Intercompany Financial Management

In the business world, divisions, subsidiaries, franchises, or other units may operate independently but are owned by a parent company. These units often exchange financial resources with one another or with the parent company.

This type of financial activity is referred to as intercompany transactions, and the management of these transactions constitutes intercompany financial management.

Financial management refers to the application of general management principals to the finances of a business. In particular, it is concerned with the making of sound financial decisions that affect the business and its ability to operate and remain profitable.

Financial management concerns itself with several core objectives:

• Maintaining a healthy supply of capital

• Make sound investment decisions

• Ensuring a healthy return on investments for shareholders

• Proper use of funds

The management of intercompany finances is similar in many respects to business financial management, generally. However, it has its own set of features that reflect the unique nature of intercompany transactions.

Many businesses have franchises, subsidiaries, divisions, or units that operate independently and are owned by the larger, parent company. For example, 3M, the office supply manufacturer, owns Scotch Tape, Post-It, Bondo, and several other manufacturers of popular office products.

Gatorade and Starbucks, two internationally recognized and extremely successful companies, are owned, along with nearly two dozen other brands, by the parent company Pepsico.

In the auto industry, the Indian car company Tata Motors owns both Land Rover and Jaguar.

Not all intercompany scenarios involve large, international businesses. Many are also entirely domestic and operate on a smaller scale. For example, a lawn care company may spin off a smaller start-up to develop and sell a new line of grass seeds. Similarly, a computer hardware company may spin off a small start-up to launch a new software product. In either scenario, the start-up will act independently, but is owned by and receives financing from the parent company.

In the above scenarios, the units exchange financial resources with one another or with the parent company. This financial activity must be managed appropriately.

The fundamental premise of intercompany accounting, which is the recording, reconciling, and reporting of these transactions, holds that a business cannot report a profit or loss by conducting transactions with itself. It can only report a profit or loss by conducting business with an unrelated party (customer or vendor). Because intercompany transactions involve the exchange of financial resources with constituent parts of the same parent business, they must always be recorded and ultimately eliminated.

Intercompany elimination ensures that these transactions are eliminated, or reduced to zero, before consolidated financial statements are generated. The resulting statement will only reflect business transactions with outside, unrelated entities.

Intercompany financial management reflects the unique nature of financial activity that often occurs between related business units.

A common form of financial activity is intercompany lending. Parent companies will issue loans to start-ups and subsidiaries to give them the capital they need to launch or to help with an infusion of cash. They offer the advantage of easy access to funds without all of the costs and credit hurdles associated with loans from a bank.

These loans must be recorded properly. The lending entity, typically the parent company, must record the loan as a loan receivable, short-term asset. It will receive payments with interest from the borrower—the start-up or subdivision—and record these as cash payments as revenue that pays down the loan.

The borrowing subsidiary will record the transaction as a loan payable and the payments as an expense.

Intercompany investment occurs when one company has an ownership stake in the other company. A parent company can have an ownership interest in one of several ways:

• Purchasing shares of a publicly traded company on the stock market

• Purchasing shares of a private company through negotiation

• Buying the debt of the company

Other forms of intercompany finance involve the lending of staff as a resource and selling of supplies or equipment.