How FedNow will Disrupt Vendor Payments

In Accounts Payable, the importance of vendor payment methods often goes unnoticed despite their substantial influence on the overall cash flow, efficiency of the AP team, and profit margins. The US Federal Reserve's new payment rail FedNow can shake up the landscape, offering significant time and cost savings. In this blog post, we delve into how FedNow could impact businesses and their vendor payment practices.

Over time, business payments have evolved from ACH to wire transfers and credit cards, culminating in the emergence of FedNow. Companies still rely on traditional paper checks to pay vendors, which means they grapple with various challenges, such as manual processes, difficulty tracking payments, and high check-related fees.

Unlike the drawn-out process of paper checks, digital payment methods offer simplicity, with funds directly deposited into vendor's bank accounts – a convenience vendors appreciate. The preference for online payments has surged, accelerated by the COVID-19 pandemic, prompting vendors to opt for digital transactions. Depending on your business's unique circumstances, you now have options like ACH, virtual cards, and tailored online methods for vendor payments.

However, these modern payment options require trade-offs between speed and costs. ACH is economical but slow, wire transfers are quicker but costly, and credit cards, though convenient, come with extended settlement times and high fees. FedNow presents a potential solution that combines speed and cost-effectiveness, providing an alternative worth considering for your vendor payment needs.

What is FedNow?

FedNow, by the Federal Reserve, is a versatile payment rail catering to individual users and businesses. FedNow operates as a transaction-level payment system with the unique ability to ensure instantaneous settlement, accessible 24/7 throughout the year. These are bank-to-bank transfers similar to ACH or wire transfers.

The absence of immediate bank payment options has spurred the proliferation of various digital wallets like Venmo. The US must catch up in adopting real-time payment systems and notably needs to secure a place within the top 10 nations. However, with the emergence of FedNow, the United States has a pivotal opportunity to propel itself toward embracing real-time payments and their myriad of advantages.

This payment rail is an integrative solution that banks and various applications can incorporate into their systems. The standout feature is immediate & irreversible transaction settlement, a notable departure from the conventional pacing of ACH and other comparable services. Once your financial institution or service provider integrates this solution, the process remains seamlessly user-friendly, requiring no specialized procedures akin to the user side.

"The Federal Reserve built the FedNow Service to help make everyday payments over the coming years faster and more convenient," said Federal Reserve Chair Jerome Powell.

FedNow For Businesses:

It significantly impacts your Accounts Payable process due to speed, low cost & ready availability. Let's look at some of the key benefits:

Enhancing Treasury Management: FedNow offers deterministic instant payments. This provides a strategic advantage for treasury management, affording extended windows to maximize interest earnings, all while sidestepping the risk of late fees. Furthermore, a deterministic window can allow for more effective treasury management.

Bid Farewell to Late Fees: Late payment fines vary based on industry, vendor relationship, and business size. Startups, in particular, are vulnerable to hefty late fees. Conversely, timely payments may open doors to early payment discounts, contributing positively to your bottom line.

Real-time Sync Empowerment: FedNow's transaction-level granularity means each transaction is recorded. API-generated payment receipts integrate seamlessly with services like Quickbooks, ensuring real-time synchronization. As transactions are irrevocable, the need for vendor confirmation is eliminated, simplifying and hastening the reconciliation process within your system.

24x7x365: ACH and Wire Transfers, integral as they are, suffer a notable limitation – they remain inaccessible on weekends and holidays, effectively rendering them unavailable for approximately one-third of the year. This restriction presents a significant advantage for enterprises operating within time-sensitive domains, such as logistics, which necessitate continuous financial operations. Even in financial services, circumventing the Monday rush can yield substantial benefits.

Strengthened Vendor Relationships: Timely or accelerated payments cultivate robust vendor relationships, creating opportunities for more favorable negotiation terms and better deals.

Seamless Requests for Payments (RFP): Vendors can now submit precise bill requests, streamlining the validation and approval process with a simple click. This feature optimizes accuracy and expedites the payment process.

Empowering Intra-day Credit: FedNow extends intraday credit of up to $500K for sound depositors, with the potential for future credit limit enhancements. This unique facet facilitates easy access to credit for businesses without the burden of concealed credit card fees.

Effect on Accounts Payable KPIs

Incorporating a data-driven perspective is crucial when analyzing the potential effects of adopting FedNow. As we explore this, it becomes evident that assessing what key performance indicators (KPIs) would be affected is essential.

1. Days Payable Outstanding:  All AP teams must balance paying off invoices and keeping enough cash in the business. FedNow enables payments to be executed before the stipulated deadline, aligning with vendor agreements. Generally, you must account for a few days to process the amount and keep buffer time. With FedNow, you can be remarkably close to theoretical cash flow efficiency.
   
2. Invoice Processing Cost: The American Productivity & Quality Center (APQC) reveals that top-performing enterprises expend $1.42 per invoice during processing. Comparatively, ACH payments span a cost spectrum from $0.15 to $1.5. FedNow, with its flat fee of $0.045, offers a cost-efficient alternative. Businesses that traditionally employ credit card payments can benefit more substantially from this shift.
   
3. Invoices processed per employee: The time saved through expedited payment cycles empowers AP teams to process more invoices within each cycle. The flexibility to execute payments at any juncture obviates the need for waiting to batch-approve invoices, expediting the entire process.
   
4. Straight-through processing: An efficient Accounts Payable process hinges on a high STP rate. FedNow's transaction-focused approach simplifies payment and reconciliation automation, bolstering the efficiency of your operations.
   
5. Payment Error Rate: In payment errors, duplicate payments are a persistent concern. FedNow's transaction-level recording reduces this error significantly. However, with irreversible transactions, there exists a risk of amplified losses stemming from mistakes. 

Limitations of FedNow:

With its launch in July 2023, FedNow has entered its initial experimental phase, marking a significant milestone in the evolution of real-time payment systems. However, as with any new technology, there are limitations that shape its current availability and functionalities. This segment delves into the primary constraints currently defining FedNow's operational landscape.

1. Local: The system is currently being introduced in specific US cities and isn't available for global money transfers. However, there are plans for potential future expansion to broader geographical areas.
   
2. Irreversible Transactions: FedNow transactions are irreversible; this requires high accuracy and a low margin of error.
   
3. Transaction Limit: ACH transfers' default transaction limit is $100,000. Financial institutions can increase this limit to $500,000. These limits are relevant, especially during the early phases of implementing this new payment system.

Conclusion

In conclusion, the advent of FedNow marks a pivotal shift in the US payments landscape, ushering in real-time transactions and addressing existing limitations. This enhances operational efficiency for businesses that operate around the clock and positions the US to compete globally in real-time payments. With FedNow's introduction, AP teams can manage time and save costs through better cash flow management, automation, instant settlement, and low fees.