Business-to-Business Payments and the Role of Financial Electronic Data Interchange

By Knudson, Scott; Walton, Jack K., II et al. | Federal Reserve Bulletin, April 1994 | Go to article overview

Business-to-Business Payments and the Role of Financial Electronic Data Interchange


Knudson, Scott, Walton, Jack K., II, Young, Florence M., Federal Reserve Bulletin


Scott E. Knudson, Jack K. Walton II, and Florence M. Young, of the Board's Division of Reserve Bank Operations and Payment Systems, prepared this article.

Over the past three decades, businesses have implemented a vast array of automated systems to improve their productivity. Nevertheless, most continue to bill their customers with paper invoices and to mail their suppliers paper checks with remittance information. Generating and processing these paper documents consumes significant amounts of real resources, such as labor and transportation. The purchasing company must manually enter data from invoices into its automated accounts payable system, track the receipt of supplies, print remittance documents, and issue and mall checks. After receiving payment, the supplier must manually enter payment data into its automated accounts receivable system and deposit the check with its bank for collection.

To collect payment for its customer, the suppliers' bank (the collecting bank) must typically transport the check to the bank on which the purchaser drew it (the payor bank).(1) Collecting banks frequently route checks through intermediaries, such as correspondent banks or Federal Reserve Banks, which ultimately deliver the checks to the payor banks. Thus, the transportation of checks through the collection chain and the repetitive handling of them at each bank in the chain contribute significantly to the cost of processing checks.

Today, electronic data interchange (EDI) permits businesses to replace paper documents with the electronic transmission of a wide variety of business data. Specifically, EDI consists of the electronic transmission of data in standard formats developed by businesses for documents typically exchanged between trading partners, including purchase orders, invoices, shipping notices, payment orders, and remittance advices.

To permit businesses to automate payment processing fully, the banking industry has combined electronic payment formats with EDI formats for remittance data. When electronic transfers of funds and electronic remittance data are combined to make payments, the transactions are called financial electronic data interchange (financial EDI). Using financial EDI to make payments allows businesses to replace the labor-intensive activities associated with issuing, mailing, and collecting checks through the banking system with automated initiation, transmission, and processing of payment instructions. Thus, it eliminates the delays inherent in processing checks. Financial EDI also improves the certainty of the payment flows between corporations' bank accounts because the payee's bank can credit its account on the scheduled payment date and the payor's bank can debit its account on the same day.

Despite the potentially significant benefits of financial EDI to businesses and the banking industry, businesses continue to use traditional methods to make most of their business-to-business payments.

This article examines the ways business-tobusiness payments are made today and describes the methods for making financial EDI payments. It also explores the reasons that businesses have chosen to use various payment instruments, the benefits of financial EDI, and the impediments to its use.

HOW BUSINESS-TO-BUSINESS PAYMENTS ARE MADE

The three principal types of noncash payment instruments currently used for business-to-business payments are checks, large-dollar funds transfers, and automated clearing house (ACH) transfers.

Checks

Checks are debit transfers, that is, payees must collect funds from payors. Funds made available by banks to depositors of checks are provisional and may be reversed if the payor does not have sufficient funds in its account to pay the check when it is received by the payor's bank. In 1993, more than 96 percent of all noncash payments made in the United States were made by paper checks (table 1). …

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