What is EDI and How Does it Work?

Published on August 5, 2022

Getting started with electronic data interchange (EDI) may seem daunting for many businesses. It’s a concept that can appear complex and highly technical, but EDI can offer significant benefits for organizations looking to accelerate and streamline their accounting processes. In our discussion below, we cover the foundations of EDI to help you answer the following questions for your business:

  • What is EDI?
  • How does EDI work?
  • What are the different types of EDI? Which might best fit your requirements?
  • When it comes to EDI management, what are your options? Is an internal EDI system or outsourced solution optimal for your needs?
  • How does EDI accounting automate and speed up processes like invoicing?
  • What are the potential risks involved in EDI?

What is EDI?

EDI allows trading partners to send and receive electronic documents between systems, replacing manual processes for exchanging business documents. Frequently exchanged EDI documents include invoices, purchase orders, and shipping notices.

The U.S. military launched EDI in the 1940s for logistics communications, and in the 1970s, corporations began adopting the framework for business purposes. Today, EDI is in widespread use and often serves as a core component in business-to-business (B2B) e-commerce transactions.

An in-house EDI system can help enterprises speed procurement and reduce accounting costs; for smaller businesses, outsourcing EDI via a managed service may be the most cost-effective approach.      

How Does EDI Work?

The EDI process has three main steps: preparing, translating, and transmitting data.   

1: Preparation

In the initial step of the EDI process, a business needs to collect and organize the necessary data. So, for example, to exchange a purchase order via EDI, a company will need to create an electronic file containing the required information to build the order as an EDI document. A business can create this file by manually exporting data fields or by using software with a built-in EDI interface.

2: Translation

Next, the business will convert the data into EDI format. The process requires expertise to define how company data will be mapped for use in the EDI framework. Some businesses leverage translation software, which is available for diverse computing environments and budgets; others engage an EDI service provider for data translation.

3: Transmission

After translating data into EDI format, an EDI document is ready for transmission. A business can choose to connect with trading partners and transmit EDI documents directly or via an EDI network provider. 

What are the Types of EDI?

Direct EDI (point-to-point EDI)

Frequently used by enterprises conducting a large volume of business transactions daily, point-to-point EDI involves a single direct connection between trading partners.

EDI via VAN (value-added networks)

When performing EDI via a network service provider—also referred to as a value-added network (VAN)—a company connects to the provider using its preferred communications protocol, and the provider is responsible for connecting with and transmitting data to each of the company’s trading partners. Many businesses choose this model to avoid the complexity involved in communicating via the different protocols required by different partners.    

EDI via AS2 (using the Internet)

Among the most popular approaches, EDI via AS2 communications protocol transmits data securely over the Internet. The AS2 protocol essentially provides an “envelope” for EDI data, using digital certificates and encryption for secure transmission.

Web EDI (using a standard Internet browser)

Conducted with a standard Internet browser, web EDI can make EDI document exchange easy and cost-effective for small-to-medium-sized businesses. This method is most frequently employed by organizations with only occasional requirements for EDI transactions.

Mobile EDI (using mobile devices)

Security concerns and the size of mobile devices have limited the use of mobile EDI; however, the current industry focus on developing effective apps will likely lead to far greater mobile EDI adoption in the near future.

EDI outsourcing (managed services)

For businesses lacking the internal resources to devote to EDI management—or those simply preferring to offload the function—EDI outsourcing (which can be a component of a larger B2B managed service or B2B outsourcing solution) is optimal. In this approach, dedicated external specialists manage a company’s EDI environment.

EDI Examples

EDI in e-commerce

In e-commerce, B2B trading partners use EDI to exchange documents and business information related to orders and invoicing.

EDI in operations management

Operations management functions—which can include logistics, procurement, production, and supply chain processes—can use EDI to quickly and effectively exchange documents in a standardized format. Additionally, EDI transactions include status updates and other useful information for tracking purposes across operations.

EDI in healthcare

In healthcare environments, EDI enables secure, HIPAA-compliant data exchange. For example, a healthcare provider can use an EDI-enabled electronics medical records (EMR) system to submit an EDI query checking a patient’s insurance coverage, deductible, and copays for billing purposes, and an insurance company can use EDI to submit payment for the patient invoice.

EDI in accounting

EDI can also automate document and data exchange between accounting systems for EDI invoicing or EDI invoice processing. In a common EDI accounting scenario, a company makes a sale and its EDI software transmits an EDI purchase order into its ERP system instantly. When the company ships the ordered product and generates an invoice, the software creates a billing transaction in EDI format, and an EDI invoice is sent to the customer.

Benefits and Risks of EDI

The benefits of using EDI are clear. With EDI, businesses can eliminate manual data entry, boost productivity, drive down costs, and accelerate and streamline processes. EDI ensures that vendors receive invoices on time, accounts payable transactions are automatically recorded, and financial and cash flow data is accurate.

However, EDI can introduce a particular element of risk. Analysts can evaluate a company’s data and EDI use cases to gauge vulnerability to potential security risks—including unauthorized data disclosure, modification,  system access, and poor system availability—and recommend preventative measures.

Master Business Accounting with Invoiced 

EDI can play a critical role in modernizing and streamlining your accounting practice. To find out more about automating and accelerating accounts receivable from end to end, read our guide outlining today’s most effective tools, services, and techniques.

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