Q&A: How to Calculate Earnings Allowance?

When I thought to write Q&A posts I assumed I'd run out of questions to answer but, from outside the field, very few Bankers or Treasurers understand Account Analysis so it has given me more to write about and - hopefully - this space remains informative.

What is required to calculate the Earnings Allowance?

Calculating your Earnings Allowance (EA) requires:

1. A Collected Balance (CB)
2. The Earnings Credit Rate (ECR)
3. The Reserve Requirement (RR)
4. Days in the Period (DP)
5. Days in the Year (DY)

Where, EA = CB * (1-RR) * ECR * (DP/DY)

In some instances where the month itself is unknown so you cannot accurately calculate whether there are 30 days versus 31 days in the period, some calculations use the following:

EA = CB * (1-RR) * ECR/12

Can you calculate EA without a Collected Balance?

Sure, you can but I wouldn't call it an Earnings Allowance.  If the Earnings Allowance relies on a Collected Balance to determine how much that balance has "earned" to offset qualifying bank service fees, then how can you calculate EA without it?  The answer received...

There is no standard!

Umm.  Yes, that is theoretically correct; there is no standard because no one felt they needed to standardize such a thing.   

When there is difficulty figuring out how your bank is calculating the Earning Allowance (or anything for that matter), the best thing to do is to ask the bank to provide you their calculation formula.  Not including a Collected Balance in an Earnings Allowance calculation formula might appear to be a typo at first until you get a response such as, "there is no standard!"  At that point, you may assume the attitude is, "we can do whatever we want and make up calculations because no one has told us we can't."  

Ask questions and ask them often even requiring an explanation for things that just do not compute.  

Happy Analyzing!

Fee vs Balance Compensation

There are two strategies a treasury department can pursue when determining how to pay their bank fees; Fee or Balance Compensation.

Fee-Based Method

With a fee-based method, Treasurers maintain low account balances fully aware that they will not earn much by way of an earnings allowance.  Why this strategy?  The intent with this method is to forgo any potential earnings allowance and instead pay the service fees incurred. Since the ECR of most corporate accounts have been ridiculously low, most can find investments with higher returns than the bank-offered ECR elsewhere.  When considering the earnings potential of excess funds, the fee-based method may be the best strategy.  Outside of investing, paying down high interest debt is also a great alternative for excess funds.

Balance-Based Method

With a balance-based method, Treasurers maintain certain balances in their accounts to earn enough earnings allowance which then offsets qualifying bank service fees.  Why this strategy?  The ECR is not too low compared to other investment options, the balance compensation method covers the service fees incurred, and the company may stand to gain some benefit from the bank by maintaining high account balances.

Company's vs Bank's Perspective

Neither strategy has consistent pros or cons since both depend greatly on the needs of the company at a given time.  Also, there are other issues to consider such as taxes and the liability of accounting for those high bank balances. Above are some reasons why the Fee-Based or Balance-Based Compensation method is used from a Treasurer's perspective; there are also various reasons to consider from a bank's perspective as well. However, since my day job consists of helping companies save on their bank fees, we will ignore the bank's perspective.  But, it is good to know both and understand both sides of each strategy to understand who stands to gain in either and how best to negotiate, if needed.

One German bank in particular recently notified their balance-based compensation corporate account holders that their billing method will be changed to a fee-based method.  The reason cited for the change was the low interest environment and its currently financial impact.  Sometimes, Treasurers make the best decision possible in the interest of their company.  Other times, the decision is made for them.

Happy Analyzing!

Investable Balance (NIF) (7/14)

Account Analysis consists of balances and fees which comprise a basic math calculation. There are 14 balances that I refer to as "Remember the Math". I will discuss all 14 in 14 different posts.

Investable Balance (NIF)

The investable balance is the amount available for the bank to invest after the deduction of any reserve requirement so it's the net investable funds (NIF) available.

Investable Balance is one of the numbers used to calculate/audit the Earnings Allowance sent by the bank on an 822 file.  Some calculations call for the Available Balance * (1-RR), where RR is the Reserve Requirement, but the NIF is already that net value.

Lucky Number 7

In the math thus far, Investable Balance is the 7th balance on the Compensation side of the Account Analysis equation referred to as "Remember The Math":

         Average Positive Collected Balance
 less DDA Balance Reserve Requirement
         Investable Balance (NIF)

Because the Investable Balance may be used to calculate the Earnings Allowance and/or determine the minimum account balance needed to offset service charges it is one of the 14 key balances in Account Analysis.

Happy Analyzing!  

AFP Code or BSID Code

What is the difference between an AFP Code and a BSID Code?

This is a common question from Treasury staff either for their own understanding or to help them explain the difference (or what either one may be) to their Bank Relationship Rep/Manager.

On an EDI 822 file, you will usually see both an AFP and a BSID Code.  I say "usually" because the standard does allow for a bank to send both or only one of the two so long as correct formatting rules are followed.

