Many businesses have multiple units, divisions or subsidiaries. For the parent business to have a clear and thorough accounting of its financial health, it must produce statements that are inclusive of all the financial activity taking place within its various subsidiary entities.
Financial statements are documents that show the financial position or status of an organization. Typically, these include a balance sheet, income statement, and cash flow statement.
Consolidated financial statements are accounting documents that reflect data for all the entities within a business.
Each unit within a business has its own independent accounting and financial statements. Consolidated financial statements gather the information from these independently produced documents and combine them into aggregated statements that comprehensively report the financial activity for the entire business.
Consolidating financial statements typically involves multiple steps:
Accountants must first determine and identify all subsidiaries or entities within the organization that must be considered for the consolidation process.
These will include any business operation for which the parent company has a majority ownership, majority voting rights, or the ability to otherwise control or govern its decisions and operations.
The business will then gather financial statements and financial data for the period in question for all the identified subsidiaries or entities. This will include trial balances, general ledgers, and all supporting documents, such as invoices and other transaction records.
It is important to have consistency when preparing consolidated financial statements, so accounts must check and adjust financial statements.
Accountants will look for differences in reporting practices and financial reporting periods. The business units should follow similar practices, like generally accepted accounting practices (GAAP). If there are differences, then adjustments must be made to ensure that all data is reported according to the same procedures and guidelines.
Often units or subsidiaries within the same business have transactions with each other, in the form of sales and purchases, loans, staffing, and other exchanges of resources that carry monetary value.
However, these transactions can never be recorded as a profit or a loss because a business cannot gain or lose money by engaging in financial activity with itself.
In these instances, the transaction will ultimately cancel out, or equal zero. This is referred to as intercompany elimination because the transaction will be eliminated before consolidated financial statements are generated. The resulting statement will only reflect business transactions with outside, unrelated entities.
Lastly, accountants consolidate the report or combine financial statements. The resulting financial statements, including balance sheet, income statement and cash flow statement, will reflect the combined assets, liabilities, equity, expenses and revenue attributable to all the entities owned by the parent business.
Many well-known corporations own other companies. For example, Berkshire Hathaway, Coca-Cola, Johnson & Johnson, General Electric and Disney, among many others, own multiple companies, whose names are also very recognizable.
Any of these parent companies will produce consolidated financial statements to reflect the true financial health of the business and all its subsidiaries.
The practice is not unique to multi-national companies with brand names that everyone recognizes. Any business that owns other smaller subsidiaries will produce consolidated financial statements.
For example, if Company A has $2,000,000 in income and $1,000,000 in expenses, it will report these figures on its financial statements. If the business also owns a subsidiary, Company B, which has $500,000 in income and $200,000 in expenses, it will also report these figures.
The consolidated financial statements will show total income of $2,500,000 in income and $1,200,000 in expenses. This is a more accurate reporting of all the financial activity for the business and its subsidiary.
Consolidating financial statements can be a time-consuming and challenging process, especially if it is done manually. By applying software solutions, businesses can see many benefits:
Streamline the Process: Applying digital solutions streamlines the process by introducing rules-based tasks and digital workflows.
Improved Accuracy and Efficiency: Utilizing a centralized database and standardized data entry eliminates the differences between units that can create errors, leading to increased accuracy and efficiency.
Improved Decision-Making: With improved data and a more timely process, managers can make better and more well-informed decisions.
Increases Transparency: Having a process that integrates units increases transparency in the company.
Enhanced Compliance: Accurate data and a timely process supports enhanced compliance with financial reporting requirements.
Scalability: Applying smart technology introduces scalability to the process. By streamlining the consolidation of financial statements, the business is in the position to make improvements and customize digital solutions.
Improves Investor Confidence: Improving the quality of financial statements for the entire business improves investor confidence.
Improved Risk Management: With quality data and better decision-making, the business will see improved risk management.