser. Based on the costs and benefits of each payment type, a complete overhaul of your payables may be in order.
Remember to think card first, ACH second. Many businesses that are finally on board with purchasing cards are wondering why they hadn't done it sooner.
Joe Meterchick is senior vice president for corporate banking in Philadelphia at PNC Bank, National Association, member of The PNC Financial Services Group Inc. Reach him at (215) 585-6810.
This was prepared for general information purposes only and is not intended as specific advice or recommendations. Any reliance upon this information is solely and exclusively at your own risk.
- Senior debt vs. junior debt. Senior debt is debt that has priority of repayment in a liquidation, and, therefore, is usually lent at more competitive interest rates than junior debt.
Typically, 50 percent to 70 percent of a mid-sized company’s capital structure is senior debt. It can be extended on a secured or unsecured basis and may or may not carry the guarantee of the owner(s). Junior debt is either unsecured or has a lower priority or repayment on the same asset or property as senior debt.
- Cash flow lending. Cash flow lending, a form of senior debt, is typically extended to companies that generate significant cash from operations each year, but may not possess a great deal of balance sheet assets, such as a service company.
The leveraged buyouts of the past have set the stage for this type of lending, where financial institutions may extend credit based on a multiple of a firm’s cash flow. For these purposes, cash flow is typically defined as the borrower’s earnings before interest, taxes, depreciation and amortization (EBITDA).
- Asset-based lending. Asset-based lending, another form of senior debt, is a good choice for highly leveraged/undercapitalized companies, companies with seasonal revenue, or businesses that generate more working capital and assets than cash flow.
Many are surprised by the interest rates that are competitive with traditional business loans. Because this type of lending is based primarily on a company’s short-term assets, lenders can extend credit to businesses with higher-risk profiles.
- Second-lien loans. Second-lien loans have emerged as a mainstream solution for growing companies needing liquidity. Favorable pricing, an active mergers and acquisition market and increased use of recapitalizations have fueled this increase. These loans are junior in collateral rights and have higher interest rates.
Companies use this option to bridge the financing gap between cash flow and equity, particularly following a merger, acquisition or recapitalization. Second- lien borrowing is also a way to monetize your investment in your company during strong economic times by cashing out, replacing equity or refinancing subordinate debt through a recapitalization.
- Mezzanine loans. Used to finance a company’s expansion, an acquisition, a dividend payment or stock repurchase, a mezzanine loan typically is unsecured and considered junior debt with a longer payment term than other loans. Mezzanine loans are characterized by quick turnaround with minimal due diligence and little or no collateral. These loans are priced with the lender seeking an 18 percent to 22 percent return on its investment.
A typical structure would be a six-year loan with no principal payments until the maturity date, an interest rate of 12 percent and an equity interest to potentially yield the returns cited above.
- Equity investments. Instead of a loan, you can raise money by selling common or preferred stock to individual investors. In return for this equity investment, your investors receive ownership interests in your business, such as shared profits, a seat on the board of directors and input into how your company operates.
To help you decide what financing best meets your needs, it is important to work with a lender who is willing to take the time to understand your business and has access to and experience in all available options. No matter which options you choose, working with a trusted business adviser can provide ideas, advice and solutions that can help your business achieve its goals.
This summary is not legal or financial advice, and does not purport to be comprehensive. Please consult your own adviser. Any reliance upon this information is solely and exclusively at your own risk.
Joe Meterchick is senior vice president for corporate banking in Philadelphia for PNC Bank, National Association, member of The PNC Financial Services Group Inc. Reach him at (215) 585-6810.