AFP Service Codes

Formerly called TMA (Treasury Management Association) Service Codes, an AFP Code is a 6 digit code used to categorize and create an apples-to-apples comparison for bank service fees across various banks.  Recently, the AFP developed Global AFP Codes which are 8 digit codes used to categorize and compare international bank services.  Although the 6 digit domestic codes are still in wide use, we have seen some banks send global codes on Account Analysis files.  

For an AFP Code, the first and second pair of digits denotes a classification with the last two digits further classifying the bank service within that group.  Also, the code does allow for undefined services if a bank service does not fit any one category perfectly.  However, shoving too many services into an undefined bucket is counterproductive.  Once you become familiar with AFP Codes, you'll be able to at least identify a service grouping quickly from the first two digits.

An apples-to-apples comparison of one's bank services across different banks is only possible if the AFP Codes are mapped correctly.  For example, if 3 Treasury Analysts are mapping 1 bank service they each may decide on 3 different AFP codes determining on opinion and/or expertise alone.  Mapping of AFP Codes may be more of an art than a science but, when done as accurately as possible, it allows the account holder to analyze their bank service fees by category to determine many different things; level of activity, fee comparison, and/or number of undefined bank services which seem to fall through the cracks for reporting purposes.

BSID Code 

A Bank Service Identification (BSID) Code is an alphanumeric bank proprietary code.  Unlike the AFP, BSID codes are developed and assign to services by each individual bank so it does not offer an apples-to-apples comparison across banks but it does allow you to quickly identify a code when speaking with your bank rep about your bank fees.  

For a BSID Code, it allows the most benefit to track individual bank service fee history overtime and its level of activity.  BSID Codes do not require mapping since this is handled by the bank and sent through on the Account Analysis statement.  What I have found is that the paper statement usually doesn't include the BSID code so they are more likely to appear on an EDI 822 Account Analysis statement.  

Unlike AFP Codes, from the account holders perspective, there is no rhythm or reason to the assignment of BSID codes.  As it relates to an EDI 822 file, BSID codes are supposed to remain static.

How does this relate?

Of course, an AFP code and/or a BSID code may be found on an EDI 822 file.  Both classify bank services into comprehensible groupings to at least one party.  Both assist in the analysis and reporting of bank service fees.  And, both strive to make a bank service easy to identify with the Global AFP Codes opening the door to include international services as well.   It seems no topic is ever too elementary to write about when we all have specialized knowledge in select areas.  

Happy Analyzing!

Q&A: What is an 822 File?

When I thought to write Q&A posts I assumed I'd run out of questions to answer but, from outside the field, very few Bankers or Treasurers understand Account Analysis so it has given me more to write about and - hopefully - this space remains informative.

What is an 822 file?

An 822 file is an EDI (Electronic Data Interchange) transmission of a bank account statement; account balances, service activity, charges, service fees, applicable rates, adjustments, etc.  Also included is basic information such as the bank itself, its routing and transit number, the company/account holder, account names, account numbers, classification of account levels and various service and charge classifications.  The vast majority of bank account holders receive a paper and/or EDI 822 file monthly.

Which financial institutions can produce an 822 file?

Most of the big banks can produce an 822 file and a couple does so very well as far as adhering to the standard format.

A common misconception is that the 822 file shall always match the paper statement.  In theory, the same data should be translated from common layman's terms and dollar amounts found on the paper statement to an EDI format without altering the data itself.  In the event this does not happen, it is likely the EDI language is not understood and/or its format was not followed.

EDI is a terminology/format that is not as common as I'd originally thought.  For example, if they place the word "CREDIT" in any segment on the 822 file it will not read as "CREDIT" in EDI terminology. To communicate successfully, those responsible for the construction of the EDI 822 file must be fluent in the EDI 822 terminology and standard.

Without a good understanding, your file may be called an 822 but it's really just an alphanumeric file with special characters that Person A believes translates into something that Person B cannot comprehend.

Happy Analyzing!

Q&A: Adjustments

Q&A: Every question deserves an answer...

Balances, charges, and fees are sent on an EDI 822 file.  What happens if something was sent incorrectly or omitted entirely?  Usually, a bank sends a restated 822 file with the mistakes now corrected.  But, when a restated 822 file is not sent, any adjustment is made.

Adjustments (ADJs) are made on the bank's end, sent on the EDI 822 file, and then applied to the appropriate balances.

What is sent on the EDI 822 file?

From my end, I cannot see when the bank has made an adjustment until it is sent on the EDI 822 file.  At that point, I can tell...

1. Which charge/balance the ADJ is for
2. The amount of the ADJ
3. The original charge/balance amount
4. Whether the ADJ is for the current or prior period
5. When the original transaction requiring the ADJ occurred 
6. How the ADJ is being applied

Adjustments can be sent for either a ledger balance, float balance, or service charge.  All three have specific ways in which they must be formatted on the EDI 822 file according to AFP standards to signify to which of the above 3 areas the ADJ is for.  But, banks cannot just send the ADJ information alone.

