Nearly 50 years ago, Paychex was launched as a provider ofoutsourced payroll services to small and midsize businesses inRochester, N.Y. Since then, the company has expanded dramatically.Today, its 14,000-plus employees serve more than 8 percent of allprivate-sector workers in the United States. The company's menu ofservices and solutions has also grown. Now clients can outsourcemost HR activities to Paychex, from hiring and employee on-boardingto time-keeping, retirement services, and insurance services. Arobust software platform enables Paychex to make most of theseofferings available via self-service online portals.

Still, payroll processing remains core to the business. And thePaychex risk management team recently uncovered a missed revenueopportunity in a crucial payroll-related process. Extreme riskaversion among operational decision-makers was eliminating asignificant amount of interest income on clients' tax payments.

"In addition to sending out payroll checks, we offer a payrolltax administration service that entails filing and paying taxes onbehalf of our clients," explains Ken Bersani, operating riskmanager with Paychex. "We file with the IRS, with the SocialSecurity Administration, and with various state agencies."

The appropriate cadence of these filings depends oncharacteristics specific to the client. For example, for small tomidsize businesses, the IRS typically requires federal income taxwithheld from paychecks to be paid on either a monthly or asemi-weekly basis. Businesses are expected to know which cadence isappropriate for their circumstances. Whether they file monthly orsemi-weekly makes a big difference in the timing of their taxpayments.

"With a semi-weekly filing frequency, a company might have topay the IRS twice a week," Bersani says. "A company that runspayroll on Tuesday will owe the tax by Friday. In contrast, acompany with a monthly filing frequency doesn't owe the IRS untilthe 15th of the following month. So tax withheld from a payroll runin early November isn't due until December 15."

For Paychex, which withholds tax funds from clients' payrollruns, paying taxes on December 15 for a November 5 paycheckrepresents five weeks of additional float, compared with payingthose same taxes on November 8. However, Bersani's team discoveredthat the company was using semi-weekly as the default filingcadence for most incoming clients. The approach made sense from acustomer service perspective.

"If a company files monthly whenit should be filing semi-weekly, it will receive a discrepancynotice from the IRS and may owe penalties," Bersani says. "No onewants to receive that mail. In an effort to better service ourclients—to ensure there is no possibility they will ever receive adiscrepancy notice—we began assigning a semi-weekly filingfrequency to almost every client. This avoided any chance of riskand ensured we were always paying at the most frequent ratepossible."

The risk management team immediately saw this approach'sdownside for corporate cash flow. They also understood that changewould require a concerted education effort. "Shifting a client fromthe default frequency of semi-weekly filing to monthly filing wasgoing to introduce a small possibility that the client might haveto pay a penalty in the future," Bersani says. "We were proposingintroducing some risk of an event that could potentially damage aclient relationship. Gaining buy-in from sales and field operationswas going to require quite a bit of data and communication."

The risk management team researched options and developed amethodology and algorithm that they were confident wouldeffectively identify clients that qualified for a monthly filingcadence. As a proof of concept, they selected a subset of long-termPaychex clients. "For this initial group, we had internalinformation spanning the entire look-back period the IRS uses todetermine correct filing frequency," Bersani says. "We ran themthrough our new process, and the algorithm indicated that 25percent of our semi-weekly filers had the potential to move to amonthly frequency."

Next they calculated the lost interest that the company wasmissing out on by filing far too frequently for those customers."We determined exactly how cash flow would be affected if wetranslated some of those lowest-risk clients to a monthly frequencyto yield more favorable float results," Bersani says. The numberswere significant enough to convince corporate leadership to acceptthe modest risks Bersani's team was proposing.

After transitioning that initial group of clients to monthlyfiling, the risk management team began running the algorithm onclients for which Paychex had less internal information. As theyslowly added more clients to the monthly cadence, the algorithmproved to be 99.99 percent accurate in identifying the appropriatefiling frequency for each company, according to Bersani.

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• Model of Excellence in Financial RiskManagement

In fact, it has proven so successful that Paychex has begunextending this process to some state taxes, as well."Unfortunately, each state has its own rules and calculations,"Bersani says. "We can use the IRS algorithm as a basis, but then wehave to recode and reclassify the risk factors for the individualstate because it might make determinations much differently thanthe IRS does."

Bersani sees this project as the perfect demonstration that riskaversion carries opportunity costs—a fact that may not be obviousto people outside the finance and risk management functions. "Wehighlighted that our prior approach, which was perceived internallyas being extraordinarily helpful to our clients, was actuallyhaving a serious negative impact to the bottom line," he says. "Wehelped people understand that they need to look at all thedifferent risk factors and potential fallout of theiractivities.

"As a result," Bersani adds, "we're seeing more and morerequests coming into our risk team where other groups within thecompany are asking, 'Hey, we're thinking about making this changeto our business. What do you think that will do to X, Y, and Z?'Because of the demonstrated success of this project, business unitsthroughout Paychex are now looking to us as essential partners tovalidate changes and help them find new opportunities in terms ofboth revenue and process improvements."

What can other risk management teams learn from the Paychexexperience? "Of course, the risk management function needs toidentify, record, monitor, and react to risk," Bersani says. "Butwe need to make sure we're also providing value in terms of theupside of risk. We need to help other parts of the organizationbecome more sophisticated in their risk management."