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Why Do Overdue and Unsettled Balances Exacerbate Intercompany Challenges and How Can You Prevent Them?

This blog explains how companies can be more agile with global cash flows by not relying on formal terms for intercompany balances to decrease the need on working capital.

Steven Lucier
Steven Lucier

Apr 21, 2022

Why Do Overdue and Unsettled Balances Exacerbate Intercompany Challenges and How Can You Prevent Them?

It stands to reason that overdue and unsettled balances are a big deal when it comes to intercompany. But what exactly are they, what impact do they have, and how can they be prevented? This blog post defines overdue and unsettled balances and explains their significance to a multinational organization.

Unsettled intercompany balances are balances that are accumulated with posting of transactions that are due to be paid. Overdue balances are outside your internal policy for making payments on intercompany balances. Larger companies will have different payment terms than they would for dealing with third parties. For example, many larger companies will say that intercompany transactions need to be paid within 30 days. Some will say a maximum of 30 days, while others will say a minimum of 30 days. So overdue balances become about aligning your outstanding balances and performing the appropriate aging against that policy element. Those that are outside your parameters would be overdue. Companies are also increasingly looking for ways to be more agile with global cash flows and not relying on formal terms for intercompany balances to decrease the need on working capital.

While this all seems straightforward, it’s quite the contrary. Intercompany invoices sit across various systems, sometimes mixed in with all other third-party invoices with varying terms, and varying vendor and customer codes. Once isolated, country level settling requirements need to be considered when making or receiving payments, especially on a netted basis (where applicable). Additionally, not all parties agree on the open balances or have sufficient funds within their linked bank accounts, causing aged invoices to build over time. All this culminates in a messy process that is time-consuming across various organizations, resulting in processes running far less frequently than one would expect.

Dealing with open balances

Something that happens frequently with intercompany is when your subsidiaries are billing each other, and the open balances keep growing over a period. This happens because, as you seek to reconcile during the close, there’s not proper alignment on those intercompany balances. It takes a long time for companies to manually investigate and adjust those records. They often remain open for long periods of time. What ends up happening is a transaction balance that might age to the appropriate limit as prescribed in the credit poll and intercompany policy. But then, at that point in time, as they’re looking about settling, they’re often consulting two parties in some cases to confirm those balances to be paid.

At that stage, there’s a dispute that’s brought up, with one of the parties saying they don’t agree that they don’t have that transaction, or they don’t agree that that transaction took place, or they don’t agree with the amount, or they don’t have sufficient funds. These transactions continually build up over time as they’re going through those dispute processes, as well as just trying to investigate all those ones that have popped up during the close process as well.

It's difficult to figure out who owes who when it comes to intercompany. There are multiple reasons for this. Often, there are companies that are set up in different ERPs differently. Some might be set up as a vendor or a customer in one ERP, or as you move to another ERP, those same companies could have a different customer vendor number and a different ERP. If you roll all that up, a particular entity could take on multiple different identifiers as a customer, or as a vendor. As you’re trying to figure out who owes who, you have to understand how you identify party A across all of those ERPs. It’s a very arduous process of trying to sift through and align all that data to even identify the party balances themselves.

The unique identifier is the first major problem in aligning the data. The second reason is how they're being recorded. Sometimes companies are recording in the subledger and identifying vendors and customers. Sometimes customers are recording through their general ledger and they're not tagging each of the transactions with the appropriate trading pair or the ERP is automatically identifying when a transaction has crossed legal entities. The ERP is automatically posting transactions through an intercompany due from account. But each of those lines are not being tagged with an appropriate trading partner.

What ends up happening is you have company A, which could have a receivable position of $100 million. But if you break that down into a thousand lines of activity, you don't know who's attributable to those thousand lines of activity. You just know there's $100 million owed to that company, but there hasn't been a tag at the detail level. That's often the second disconnect in the process.

Additionally there are numerous balance differences that could result from manual processes, including timing issues between billing records and processing accounts payable across companies, amounts entered in various currencies with different amounts, revenue, and expense recognition points when goods are in-transit. There are numerous reasons that feed into the ever-growing investigation and dispute processes.

How to prevent your overdue and unsettled intercompany balances from accumulating

Preventing overdue and unsettled intercompany balances from accumulating is all about minimizing your risk. Anytime you have an open balance, even though it's internal, there's an open balance, which means there's likely a reason why they're aging beyond an appropriate term. What that means is you're exposing yourself to a degree of risk and that degree of risk could manifest itself. The fact that you've got to do potential write-offs for those intercompany receivables and for some companies, that's a very considerable amount.

The risk can also manifest itself in the fact that some of these companies who have recognized revenue over the years are now subject to do restatements. They now must restate some of that revenue. They must also restate some of their balance sheet to reflect that they either had to write off some of that balance or reduce their number of receivables. They could also write off some of that balance as a result of realizing that some of these transactions are not aligned, and aren't substantiated.

