Group / Intercompany Netting
Do you have multiple subsidiaries with intercompany payments?
Do they pay the IC-invoices to each other direct? -
This bears high risks, is inefficient and cost a lot of money!
Netting, derived from the action "to net" is a process in which
receivables and payables are compared to each other for all group
companies and cleared, i.e. settled vs. each other through a
centralized Netting Center - also called Corporated Netting Center.
Final reason is the payment (mostly, but not always in cash),
reduced to just one amount which is paid / received only. But the
largest benefits are not visible at a first glance!
Provided that at this point netting in organisational terms is only
intended for for receivables and payabels occurred within a legal
group structure: the clearing of accounts receivables- and payables
is also common practice, but ends with the single vendor-customer
relationship. However, the principle idea is the same.
Way of posing a Problem / Task
Meet this example also your group?
•
XYZTest Group, holding in country A with subsidiaries
(controlled) in countries A, B, C, D, E and F.
•
A delivers to B and E and invoicesin currency A.
•
C delivers to A and D and invoices in currency C.
•
D delivers to E and invoices in currenc E.
•
etc etc.
Therefore following problems arised and in relation to it, these risks
will arise:
A) Quantitative Impact
1.
High expenses for payment orders because of a large number
of payment transactions.
2.
Foreign exchange risk at the receiver of the rendered service.
Those are often in other countries and/or receivables in other
currencies than the one they need to settle the invoice.
Conclusion: due to internal process external risks are
build up! They can be measured quantitative for example with
Value at Risk resp. Cash Flow at Risk.
3.
Foreign Exchange costs: for the same reason as 2. above the
reciever of the service has to pay relative quite low amounts.
Often dedited/credited from an account, which is denominated
in another currency than the invoice-currency. These additional
transaction costs are approx. 2%-4% of the total invoice
amount! In these days, where margins have to be calculated
on the second digit after the comma and agreed in heavy
negotiationes, this way of paying invoices can be considered
as pure destruction of money.
4.
With every single payment also the risk increase of manual
input errors that it will be paid too much or too less. This leads
to binding of intensive human resource power what is at the
end expensive. If you would measure these items for a specific
period the one and other CFO would wonder what he pays for
this unfavourable process.
5.
In case the foreign exchange risk would be centralized by a
netting process, the netting center would be able a) to
eliminate these fx-risk in a first step (overlay) and b) to
manage the remaining amount per currency with hedging, for
instance fx-swaps.
B) Qualitative Impact
1.
The counterparty risk increase with every single transaction.
Imagine, you give your bank a payment order and your bank
has no direct nostro account with the correspoding bank of the
beneficiary. Such payment processes through intermediary
banks are very common in the international payment system.
Assume that the intermediary bank is Lehman Brothers. You
as ordering party don’t know that and have no control about it.
But in case of a total shortfall of this intermediary bank
you have to pay this total loss! Because this risk is just
hardly to be quantified we mention it here as qualitative risk.
2.
Monthly and quarterly intercompany reconciliation is
unpopular, time consuming, fraught with risks and therefore
need to be implicitely avoided. A centralized reconciliation
which is always up to date can be outweight in these times
with gold. Due to the permanent clearing process, the typical
monthly- and quarterly differences will be (if they still happen)
resolved in very short time. And: not by the Accountant which
is heavy under pressure during closing days, new by a
Treasury Manager which has anyway the overview about all
transactions throughout the month.
Concerned Transactions
The characteristic of the concerned transactions is given by the legal
frame: receivables and payments need to be due and in their content
need to be qualified for netting. Most intercompany transactions are:
•
Local expenes which have been pre-paid by a entity
•
Interest from intercompany loans
•
Products from a pre-production (e.g. unfinished goods)
•
Management Fee
•
Service Fee
•
Corp. Re-Charges with fix determined key
From Chaos to Order
A) Before
B) Afterwards
Organization
As monitored in the “After” picture above, the Corporate Netting
Center is the central key-element between all group companies.
Hence, the question for the location of the corporate netting center is
already given.
Preferrably the Netting Center should a) belong to the Treasury
Department and b) at a location which should qualify for possible tax
benefits because of double tax agreements and as less as possible
restrictions by local authorities. Those are complicate and often
discretionary by the responsible officials. Positive examples are the
Netherlands, Luxembourg (under the consideration that both have to
apply European Untion law), Switzerland and especially Singapore.
Negative examples are all countries in Africa, Russia, most of the
Latin American coutnries, especially Venezuela and Argentina.
Risks
Nothing in our world is without risk and nothing is for free (Adam
Smith mention it already in his Wealth of Nations). Starting with the
implementation risk that current processes are going to be changed
can be a risk. With exact- and important, professional planning as
well as balancing strenghts - weakness - chances in a project those
risks are recognized and can be held under control. In order of
completeness we mention at this point the risk of transfer pricing,
which, also recognized in time, is then no more risk.
Summary
By introducing a central clearing center, called Corporate Netting
Center, many expensive costs are avoided with less complexetiy
(mostly in relation to IT-investments which are very low with our
Treasury Software STS, valuable risks are reduced and
reconciliation processes are made clearly more simple . Order now
a free presentation for managing Group Netting and see here
how it works.
Contact us, we would be glad to show you the possible
opportunities!