Application is important...

There are 2 balances in particular whose sole purpose is to apply ADJs for either the ledger or float balances.

• Balance Adjustment – Prior Period Ledger
• Balance Adjustment Prior Period Average Float

Let's say your EDI 822 file has an ADJ for Ledger.  Based on the information sent you can see how ledger was adjusted, by how much it was adjusted, and for which period the adjustment applies.  The same goes for any float adjustment.

For service ADJs, these should be sent as service line items in the account's service detail section of the EDI 822 file.  Some are sent with "credit" or "adjustment" in the service description with the charge sent as a negative or positive to deduct that amount from the total service charges due.  But, each bank is different.

Without sending Balance Adjustment – Prior Period Ledger for a ledger ADJ, Balance Adjustment Prior Period Average Float for a float ADJ, or an adjustment service line item - the ADJs will not apply towards your final balances/charges so the information on the 822 file becomes nothing more than a memo entry.

Happy Analyzing!

*Have an Account Analysis question? Send me an email girlmeetaa@gmail.com

DDA Balance Reserve Requirement (6/14)

Account Analysis consists of balances and fees which comprise a basic math calculation. There are 14 balances that I refer to as "Remember the Math". I will discuss all 14 in 14 different posts.

DDA Balance Reserve Requirement

DDA means Demand Deposit Account.  A DDA is essentially your typical non-interest-bearing checking account you can open at just about any bank.

Prior to the Great Recession, the DDA Reserve Requirement balance for corporate accounts was ~10% of the Balance Subject to Reserve.  Balance Subject to Reserve is the final balance used by financial institutions to compute the balance percentage they will deduct for any reserve requirement.  This deducted amount is not subject to the Earned Credit Rate (ECR) of the account and thus not eligible for Earnings Allowance.

Why is this 10% reserve requirement (RR) deducted at all?

The Federal Reserve (Feds) required financial institutions to place 10% of their total deposits on reserve.  This 10% requirement must be sat aside at the Fed so it is exempt from any interest-bearing activities the bank would have otherwise invested it in. Most financial institutions make money off the deposits of their account holders.  You deposit funds into your account at Bank XYZ.  Bank XYZ then takes those deposited funds and loan them out, at interest, to some other entity thus making money off your money you've allowed the bank to "hold" for you.  If the funds are not loaned out, they are invested in various securities again potentially earning the bank a return off your money.

When the Feds implemented the 10% RR, this left the bank access to only 90% of their total deposited funds since they could no longer invest the other 10%.  The banks were losing out on the investment opportunities and potential earnings for this 10% so instead of absorbing that loss they passed that loss down to their corporate account holders.  Since the bank could not benefit from earning interest on the entire 100% of their deposits then neither would their corporate demand deposit account holders.  This 10% deduction from the account holder's end is shown in the DDA Reserve Requirement balance which is 10% of the Balance Subject to Reserve balance.

So, what changed the 10% RR rules?

For some time, Regulation Q prevented corporate DDA holders from earning interest on their bank account balances.  But, they are allowed an ECR which does not violate Reg Q since it is considered a "soft" interest.  According to Wikipedia, Reg Q was enforced from 1933 following the Glass-Steagall Act to 2010 when it was repealed by the Dodd-Frank Act.  What was also changed during the Great Recession was the Feds now allowing financial institutions to earn interest on their 10% RR.

No longer were financial institutions required to forego earnings on those funds sitting at the Fed.  This now gave 100% of the bank's deposit balances the right to earn interest which made it difficult for those same banks to justify the 10% RR they had passed down to their corporate DDA holders. This change was eventually reflected on the EDI 822 files when the DDA Reserve Requirement balance was sent as $0.00.  When one bank made the RR change there was a "hooray!" heard across the land (the small Account Analysis land).  This resulted in a little nudge to other corporate DDA customers asking them, "why isn't your bank now subjecting 100% of your balances to ECR? Hmm."

Current day Reserve Requirement calculations...

The following balances may play a part in the DDA Reserve Requirement calculation:

• Compensating Bal Req-Credit Facility-Subject to Reserve
• Other Balance Subject to Reserve

Both Compensating Bal Req-Credit Facility-Subject to Reserve and Other Balance Subject to Reserve may be sent but I don't usually check for them unless there's a calculation issue which will cause other subsequent balances to be off.

We have already discussed this balance which, as its name states, is the balance subject to the reserve:

• Balance Subject to Reserve

The balance which displays any reserve requirement deduction is:

• DDA Balance Reserve Requirement

This topic opened the door for both soft and hard interest to be seen on the EDI 822 Account Analysis files.  I have seen only one thus far so not enough data to compile an informative blog post.  We shall see...

Happy Analyzing!