FINANCIAL CONSOLIDATION

What is the financial consolidation process? Basically, it is the process of joining the financial data of a company’s subsidiaries and segments (e.g., entities that the company controls) into a single set of financial statements. Because the parent company controls its subsidiaries, it makes sense that the assets, liabilities, equity, income, expenses, and cash flows of the parent and its subsidiaries be presented in a financial statement as if they were a single economic entity. 

Consolidated financial statements provide a company’s stakeholders with a view of the company as a whole. Specifically: 

• Regulators and auditing entities rely on this source to check whether a company is compliant with the rules and regulations it is bound to. 
• Investors can rely on consolidated financial statements to assess a company’s situation, i.e., whether that company is winning or losing in its marketplace, and how that company’s operating, financing, and investing activities are being managed. 
• High-level managers and executives review consolidated financial statements to evaluate their corporate performance and identify high- and low-value-added business segments as well as potential risks and opportunities. 

For consolidation purposes, the financial statements of parent companies and their subsidiaries need to be prepared with the same date and uniform accounting policies.  

Though financial consolidation requires combining the financial statements of the parent and its subsidiaries, financial consolidation is not simply adding together the subsidiaries and the parent’s assets, liabilities, equity, incomes, or expenses. Instead, subsidiaries’ transactions are complex and usually require adjustments for consolidation. 

Depending on their situation and strategies, companies approach the financial consolidation process in different ways. 

Using spreadsheets 

The most common approach involves the use of spreadsheets to manually process and consolidate data exported from disparate financial systems. 

Its advantages: 

• It is the fastest and cheapest solution in the short-term 
• Familiar user interface 

Its disadvantages: 

• High chance of administrative errors resulting in inaccurate data
• Issues with version control
• More time and money spent on the close in the long run 

It is time for modern CFOs to move on and find other better alternatives to Excel.

Using ERP systems 

Companies taking this approach want to use the general ledger component of their existing ERP system. 

Its advantages: 

• Allows businesses to leverage existing technology 
• Does not require staff re-training to use the system 

Its disadvantages: 

• May not work well for bigger companies with multiple ERP systems and charts of accounts 
• Limited reporting capabilities 

Using specialised tools 

Using specialised closing and consolidation software provides a fast track to consistent financial consolidation and reporting, as companies with disparate systems are integrated through a mapping process. Existing core financial systems and data centres remain intact, and such a tool is also relatively fast to implement with low resource impact. 

Its advantages: 

• A high level of out-of-the-box functionality 
• Flexible reporting capabilities 
• Easy integration with other ERP systems 

Its disadvantage: 

• Choosing the right tool in the somewhat saturated market can be difficult 

According to Ventana Research, businesses nowadays take longer to close than they did five years ago. Pressures from both within and outside of organisations are preventing them from achieving an efficient financial close. 

External demands for a faster financial consolidation process 

Companies are facing tighter regulations regarding filing deadlines, integrity and business disclosures from global financial markets. 

Customers, partners, employees and communities are demanding more transparency into the inner workings of companies and how companies impact the environments in which they operate. 

Internal problems 

Some of the most prominent issues include: 

Data Quality and Collection Errors 

Companies, especially those with multiple branches in different locations, will need to put in extra effort to achieve a “right-first-time” financial consolidation process, from data collection to normalisation, and overcome the issues that may arise during the process, such as: 

1. Manual data entry errors 
2. Late delivery from reporting units 
3. A lack of validation and controls 
4. Poor integration with source systems 
5. Lack of integration across multiple close processes 

Intercompany Reconciliation 

Intercompany transactions can cause significant delays in the close cycle. Staff at both HQs and local branches have to spend time on resource-intensive tasks, such as eliminating intercompany transactions and calculating group ownership and minority interests. 

Weak Performance of Consolidation Applications 

Financial consolidation is inherently iterative and involves many rounds of consolidation, review and adjustment before the process is finalised. Hence, limited capabilities of financial close software can seriously hinder the whole process. 

Lack of Automation 

Many financial consolidation elements can be automated to speed up the closing process and reduce errors, as well as increase staff availability. Without automation and guided workflow, issues associated with staff that may be unfamiliar with business processes and reporting systems may arise. 

