Treasurers are constantly seeking new ways to improve operations and streamline workflows. One of the most effective solutions, multilateral netting, actually is an ageless classic that can add real economic value. Surprisingly, many global organizations who manage multiple currencies have yet to adopt this proven treasury workflow solution. Instead, many treasurers continue to settle intercompany invoices and payments on a one-off basis, thus missing out on benefits that extend well beyond their team.
At its core, a netting program allows corporations to efficiently settle intercompany (and external) payables and receivables in a timely and disciplined manner—typically monthly. For example, ACME Corp., a global producer of widget varieties, manufacturers its products in two separate manufacturing sites. It ships these widgets to four distribution entities, who then sell them to eight sales entities around the world that ultimately sell these widgets within their local markets. This simple flow-of-goods creates intercompany invoices, which in turn generates intercompany payments to settle the invoice. Obviously, the ACME example is a simplified version of any manufacturing company—but the flow of product, services, cost-shares and intellectual property allocation can further complicate an intercompany structure and significantly increase the quantity of intercompany invoices and the subsequent spider web of intercompany cash payments—until you implement a netting solution.
By leveraging a multilateral netting program and technology solution, each entity’s intercompany payables (and/or receivables) are imported from their respective ERP solution. All payables are netted against their receivables to arrive at a single net settlement amount where the payment or receipt is facilitated through a single legal entity that serves as the netting agent; often, this is also the in-house bank “parent” company. This netting workflow also includes invoices in other currencies besides the functional currency of the netting participant; these non-functional currency amounts are then translated at a consistent FX rate to arrive at a single payable or receivable amount in their functional currency.
Value for treasurers
For many treasurers, the efficiency gains alone are significant and justify implementing a netting program. However, there is much more to be gained:
- A robust, auditable tool to ensure intercompany trade and non-trade payables are paid in a timely manner. This reduces significant tax treatment risk, internal and external audit compliance risk and improves accounting’s ability to clearly reconcile and clear intercompany balances.
- Lower bank fees by reducing physical intercompany payments. By routing these intercompany net settlements though a single legal entity the overall impact to the company is a zero-sum game and bank transaction costs are drastically reduced.
- Reduced FX transaction volumes. The netting program enables treasury to reduce FX transactions to a single legal entity, which adds great efficiency to an intercompany FX and hedging program.
- Further reduction of physical intercompany settlements by optimizing an in-house bank structure within the netting program. For example, assuming the netting agent is also the in-house bank company, if the netting participant belongs to the in-house bank they can settle their netting obligation by a simple in-house bank balance adjustment versus a physical wire payment; a true cashless settlement.
- Mitigating tax and compliance risk. In addition to trade payables and the recurring core business activities, netting can also be extended to include many other intercompany and external transactions, including:
- Intercompany dividends
- Compensating adjustments
- R&D cost share
- Intercompany term loan principal and interest payments
- Capital contributions
- Entity liquidation settlements
- Intercompany tax payments and adjustments
- Prior period accounting adjustments
- Transitional service agreement (TSA) settlements (internal and external).
This is the short list of immediate benefits, but one can see how expansive and all-encompassing a netting program can be. Competitive advantages come to those organizations who accurately manage their flow of funds and ensure intercompany profits, costs, investments, debt and cost share cash flows are properly managed. This is especially true for rapidly expanding global companies whose complex legal entity structures and dynamic tax strategies are increasingly more complex with every new region they enter.
Greg Person is vice president, global presales and strategic value at Kyriba.