The benefits of a virtual accounts payable card program in a rising rate environment.

How virtual payment card programs work

Organizations that want to pay bills by virtual card must first gain permission from their suppliers. In many cases, supplier enrollment is managed by the financial institution contracted to process the card payments on the organization’s behalf.

Suppliers that agree to participate send their invoices to the organization as usual, expecting payment according to the terms they have negotiated, typically within 30 to 45 days. The organization approves the invoices and provides payment data to its financial institution, which typically sends the supplier an email with a link to a single-use virtual card. The supplier charges the amount owed to the card, and the financial institution immediately pushes those funds into the supplier’s merchant account over the card rails.

In some cases, suppliers may receive an email with the remittance details, alerting them that the funds are being deposited into their account with no action required on their part.

In either instance, the supplier pays a small percentage of the invoice amount (known as interchange) for the benefits of accepting a virtual card payment. In return, the organization making the payment will see a large portion of that interchange credited back from their provider as a “rebate” or “revenue share.” The greater benefit, however, is often the extra time an organization maintains use of the money that will eventually fund these payments.

The length of time the business can hold onto its money depends on the terms the organization negotiates with its financial institution. For example, organizations that contract with a financial technology company for a virtual card program must typically prefund the payments. Because no line of credit is involved, these cards function similarly to debit cards, with no working capital benefit.

Banks that provide virtual card programs have historically offered customers a “Weekly Three” term. That is, a bank requests funds once a week, which an organization then has three days to pay. Those funds are then used to reimburse the bank for invoices it paid during the previous seven-day cycle, enabling an organization to hold and use that cash for a few extra days. The average extension is approximately 6.5 days — half of the cycle plus a grace period.

New extended terms

With rising interest rates, some companies are expressing interest in extending payment terms even further in hopes of maximizing cash flow. Financial institutions like Commerce Bank are responding by offering some customers a 30/15 payment cycle, similar to that of their corporate purchasing cards.

That means a bank pays suppliers via virtual card at the term agreed to between the buyer and supplier, but only requests funds from its customer once every 30 days. The company then has 15 additional days to remit the funds to the bank. In practical terms, that means a business holds onto its cash for an average of 30 days AFTER the vendor has been paid.

With a working capital benefit of 30 days or more, organizations can temporarily repurpose that cash to pay down a line of credit, fund an outside investment or otherwise help the organization generate profit before it must be spent on supplier expenses. The revenue share on card purchases decreases with this credit extension, but based on the cost of working capital, the net benefit of the credit extension will likely make the switch worthwhile.

Weighing the options

Finance professionals have multiple factors to consider as they assess the cost of working capital and compare its impact on their payment options for each supplier.

Consider a supplier, for example, that has a 30-day payment term but offers a 2% discount if an invoice is paid within 10 days. By taking advantage of the early pay discount, an organization saves 2% but also loses 20 days to use those funds, had it chosen to pay on the invoice’s due date instead. Using a virtual card as its payment mechanism, it could hold onto those same funds for 50 more days, which could have a higher net benefit than a 2% discount at 10 days.

A virtual card program’s value can be best measured by reviewing the cumulative impact it creates. For example, an organization with $100 million in annual spending that funds 15% of its expenditures through its card program essentially achieves a 30-day extension of terms on $15 million a year.

If that same organization expanded its virtual card program to capture an additional 5% of spending, it would net a greater revenue share and extended payment terms on $20 million. Achieving a 20% enrollment rate is no small feat. But for banks like Commerce Bank that have a robust enrollment process and a dedicated team that is experienced with leveraging data, it happens every day.