The impact of electronification on the balance sheet.

While it's not in the dictionary, the word "electronification" has been used in financial circles for years. With several new and significant payment options available, the following definitions of terms can provide readers with common ground for discussing the impact of electronification on financial statements:

Electronification is the movement or conversion of information and/or funds through electronic means. This includes the following payment types:

Direct Payment includes direct deposit, direct payment and financial electronic data interchange. These use the Automated Clearinghouse (ACH) to settle funds and move payment information.

Truncation: Check21. This allows banks to submit image replacement documents (IRDs) in lieu of checks for clearing.

Conversion. A check is converted to ACH transfers at either the retail counter or at a lockbox, thereby becoming a document used to create the payment.

Thoughtful financial professionals take a broad view when assessing the impact of electronification on their organization. The total impact is significant, as it includes financial, customer and vendor opportunities and process changes. The following focuses on the balance sheet; a future article will highlight the income statement. These are overlapping areas, since improving the balance sheet may also improve the income statement.

Working Capital and Liquidity

Electronification targets a few areas of traditional cash management float (mail, processing and availability), and often indirectly benefits other order-to-receipt float and process components. The dual perspective of the treasurer and controller is required in order to secure optimal balance sheet benefits.

* Float Impacts. Let us call a truce between the warring factions of treasurers and controllers. Treasurers may focus solely on liquidity, while controllers might exclusively view cash from a generally accepted accounting principles (GAAP) reporting perspective. This difference is evident when a paper payment is received in-house. From an accounting perspective, the entry relieves accounts receivable (A/R) and increases cash today. Those funds may not be available for use for three days and are not liquid, according to the treasurer. Balance sheet measures, such as days sales outstanding (DSO), use point-in-time accounting measures, which are easily captured and reported but are not completely sufficient for liquidity planning.

The controller sees no difference between a paper and electronic item received today, while the treasurer notes the differences in liquidity and borrowing costs. Banks use the term "ledger balance" to reflect the accounting and "available balance" to show that all dollars are not equal from an availability perspective. Both must understand the different purposes that their disciplines require, and the limitations of the metrics.

An effective electronification plan estimates and tracks both balance sheet and liquidity impacts, as some types improve either or both measures.

Electronic and paper float components vary and highlight the impact on liquidity and the balance sheet.

* Secondary Float Impacts. Secondary benefits may surprise those who measure them. A $5 billion company tracked DSO by client payment type and discovered that those with whom they did business electronically paid seven days sooner than others. Fewer errors, disputes and overall smoother customer relationships helped streamline the process.

* Benefits Exist on the Order-to-Pay Side. Balance sheet benefits of electronification exist on the order-to-pay side, too. A medium-sized manufacturer automated its payables activity to gain float while still paying suppliers on time. Being decentralized made each area issue payments infrequently, and not wanting to pay late required paying some vendors earlier than necessary.

By electronifying this process, vendors are paid on the exact day the company chooses--neither early nor late. The permanent liquidity gain was $1.25 million, while maintaining vendor relationships and simplifying internal processes.

The notion that "float" is a zero-sum game is derailed when considering corporate accounts payable (A/P) and A/R items. For most businesses, decreasing float in both directions will provide disproportionately positive benefits since the receivable side is larger than the payable side. A company with sales of $500 million and $200 million running though A/P will realize a permanent $1.2 million liquidity improvement for each day of float that disappears.

The effective and proactive use of electronification can have a significant positive impact on financial statements. The balance sheet can experience improvements in working capital and liquidity. The Electronification Readiness & Impact Assessment is the critical first step for organizations wishing to optimize their benefits. Those organizations that create a plan and act now will reap permanent and more significant benefits than those who passively wait.

Craig A. Jeffery is Managing Director of Strategic Treasurer LLC, based in Atlanta. He can be reached at 770.632.5720 or [e-mail].