In today’s highly globalized world, businesses and even governments need a fast and simple way to transmit payments to one another. What is the solution? The answer is financial EDI.
Financial EDI is the seamless transmission of payments, which not only fuel the global economy but allow governments to collect and distribute tax money as well. Read on to learn about what financial EDI is, how it works, how it came into existence, how it streamlines financial processes, and what factors will make financial EDI an even bigger part of the payment technology landscape.
What Is Financial EDI?
Electronic data interchange involves the electronic transfer of information in a standardized, machine-readable format. Similarly, financial EDI is the electronic transfer of payments, payment-related information, or other financial documents in a standardized, machine-readable format.
Businesses use financial EDI to transmit payments to one another. However, governments rely upon financial EDI to transfer tax payments. Financial EDI powers today’s globalized economy; without it, transferring payments on a massive scale would be slow and labor-intensive.
How Does Financial EDI Work?
To send a payment through financial EDI, there are a few steps that a company or institution undertakes.
The buyer electronically extracts payment information from the organization’s accounts payable system. That data is formatted into an EDI standard. Then, the transaction set is transmitted to the organization’s bank.
Next, the bank formats that information into the format necessary for its transmission through the Automated Clearing House (ACH) Network as an ACH transaction. The ACH network delivers the payment and its associated data to the seller’s bank, with the bank crediting the seller. It automatically transmits the payment information to the seller’s accounts receivable system, where the seller can see the funds have been posted.
The Evolution of Financial EDI
Financial EDI stems from the development of electronic data interchange. EDI owes its existence to Edward A. Guilbert, who served as a logistics officer in the US Army in World War II.
Guilbert was tasked with standardizing manifests during the Berlin Airlift. Almost 300,000 flights delivered vital goods throughout the operation. After the war, Guilbert took his logistics expertise to DuPont, where he developed the first electronic standardized messages.
The precursor to EDI was implemented in the transportation industry, which was badly in need of technology to automate communication. By the late 1960s, electronic messaging within the transportation industry had gained widespread popularity. However, the variations in formats caused confusion, helping to establish the Transportation Data Coordinating Committee (TDCC).
Guilbert served as president of the committee, which created the standards that would become ANSI X12 and modern EDI. Eventually, the standards TDCC developed spread to other industries, and around this time, the banking sector took an interest. By 1981, standards for the banking industry were published, allowing financial institutions to take advantage of the fast and efficient method of transmitting information (and payments).
How Does Financial EDI Streamline Processes?
The financial services industry is no stranger to complexity. Banks provide a wide array of services to their clients, and their clients are quite diverse. Retail and commercial clients have divergent needs, too. Clients, services, and processes generate a great deal of information. How do financial services organizations cope with the enormous flow?
Before financial EDI, the financial services industry relied upon paper processes. The problem with paper processes is that they are labor-intensive, error-prone, and downright efficient.
Financial EDI automates many of the processes in the financial services industry. Thanks to financial EDI, organizations can electronically receive an invoice and initiate a payment. For major companies, that ability saves time, paper, and money, both for the buyer and the seller.
Aside from saving time, paper, and money, automation enables companies to get paid faster. It takes less time to get paid electronically than it does by check. As a result, companies can optimize their cash conversion cycles.
Additionally, financial EDI provides a lower-cost alternative to paper-based payment methods. It can be expensive to process checks because of the need for human intervention. Financial EDI requires minimal human intervention. As you know, to err is human. Those errors are expensive, and by eliminating the need for human intervention, companies save money.
Real-Life Examples of How Financial EDI Streamlines Processes
The section above illustrates how financial EDI streamlines processes. However, without real-life examples, understanding how financial EDI benefits companies and organizations can be a bit hard to imagine. Below, we provide some common examples of financial EDI transaction codes:
- EDI 139 - Student Loan Guarantee Result. Loan guarantee agencies use EDI 139 to inform a lender or school about the status of a loan guarantee.
- EDI 144 - Student Loan Transfer and Status Verification. Lenders and guarantors use this transaction to send or receive information about transferring student loan ownership.
- EDI 154 - Secured Interest Filing. If you have to file Uniform Commercial Code (UCC) financing statement forms, liens, judgments and other statements of secured interest, or exchange secured interest filing information, this is the code you use. As the UCC applies across the US, this is a very common transaction.
- EDI 812 - Credit/Debit Adjustment. Instead of sending a credit or debit memo, EDI 812 serves as a multi-directional notification to trading partners to let them know about adjustments and/or billbacks.
- EDI 820 - Payment Order/Remittance Advice. This transaction has two purposes: the first is to alert trading partners of an intent to pay an invoice, and the second is to order a financial institution to pay a seller.
- EDI 821 - Financial Information Reporting. EDI 821 reports balances, detail and summary financial transactions, and other related financial account information.
- EDI 823 - Lockbox. This transaction is the electronic version of a paper lockbox; it transmits incoming payment information and totals from a bank or any other lockbox service provider to a lockbox owner.
- EDI 827 - Financial Return Notice. Sometimes, a transaction cannot be processed by the originating financial institution. EDI 827 tells the originator that an 820 transaction cannot go through.
- EDI 828 - Debit Authorization. Payers use EDI 828 to provide information to a financial institution regarding authorized debits and it is often utilized in conjunction with ACH and/or EFT payments.
- EDI 829 - Payment Cancellation. A payer will use EDI 829 to cancel a previously authorized electronic payment from a financial institution prior to funds being released.
Why Will Financial EDI Become Even More Popular?
There are a few factors driving the adoption of financial EDI. They are:
- Healthcare payment requirements
- Increased B2B payments needed
- International payment regulations
- Governmental tax payment regulations
Healthcare payments are one set of payments driving the adoption of financial EDI. HIPAA mandates the use of EDI in the healthcare industry so that processes are more efficient. There are financial EDI transaction codes designed specifically for the healthcare industry: 835 for submitting payments, 820 for payroll deductions; NCPDP Telecommunications Standard version 5.1 for transmitting retail pharmacy claims; and 837 for submitting claim information.
Another factor is the increased business-to-business payments required. International trade is a fact of life; your suppliers are most likely no longer located on the same continent as you are anymore. Being able to pay, and to receive payments quickly, is crucial.
International regulations will drive increased financial EDI adoption, too. NACHA, the electronic payment association, requires payment gateway operators to submit remittance data for payments, making financial EDI a necessity. Financial EDI makes that possible, as information is transmitted seamlessly and quickly to those who need it.
Taxes are one of the certainties in life, and governments need a fast and efficient way to collect them, which is where financial EDI comes into play. The IRS uses the Electronic Federal Tax Payment System (EFTPS), a secure government web site that allows users to make federal tax payments electronically. Electronic tax payment on such a massive scale requires a fast and easy way to process those remittances.
The federal government is not the only one who needs financial EDI for taxes; individual states levy taxes, too. Financial EDI allows them to quickly process (and pocket) those payments, so tax money can be allocated for vital programming.
More and more companies and governments are using financial EDI to transmit payments, and for good reason. They understand that it is the best way to complete those processes because it automates payment transmission, so payments are received on time and all the information is correct. Want to learn more about what financial EDI can do for your organization? Calculate your cost by downloading our free EDI Calculator to see how much you can save.