Innovative treasurers are constantly seeking new ways to improve operations and streamline workflows. One of the most effective solutions, multilateral netting (MLN), is an ageless classic that can add real economic value. Surprisingly, many global organizations who manage multiple currencies have yet to adopt this proven treasury workflow solution. Perhaps the solution appears more like a wall than a stairway, and instead of creating an opportunity to minimize operational barriers, many treasurers continue to settle intercompany invoices and payments on a one-off basis, and thus miss out on generating improvements to treasury operations, and benefits that extend well beyond their team.
Additional reading: The CFO’s Toolkit: Minimize Risk and Ensure Compliance
At its core, a netting program allows corporations to efficiently settle intercompany (and external) payables and receivables in a timely and disciplined manner – typically monthly. For example, ACME Corp, a global producer of widget varieties, manufacturers its products in two separate manufacturing sites, ships these widgets to four distribution entities, who then sell these widgets to eight sales entities around the world that ultimately sell these widgets within their local market. This simple flow-of-goods creates intercompany invoices, which in turn generates intercompany payments to settle the invoice (Figure 1). Obviously, the ACME example is a simplified version of any manufacturing company – but the flow of product, services, cost-shares and intellectual property allocation can further complicate an intercompany structure and significantly increase the quantity of intercompany invoices and the subsequent spider web of intercompany cash payments –until you implement a netting solution.
By leveraging a multilateral netting program and technology solution, each entity’s intercompany payables (and/or receivables) are imported from their respective ERP(s) solution. All payables are netted against their receivables to arrive at a single net settlement amount where the payment or receipt is facilitated through a single legal entity that serves as the netting agent; often, this is also the in-house bank “parent” company (Figure 2). This netting workflow also includes invoices in other currencies besides the functional currency of the netting participant; these non-functional currency amounts are then translated at a consistent FX rate to arrive at a single payable or receivable amount in their functional currency.
Value for Treasurers
For many treasurers, the efficiency gains alone are significant and justify implementing a netting program. However, there is much more to be gained, the list below outlines a number of proven benefits corporate finance organizations realize following the implementation of an intercompany netting program:
- Lower bank fees by reduction physical intercompany payments. By routing these intercompany net settlements though a single legal entity the overall impact to the company is a zero-sum game and bank transaction costs are drastically reduced.
- Netting allows treasury, and all other finance functions, a robust, auditable tool to ensure intercompany trade and non-trade payables are paid in a timely manner; thus reducing significant tax treatment risk, internal and external audit compliance risk and improves accounting’s ability to clearly reconcile and clear intercompany balances.
- Reduce FX transaction volumes. The netting program enables treasury to reduce FX transactions to a single legal entity, which adds great efficiency to an intercompany FX and hedging program.
- Opportunity to further reduce physical intercompany settlements by optimizing an in-house bank structure within the netting program. For example, assuming the netting agent is also the in-house bank company, if the netting participant belongs to the in-house bank they can settle their netting obligation by a simple in-house bank balance adjustment versus a physical wire payment; a true cashless settlement.
- Avoid US repatriation tax. US companies that delay settling intercompany payable balances to foreign subsidiaries beyond standard payment terms are at risk of having these balances treated as deemed dividends under IRC Section 956 and thus subject to 35% tax. In addition to trade payables and the recurring core business activities, netting can also be extended to include many other intercompany and external transactions, including:
- Intercompany dividends
- Compensating adjustments
- R&D cost share
- Intercompany term loan principal and interest payments
- Capital contributions
- Entity liquidation settlements
- Intercompany tax payments and adjustments
- Prior period accounting adjustments
- Transitional service agreement (TSA) settlements (internal and external)
This is the short list of immediate benefits, but one can see how expansive and all-encompassing a netting program can be. Competitive advantages come to those organizations who accurately manage their flow of funds and ensure intercompany profits, costs, investments, debt and cost share cash flows are properly managed.
One such company is A. Schulman, a global high performance plastics supplier. A. Schulman were able to realize many efficiencies by adopting a multilateral netting program. Nicolas Tusseau, Global In-House Bank Manager at A. Schulman explains , “the Netting module has saved the company $500 million (USD) of transaction volumes per year globally, not to mention the associated bank fees. When we launched our netting program, we were able to clean up and streamline many operations.” Below are some additional efficiencies and financial benefits A. Schulman realized following their Netting implementation:
- Reduced FX transactions costs, interest and bank fees
- Elimination of bank settlements and corresponding settlement risk
- Improved intercompany cash allocation as each entity receives a detailed remittance advice of all invoices settled
- Significant improvement towards global standardization of processes
Similar to the ACME example above, A. Schulman had payables and receivables that were not settled in a single net settlement amount. With a multilateral netting solution in place, A. Schulman was able to transform its treasury operations,” said Tusseau. There were at least three levels of immediate business value that extended corporate treasury and other global cross-functional teams:
- Value to treasury: no settlement risk, reduced FX transactions costs, bank transactions costs eliminated.
- Value to cash flow and working capital: By eliminating physical payments, cash was no longer traversing the world with no tangible benefit. This improved working capital as A. Shulman eliminated value dating potential overdraft balances.
- Value to organization: Cross-functional productivity enhancements as local global finance are able to more efficiently allocate intercompany payments/receipts and eliminate the time previously spent preparing and reconciling physical payments.
This is especially true for rapidly expanding global companies whose complex legal entity structures and dynamic tax strategies are increasingly more complex with every new region they enter.
In summary, the value of netting program is immense. Whether a large established multi-national corporation like A. Shulman, or a rapidly expanding global company with increasingly complex tax and intercompany structures. The benefits of netting are not Treasury’s alone, but allow treasury to champion a proven operational enhancement that will also benefit accounting, tax, legal and local finance teams. With advanced SaaS netting technology available in the market, and global audit and tax firms’ consistent endorsement of these programs, implementing this ageless classic is easier than you think. Your netting benefits await.
Figure 1. Example of flow-of-goods creates intercompany invoices, which in turn generates intercompany payments to settle the invoice.
Figure 2. All payables are netted against their receivables to arrive at a single net settlement.
Kyriba Client A. Schulman reports on the value of multilateral netting to their organization
For A. Schulman, a global high performance plastics supplier, there were many efficiencies picked-up by adopting a multilateral netting program. Nicolas Tusseau, Global In-House Bank Manager at A. Schulman said, “the Netting module has saved the company $500 million (USD) of transaction volumes per year globally, not to mention the associated bank fees. When we launched our netting program, we were able to clean up and streamline many operations.” Below are a few immediate benefits A. Schulman realized:
- Reduced FX transactions costs, interest and bank fees
- No bank payments and therefore no settlement risk
- An easier cash allocation, since each entity receives a detailed remittance advice of all invoices paid
- Significant momentum towards standardized and improved global processes
Similar to the ACME example above, A. Schulman had payables and receivables that were not settled in a single net settlement amount. With a multilateral netting solution in place, A. Schulman was able to transform its treasury operations,” said Tusseau. There were at least three levels of immediate value:
- Value to treasury: no settlement risk, reduced FX transactions costs, bank transactions costs eliminated
- Value to cash flow: No cash traversing the world with no tangible benefit: better working capital. No settlement = no value date lost in translation and no interest to pay on potential negative balance
- Value to organization: Time saved for associated in the payments department. Standard global approach for remittance info to make cash allocation easier. Same process for all the entities globally, on the path of a modern Treasury organization
This artcle appeared in Association for Financial Professionals (AFPonline): 5 Reasons Why Treasurers Should Adopt Multilateral Netting