The third major risk area comes down to taxes because you can't appropriately reflect some of these charges or these revenue in your appropriate tax position. That often results in a higher tax rate for these companies because they're not able to substantiate the transactions.

The other risk areas are around holding a balance or holding a payable position, especially for those companies that are holding these balances open in multiple currencies. What that means is by having a balance open, you’re having a company think through the supply chain. The company at the beginning part of the supply chain had to expend actual cash out the door. They had to pay their workers to assemble the product or perform the service. You had to potentially have costs incurred with inventory and they all need cash to buy those items.

What you will often find is companies that are earlier-on in the value chain for those supply chains have had to expend inventory. They have cash outflow. If that cash outflow is held in a receivable position for periods outside their normal terms and they’re often overdue, that company has to go to market to find the extra cash. That cash could come in the way of the fact that you’ve got to use some cash that you would have used normally to support your operations. Perhaps you have to have more loans or maybe issue additional stock.

 It all comes down to working capital. You have expended more working capital. If you think through each individual company, each company in a different receivable and payable position are expanding different working capital needs. Individual countries will often have to seek working capital because there’s this imbalance, whether that be country A or country B, there’s often an imbalance of one that creates a favorable position versus unfavorable position. The unfavorable position is something you have to go to the market to correct.

Next, if you think through those balances, they’re sitting in multiple currencies. So, each of those currencies are floating. Any aged balance that’s sitting outside of a currency, especially those currencies that are devaluing, is the fact that now you’re having gains and losses, mostly losses in those positions of 1.5% over a 30-day period. That’s very considerable for large companies when you look at how they have to disclose that financially.

As an example, think of a courier company where a package might flow from the US to Germany. It might go through five different countries. Each of those countries have to recognize revenue and expenses. Often, those expenses are a revenue and cost to goods sold allocations. They’re intercompany transactions that record every movement along the way. If you can’t describe the basis for how you recorded both the revenue and that expense of your business, that points to the high risk and auditors might not accept that. The fact is you have no documentation to support each of those movements as they move between countries. That just heightens your risk that you won’t be able to have those as qualified expenses on your tax return or why you shouldn’t recognize more revenue within the borders of that particular country. This will, as we know, raise your effective tax rate in these countries.

Best practices to avoid overdue and unsettled intercompany balances

To solve these problems, let’s look at what you can do from an organizational, process, and technology standpoint.

First, realize that you don’t need a centralized process. What you need is a standardized process. You don’t necessarily need to consolidate all the transactions to be done by the same set of individuals. What you need is a process that is standardized and will ensure that regardless of who’s posting it, and their level of knowledge, will do so accurately.

This means that you’re needing to develop a standardized process, but then you also need some sort of technology that’s making sure it’s following all your internal and external process requirements, and that’s all done behind the scenes. Fortunately, you don’t need to be an intercompany expert. You can have a system say, “Here’s the type of transaction we’re posting and the parties and the countries that are involved,” and let the systems do the rest.

The system determines what are the appropriate taxes, who needs to review and approve these transactions, and what should an invoice look like knowing the countries that are involved? It's all about making that process work and be carried out by really any organizational structure itself. But just making sure that you got that well-structured process in place.

From a systems standpoint, having a system that can span your ecosystem that could involve multiple systems and/or ERPs. ERPs are a big contributor to your financial ecosystem, but you certainly have treasury management systems, you have e-invoicing systems and there’s other parties and other systems to be aware of. It's all about having a solution that can work across your entire ecosystem in a very synchronized fashion.

This enables you to ensure that you’re posting these transactions in the individual ERPs accurately. That is the main source of record for financial reporting. But then you also have a visibility layer and a centralized tool that can talk and communicate back and forth with each of these systems to make sure you also have that higher level governance process, as well.

Once the individual charges and balances are fully aligned and visible with overlaying standardized processes, balances can be settled in a streamlined manner. This means they can be run frequently since it’s an automated process. As a result, companies avoiding overdue balances have the ability to reduce payment terms and flexibility to settle quicker to tighten up global cash flows and reduce risk. This is real money that contributes to profitability and it’s significant.

How We Can Help

Global transaction management is typically manual, complex, and subject to rigorous regulatory and tax implications. This makes intercompany accounting a time-consuming, burdensome administrative process for multinational companies. Furthermore, the close and financial reporting are dependent on the process' completion, which all too frequently delays these critical tasks.

With intercompany financial management solutions from BlackLine, companies can manage the entirety of their intercompany accounting processes, minimize administrative costs, and decrease the time required to close.

 

 

Steven Lucier

Steven is a Director within the Intercompany Hub team, responsible for advising and aligning BlackLine solutions to solve intercompany challenges. Steven has over 21 years experience enabling Finance solutions and automation of processes. He has experience working across many industries, while engaging various corporate stakeholder groups to enable practical client solutions.

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