Inefficient Audit Trails

A lack of strong audit trails is not only an internal issue where central finance may seek to investigate and verify figures but also an external issue where post-close audit sign-off takes place.  

Minority interest (non-controlling interest or NCI) is the proportion of equity or net assets in a subsidiary that is neither directly nor indirectly attributed to a parent. While the parent has to consolidate its subsidiaries’ assets, liabilities, etc., into its financial statements, the asset/income attributable to minority interest should not be added to the group’s consolidated financial statements. 

A subsidiary with minority shareholders must also provide its separate financial statements. 

In the consolidated balance sheet, the minority interest should be shown within equity, but separate from the parent’s shareholders’ equity. Profit/loss of the minority interest should also be shown separately, instead of leaving it to be deducted from the consolidated income statement. 

A parent company might enter into transactions that result in changing its equity interest in a subsidiary. Some examples are: 

• The parent acquires additional ownership or disposes of some of its ownership over a subsidiary
• The subsidiary buys back equity ownership 
• The subsidiary issues new equity shares to the parent, NCI shareholders, or third parties 

Transactions that increase or decrease the parent’s ownership but do not result in a loss of control over the related subsidiary (i.e., the parent company still retains more than 50% ownership of the subsidiary) are accounted for as transactions with equity holders in the consolidated financial statement. 

For more information, please visit our blog “How to Deal With Minority Interest in Financial Consolidation.”  

Intercompany transactions are transactions that happen between two entities of the same company. Not adjusting intercompany transactions results in consolidated financial statements that do not offer a true and fair view of the group’s financial situation. 

Intercompany eliminations (ICE) are made to remove the profit/loss arising from intercompany transactions. No intercompany receivables, payables, investments, capital, revenue, cost of sales, or profits and losses are recognised in consolidated financial statements until they are realised through a transaction with an unrelated party. 

Intercompany transactions can be divided into three main categories: 

• Downstream transaction: This is a transaction from parent to the subsidiary.  
• Upstream transaction: This is a transaction from subsidiary to parent. 
• Lateral transaction: This is a transaction between two subsidiaries of the same company.  

Refer to this article for more information and examples of how to handle intercompany transactions.  

Despite its complexity, financial consolidation is often still being performed by outdated tools. This problem is compounded by the fact that CFOs are facing growing reporting and compliance requirements on a global scale. 

Let’s take a closer look at the most commonly encountered problems in financial consolidation. 

1. Manual reconciliation 

Many companies are still reconciling documents, tracking down pricing and contracts intra-company manually using spreadsheets and emails.   

This approach is problematic because it eats up tons of quality time, and creates bottlenecks for cross-checking transactions, causing misunderstandings and errors.

Subsequently, manual reconciliation not only prolongs the consolidation's final phase but also increases the finance professionals' workload, making the entire consolidation process both ineffective and low quality. 

2. Low-quality data

As information streams in from disparate, multiple sources, it takes time to compile. If there are concerns or questions regarding the data, it will extend the time taken to complete the report.  

If an entity uses a different currency from the parent company, the finance team typically has to conduct an extra step of converting it. This step is not that big of a deal but certainly is cumbersome.   

Imagine if the staff in charge forgets to update the exchange rate, or if the parent company does not re-check the dollar amount and continues to input the local currency base into the final report, the results will be greatly different.

3. Changing reporting requirements 

Statutory requirements and compliance regulations are constantly changing and getting more complex. They are coming from not only the government but also within the industry.   

These changes should also be reflected in the reporting process, which can also mean the existing financial consolidation reporting process turns into disarray, and therefore, requires finance personnel to input information manually.

4. Data manipulation 

Spreadsheets offer a simple look and feel, and everybody can edit them. The freedom to alter almost anything in spreadsheets is the root cause of multiple frauds and data manipulation which has happened countless times in the past, and even today. 

All of the above issues can be resolved with the right financial management software. The solution stores all information in one single repository and allows the consolidating and reporting processes to occur in real-time, eliminating the prolonged waiting time sending data back and forth.

Advanced financial management software also allows instant access to quality insights, which can significantly increase visibility. For example, mergers and acquisitions within the fiscal year can be easily added into the system to reflect the business' current financial position accurately or to ensure the continuity of the year-to-year forecast.