Bank account structure is a key aspect of treasury management but it is also one of the most complex to understand and implement for a treasurer. There are a range of options and trade-offs that a treasurer must consider; a corporate can establish a one-to-one account-to-business unit (BU) account structure at one extreme, or have only one account for the entire group at the other extreme. It is highly important for treasurers to also consider the legal and regulatory environment in which the corporation is operating, but let’s assume minimal regulations in this discussion.
Having a one-to-one account-to-BU account structure simplifies operations and accounting. Each BU can be given control and authority over its own bank accounts and each BU’s cash flows can be reconciled easily by analyzing the designated account’s cash flows. The trade-off is paying a lot of bank fees and having cash inefficiently spread out over numerous accounts not earning any interest.
Having one account for the entire corporate group minimizes fees and maximizes cash visibility. The treasurer can see the corporate’s day-to-day cash position and liquidity by looking at one account’s closing balance and make decisions on short-term investment/borrowing easily. The trade-off is reconciling co-mingled cash flows and setting up a control framework for numerous BUs using one bank account.
Given the two extremes, the reality is that most corporates choose a hybrid structure that lies somewhere in the middle. Services such as physical cash sweeps and notional cash pooling have allowed corporates to achieve optimal account structures that minimize fees while allowing efficiencies in accounting and control. Today, we explore a relatively new possibility that expands the efficiency frontier and allow treasurers to have the best of both worlds. We will discuss the concept of virtual accounts, also referred to as “shadow accounts,” and virtual account management (VAM).
Virtual accounts are cash management solutions offered by various banks. Just like setting up a physical cash pool and automatic sweeps, setting up a virtual account structure must also be done by speaking to your relationship manager and carrying out a project to implement a virtual account structure.
From a corporate’s perspective, virtual accounts are similar to physical accounts in that each virtual account has a unique account number. This account number can be used to pay vendors and collect from customers. A corporate can open numerous virtual accounts, establishing an account structure that facilitates easy reconciliation and financial accounting. Unlike physical accounts, virtual accounts must be associated with a physical account that is the actual settlement account for all cash flows. Transactions made/received on the virtual accounts can also be thought of as payment on behalf of (POBO) and receipt on behalf of (ROBO) made on the associated physical account.
From the bank’s perspective, virtual accounts are accounting sub-ledgers kept for the purpose of segregating cash flows. When a transaction is made, the transaction is recorded to the sub-ledger but the cash is still settled through the physical account.
Virtual accounts in practice
To illustrate how virtual accounts are being used in real life, let’s imagine that XYZ Corporation holds one physical account (Acct No. 12345678) and 100 virtual accounts with ABC Bank. The 100 virtual accounts are all associated with physical account 12345678. XYZ Corporation also has 50 operating entities under its corporation group that incurs both AR and AP.
XYZ Corporation assigns two virtual accounts to each operating entity for the purposes of AR and AP. For example, virtual account 12345678011 is used to collect funds from customers of Operating Entity 1 and virtual account 12345678012 is used to pay invoices of Operating Entity 1. On a day-to-day basis, the treasurer can make investment and funding decisions based on the balance of account 12345678 – investing excess cash when total AR exceeds AP and acquiring funding when AP needs exceed AR. During month-end bank reconciliation, the AR and AP for Operating Entity 1 is reconciled against the transactions on account 12345678011 and 12345678012 respectively and any unreconciled items can be identified easily.
Benefits of virtual accounts in account structure
Cost savings: In many banking relationships, establishing a virtual account structure allows corporates to maintain the same accounting records at much lower banking fees when compared to having the same structure with physical accounts.
Higher return on working capital: Having fewer physical accounts means the corporation’s cash position can be easily observed. This allows treasurers to make more efficient investment and funding decisions, ultimately increasing the return on working capital.
Simplified reconciliation and accounting: As transactions are reported by virtual account, accounting is able to easily perform bank reconciliation and identify outstanding transactions for follow-up.