Chapter 8

The Payment System and Financial

Institution Relationships

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 The Cash Flow Timeline

Order
Order Order
Order Sale
Sale Payment
PaymentSent
Sent Cash
Cash
Placed
Placed Received
Received Received
Received
Accounts
Accounts Collection
Collection
<<Inventory
Inventory>> << Receivable
Receivable >> << Float
Float >>

Time
Time==>
==>
Accounts
Accounts Disbursement
Disbursement
<< Payable
Payable >> << Float
Float >>

Invoice
InvoiceReceived
Received Payment
PaymentSent
Sent  2005Cash
Copyright Cash Disbursed
Disbursed
by Thomson Learning, Inc.
 Learning Objectives

 Explain, understand, and calculate float.

 Explain the roles of the two major components of
the payment system.
 Describe the major paper-based and electronic-
based payment systems.
 Understand the ACH and how its fits with the EDI.
 Use an availability schedule.
 Explain the uses of an account analysis statement.

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 Value of Float

 The delay in value transfer from the time a

check is written until it finally is charged to
the payor’s account.
 Value of float is based on differences in
present value based on time delay.

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 U.S. Payment System

 Banking system

 Payment mechanisms

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 Financial Institutions

 Product differences, Exhibit 8.1

 Geographical restrictions
 Safety considerations

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 Federal Reserve System

 Organization, Exhibits 8.2, 8-3

 Fed’s involvement in payment system
 Check clearing

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 Organization, Exhibit 8.2

 Board of Governors
 FOMC
 Federal Advisory Council
 District banks, Figure 8.2
 Member banks

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 Fed’s Involvement

 Circulate new money

 Check processing, 16 billion checks/yr
 Check settlement
 ACH
 FedWire
 Regulate availability schedules

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 Check Clearing

 MICR line, Exhibit 8.5

 Clearing process, Exhibit 8.4

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 MICR Line, Exhibit 8.5

 2 digit Fed Bank Code

 2 digit Fed Office Code
 4 digit ABA Code
 1 digit verification code
 Account number
 Sequence number
 Encoded amount

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 MICR CODE

December
December15,
15,2005
2005

Pay to the
Order of $ xxxxxxxx7.75
Dollars

Chk Sequence # ABA Bank#

Fed Bank Code Check Digit

Fed District Code
Account Number Encoded Field

00003011 101205671 062789392019 000000775

000000775
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 The Clearing Process, Exhibit 8.4

1. Customer 2. Supplier (payee) receives

writes check
sends check check

8. Customer’s 3. Supplier 6. Supplier’s

bank account is deposits account is
debited check credited

7.7.Check
Checkisis Clearing agent: 4. Check
presented
presentedfor
for “on-us”, or Fed, forwarded
payment
paymentto to or correspondent,
customer’s
customer’s or clearinghouse. 5. Supplier’s bank is
bank
bank credited
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 Clearing Mechanisms

 House/On-us checks
 Local items
 Transit items

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 “On-us” Items

 Payee deposits check in the bank on which

it is drawn
 Bank credit depositor’s account
 Bank debits payor’s account

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 Local Items

 Checks may be sent by courier to be

swapped for checks drawn on itself at
another bank
 Checks may be processed through
correspondent bank relationship
 Local clearing house may be used

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 Transit Items

 Direct send
 Correspondent bank
 Fed Reserve

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 Concept of Float

 Types of float

 Components of float

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 Types of Float

 Collection float

 Disbursement float

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 Components of Float

 Mail float
 Processing float
 Clearing float

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 Fed Float

 When the Fed grants the depositing bank credit

according to a preset availability schedule, but is
not always able to present the check to the drawee
bank for payment within the same period.
 Methods used to reduce float
– check truncation
– high-dollar group sort
– inter-district transportation system
– later presentment and deposit deadlines

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 Paper-Based Payments

 Types
 Ledger balance
 Collected balance

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 Types of Paper-based payments

 Checks

 Drafts

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 Ledger Balance

 All credits and debits

 Not all spendable

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 Collected Balance

 Adjusted ledger

 Reg CC (2 and 5 days)

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 Electronic-Based Payments

 Wire transfers
 Automated clearinghouses
 POS debit cards

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 International Payment Systems

 Paper-based systems
– Giro systems
– Value dating
 Electronic payments
– Clearing House Interbank Payment System, CHIPS
– Society for Worldwide Interbank Financial
Telecommunications, SWIFT

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 Managing the Bank Relationship

 Objective:

To ensure that all the company’s banking

services are provided reliably at a
reasonable cost.

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Managing the Bank Relationship

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 Services Provided

 Collections

 Payments

 Information

 Credit

 Investments

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Bank Selection and Relationship
Management

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 Bank Selection

 Location
 Bank/Company Fit
 Service Quality and Breadth
 Bank Creditworthiness
 Bank Specialties
 Price

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 Managing the Relationship

 Account Analysis Statement, Ex 8-14

 Required Compensating Balance Calculation
SC
RCMP = -----------------
ecr
(1-rr)(------)n
365
 Balances vs. Fees
– Bank’s view: Advantages of Balances
– Corp View: Disadvantages of balances

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 Bank’s View: Advantages of
Balances

 Effect of increasing deposits for the bank

 Balances can be lent

 Form a cushion in case of loan default

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 Corp View: Disadvantages of
Balances

 ECR is < investment rate

 Fees are tax deductible

 Fees offer tangible expense that can be monitored

 Fees are generally fixed and thus comparable,

whereas ECR floats

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 Daylight Overdrafts and the
Availability Schedule

 Definition: when a bank’s Federal Reserve

account book balance is negative during the
day

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 Optimizing the Banking Network

 Checklist
– what is bank’s compensation rate and how will it be paid,
fees or balances, etc.?
– if balances, over what time period?
– multiyear agreement available with capped price
increases?
– compare a proforma account analysis statement
– who is the account officer?
– who is the customer service rep?
– how will float be computed?
– what performance guarantees are offered?
– penalties for customer overdrafts?

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 Nonbank Service Providers

 Pepsico’s loan to Marriott

 Almost half of all consumer and business loans

held by nonbank companies

 Third-party vendors of information between banks

and companies

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 Financial System Trends

 Nationwide banking in the US

 Economic unification of Europe
 Both of these will be catalysts for an ongoing drift
toward concentration and globalization in the
banking industry
 Imaging
 Information services
 Banking on the Internet
 International aspects of banking relationships
 Global bank consolidation

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 Summary

 We developed the uniqueness of the US

payment system and its major components.
 We discussed the role the Federal Reserve
plays.
 We discussed the payment system using paper-
based and electronic-based methods.
 We discussed bank selection and relationship
management.
 We concluded with financial system trends.

Copyright  2005 by Thomson Learning, Inc.