In our previous post, we outlined the basic concept of consolidation. At the end of the day, consolidation is really about addition – adding in balancing entries. But things can get complicated quickly. Here are some of the complexities we see regularly:
1. Scaling Up to Multiple Systems
On purpose, we’ve used a simplified example. In reality, it’s rare to have such a simple situation. As companies grow, structures get complex, and multiple levels of consolidation must occur. While some people stick with an Excel solution as long as possible, it just isn’t trustworthy. Often, when people “upgrade” from Excel to a real system, they discover that what they thought was working, wasn’t.
2. Setting Up Intercompany Costs
In our example, widgets were sold at the same price to outside wholesalers and the company-owned retailer. But life is rarely so simple. There are all kinds of reasons management may want different intercompany prices. Some we’ve heard include:
- The effort it takes to sell to a related company is much less then the effort it takes to sell to an outside party. The price should reflect that.
- We can’t let those guys know our costs. If the sales guys in division X knew the cost, they’d undercut our prices.
- Everyone here gets paid based on margin. We have to set reasonable margins around the organization to keep compensation in check.
If you’re operating within one country, you have a fair amount of leverage (with some restrictions – talk to your tax guys) on allocating your profit. When your entities are in different countries, things get more complicated. Every government in the world wants to collect more tax. Any costs you set between companies need to be justified. If your manufacturing plant in Mexico charges too little to the U.S., the Mexican government is going to want to know why.
In these situations, you often need to maintain two sets of books – one for tax and one for management.
3. Currency Issues
Currency issues (the subject of an upcoming post in this series) are complex even when you aren’t consolidating. When you are consolidating, they’re even worse. If manufacturing sells to retail, what currency do you use for that transaction? How do you track the value over time? This topic deserves its own post. Stay tuned.
4. How Much Money Do Your Divisions Make?
Companies go through consolidation because outsiders don’t care about all your inter-company back and forth. They only care about the net revenue you earn from customers, not coworkers.
While simple eliminations can create a consolidated view, they don’t help you determine how much money each division really made. To figure that out, it’s not enough to eliminate entries, you also need to allocate costs. Let’s demonstrate with our earlier example:
We assumed a $2.00 cost per widget. Manufacturing charged the retail division $5.00 per widget. Is this fair? Should manufacturing get all the credit? Or should it be split differently? Which divisions should assume which portion of the costs?
5. Partial Ownership and Joint Ventures
So far in our examples, we’ve pretended that all our companies are owned fully by the same entity. This isn’t always the case. How do you consolidate with partial ownership or complex joint ventures?
In our next post, we’ll review different ways of handling these complexities.