In most companies, the accounts payable team is responsible for sending payments to suppliers, customers, and other business partners. In front of the AP team, the accounts receivable team is responsible for collecting outstanding payments from customers and business partners. These transactions (both incoming and outgoing payments) determine whether or not a business will continue to operate. If an organization cannot make payments, suppliers will stop working with it; If an organization is unable to collect payments, its cash reserves will be put at risk, along with overall profitability.
Because these teams can fall into silos, many companies miss out on net payments. At its core, a net payment is a way to simplify the number of transactions between your organization and a third-party business partner of some kind. It could be a supplier, a lender, or even a utility company.
If you can nail down a clearing process that works for you and the entities you do business with, you will see monetary savings and a reduction in processing times, and your AP team will operate as efficiently as possible.
What is compensation?
If you’re wondering, “What is compensation?” You’re not alone. By definition, netting is the act of combining multiple financial obligations between two or more parties and paying a net settlement amount. Clearing in finance can work in different ways, but regardless of the clearing process used, the goal is to reduce financial risks for all parties involved.
The trade-off becomes incredibly clear when broken down into a simple example:
- Let’s say you borrow $20 from a friend to buy a t-shirt because you forgot your wallet at home. The next day, when you have your wallet, you offer to buy your friend’s $30 dinner.
- If you didn’t know about net payments, you can send your friend $20 to pay for their shirt, while they pay you $30 to pay for dinner.
- However, with a quick clearing process in place, you can easily determine that if you offset the $30 they owe you with the $20 you owe them, you can sell them $10 and everything will even out.
The example above is how a net payout is represented in our everyday lives, but it works the same way between businesses. If a supplier charges your company $100 for one line item, but you charge them $50 for a different line item, your AP team can work with your AP team to offset those payments, resulting in a single payment of $50 from your organization to theirs. Ultimately, all debts are settled, but with fewer steps.
Network types
There are several ways that companies can perform netting in finance, but the main methods are liquidation netting, liquidation netting, novation netting, and multilateral netting. Different business scenarios will require a specific clearing process. Here’s how to think about each of the 4 net pay strategies:
Closing network
In most cases, liquidation compensation is not ideal for any of the parties involved. When a company defaults on debts it owes to another entity, meaning it is unable to pay principal or interest in accordance with the agreed payment schedule, the next step is liquidation compensation. In this clearing process, all debts between both entities are offset, creating a single payment amount for one company to pay the other. Once this route is chosen, all previous contracts are voided and the remaining balance is paid.
Liquidation compensation
A very common clearing process is liquidation clearing. By clearing in finance, your accounts payable team can see all income and outflows. bills have with a specific supplier or business. By clearing payments together, when it comes time to pay these bills, it can be done with a single payment instead of multiple payments back and forth from each organization.
If, after clearing payments, you are the organization with an outstanding balance, your AP team will send a wire transfer or physical check for the full balance. If you are the organization with a smaller balance, the other company will send you a lump sum payment for the remaining amount owed to you.
Compensation for novation
Novation compensation is not that different from liquidation compensation, but there are some key variations that make both compensation payment methods important. When clearing by novation, all outstanding invoices between two parties are canceled and replaced with a new single invoice for the final amount due. This is commonly used in currency transactions; Clearing invoices that share currencies can simplify both the audit trail and the payment process.
Multilateral compensation
If your AP team is clearing payments between more than two parties, multilateral clearing can be used. Multilateral clearing is the most complex method used to clear payments and often requires a central exchange or cutting-edge software solution to execute correctly. This clearing process brings together all debts that exist between three or more entities, offsets the amounts owed, and invokes a simple payment process. Multilateral clearing can also be used in complex companies that may have transactions between their own subsidiaries or business entities.
How the compensation process works
Once the answer to “What is compensation?” It is clear, the compensation process must be thought through carefully. It is important to consider the whole invoice approval process and finalizing supplier payment by solidifying the clearing process.
At a high level, the clearing process will look like this:
- Invoices are sent between both parties involved in the clearing process. Your accounting team will send invoices to the supplier or business partner, and they send invoices to your AP team when managing goods or services.
- Your organization and the company you will clear payments with must review and approve all invoices before clearing takes place. It’s important not to skip the invoice approval process because you could end up overpaying if a duplicate invoice is accidentally sent.
- Once both parties approve all invoices involved, a clearinghouse or AP software can aggregate the amounts and produce a final payment amount.
- Once the final debt is calculated, your AP team will send a payment to the other entity, or your AP team settle the balance. This could change from month to month, depending on which company has the most debt at the end of the clearing process.
Once you become familiar with completing a compensation payment, the compensation process becomes a simple component of the AP team’s monthly cycle. Payment clearing is a great way to optimize the functionality of your accounts payable team, but the benefits don’t end there.
Compensation benefits
Net payments should be a consistent part of your monthly financial cycle. Financial compensation comes with many benefits for you and the companies you regularly work with, including:
Conflict resolution
By comparing invoices on the AP and AR sides of your business, financial clearing can make it easier to resolve disputes between you and your preferred suppliers. Software programs like Nanonets automatically match incoming and outgoing invoices to a single supplier, netting you a net amount, and making it easy to find a solution that works for everyone.
Reduced financial risk
By centralizing financial transactions, they are easier to track and have less risk of getting caught up in the invoice approval flow. This means you and your suppliers will receive your payments faster, avoiding potential late payment fees or breaches of contract.
Error management
If an accounting error is made, for example, the incorrect payment amount is submitted for an invoice, it is more difficult to examine multiple invoices and payments rather than identify a larger payment made to a supplier. Clearing payments makes it easier to highlight a discrepancy and rectify it.
Simplified reconciliation
The month-end closing process is difficult enough for finance and accounting teams. By using a net pay solution, it is easier to complete account reconciliations and monthly reporting processes.
Optimized cash flow processes
Cash flow management is one of the most complex financial processes. Finding any way to simplify it can help save your finance team time and increase their overall productivity. With fewer cash transactions (on the payments or AR side), it is easier to manage cash flow.
<h2 id="simplify-netting-with-technology“>Simplify compensation with technology
If a compensation payment had to be finalized by hand every time, the work may not be worth it. However, with the use of technology and software solutions Like Nanonets, cleared payments are simple, fast and accurate. These tools can compare invoices between multiple suppliers within a given period, net the total amounts, and generate a final payment amount. Once you start using AP technologies to Optimize the supplier payment process, you will see a return on investment almost immediately. Don’t worry, these technologies were created to be easy to use and easy to implement.
Let your AP team lead the way
Accounts payable teams are fund managers; They know the ins and outs of your business and often Play an important role in every business-related transaction. Allow them to finish the process for a net payment; They are the experts. When experts are given the opportunity to design a new and improved process with the help of technology, the process is more likely to be adopted on a large scale.
What is networking, you ask? Make sure the AP team agrees with the response. If you’re not making net payments, here’s your chance to revolutionize the way you manage funds in your business!
