Mar 2015

10 Reasons Why Nobody Should Operate Without Netting


1. Reconciliation is King. There are few things in corporate finance more valuable than the reconciliation of inter-company accounts. A good netting system should include intercompany reconciliation in its regular settlement process. This lets you move beyond settlement, resolving and reconciling inter-company issues.

2. Motivation for Subsidiaries. When it comes to intercompany settlements, smaller companies within the corporate group often have to exert more effort to make sure their voices are heard during disagreements. Be it basic management, or just distribution of marketing fees, small subs are rarely listened to in a disagreement. A good netting process gives them the voice they need and engages them with corporate.

3. Fair Refinancing. Everybody knows what happens if inter-company invoices are not paid on time: nothing. When intercompany invoices go unpaid, there is little reason for subsidiaries to follow through with deals, eating up corporate liquidity. In a way, this makes inter-company netting the cheapest way to refinance a business. By assuring cashflow between subsidiaries you decrease the need for loans, meaning you don’t have to pay a cent of interest. Sadly, many companies are completely missing this opportunity, often leaving a subsidiary with no chance to stop an intercompany deal, and without the planned refinancing cost, resulting in a decrease in profit, a decrease in liquidity, and in the end the corporate group loses money. This can be easily fixed via proper intercompany reconciliation, allowing deals to be processed and those who create problems to bear the costs–and leading to fair distribution of refinancing cost.

4. Reliability in Cash Management. The most difficult part of cash management is the prediction of incoming payments. Here, netting alleviates uncertainty as the netting center always knows the value date of every payment – paid physically or settled through an interest bearing loan. With this there are no more unexpected, difficult to compare payments. The money is available on netting day. Always.

5. Reliability in FOREX. FX Swaps for delayed or uncertain inter-company payments create work and cost money. As the delay gets longer and the hedge gets mixed up with other positions, your ability to track the deal gets more muddled, the back calculation more difficult. Why is that? Because there is no need for accurate and timely payments of inter-company invoices. Netting changes this completely and there will never more be any swap on FX hedges for such payments.

6. Centralization of FOREX. Not every group company has enough skill to hedge FX risks properly. Not with banks and not internally. But if they are invoicing in foreign currencies, they should have that skill. Netting enables subsidiaries to transfer the risk completely to the Netting Center without necessitating a change the invoicing currencies. If the best people to handle FX risk are in the Netting Center, then let them. Implementing such a process is not difficult.

7. The Power of a Self-Clearing Approach. When using a Receivable Driven Netting process, subsidiaries that only deal with payables get no say in reconciliation, and when one uses a Payable Driven Netting process reverse is true. In the end one side is in control, and the other side has to obey. But there is a better solution: Agreement Driven Netting. Under this process, both sides get a say in the deal. Everything agreed on is settled. If they don’t agree, then their disagreement is recorded and reviewable by the Netting Center. No receivables available – no money. No confirmation without cause – payment is enforced. When both sides money is on the line, you’ll find that everything gets cleared up pretty quickly and neatly. No pressure necessary.

8. Simplicity of Implementation. Netting is not a complex software issue; it is a process, one which everybody benefits from. The technical impact is one time and easy, the training of users can be performed very efficiently and just in case, hosting and outsourcing options are always available to overcome any shortages in capacities.

9. The Real Value. Imagine that inter-company reconciliation does not consume any time in any company. Let us assume we save 2 days of work per company in an average month. A corporation running 35 companies is going to save 70 days, equivalent to 3 Full Time Equivalents per month. Since they are usually not in low cost areas located, this ends up between USD 15k and 20k per month, so 180k to 240k USD per year. And this doesn’t include Cash Management and FX Management savings. How can any company afford to lose so much?

10. Consolidation Loves It. If netting is properly implemented, it affects every stage of the reconciliation process. Every invoice exchanged between subsidiaries is processed through the netting system. This applies to every company in every country, even those with payment regulations. In the end there is no inter-company booking left unreconciled after an invoice is served. If these invoices are frequently compared and settled under a common agreement, there is no reason for differences in the consolidation. This department is going to save a huge amount of time which now can be spent on more valuable topics instead of going after unmotivated companies to understand and decide how to handle differences.