What is financial consolidation?
Consolidation is the process of combining things. But you add the "financial" element into the mix; financial consolidation is combining financial data of a parent company and its subsidiary companies or entities across many levels.
The result is a single set of consolidated financial statements, consisting of an aggregation of the balance sheets, profit and loss/ income reports, and statement of cash flows for all the companies in the group. This gives owners and managers a top down view of how an entire company is doing and provides high-level information to make informed decisions.
The strategic role of consolidated financial statements
For companies with many different entities, a complete overall view is required for proper corporate performance management. Consolidated financial reports have much strategic value to those doing the company's financial planning; without them, managers would be "going in blind." They'd be basing the company's financial planning on incomplete information.
Consolidations must be performed at the minimum every fiscal year, if not quarterly or monthly. Putting the steps in place to streamline consolidations and automating manual processes and resource intensive tasks should be the key goals of the finance professionals tasked with the job. If you follow best practices and use the right software tools, it doesn't have to be time consuming or difficult.
When would your company need to have a consolidation process?
Accounting rules in different jurisdictions have differing reporting and compliance requirements regarding when a company should consolidate (e.g., US GAAP vs. international IFRS standards). But in general, a company will need to generate consolidated financial statements when:
- The company has multiple wholly owned subsidiaries
- If a company owns other companies, whether wholly or partially, they should consolidate financial statements towards the top entity.
- This is common when a company has offices in different countries or starts different lines of business.
- The company owns portions of other companies
- This includes partially owned subsidiaries, joint ventures, associated companies, and portfolio investments.
- Minority interest in another company must also be reported, though many jurisdictions have a minimum threshold before consolidation is required.
Who performs the consolidation of financial statements?
- In-house finance departments - Companies often have internal finance departments responsible for daily accounting functions. These finance teams can have a few as 1 or 2 people (for SMEs) that perform manual processes, to hundreds of people for larger companies.
- Outsource accounting teams - Companies can outsource their finance teams to third-party bookkeepers, accountants, and fractional CFOs. These outsource teams are often experts in their field and are knowledgeable on the newest accounting principles and accounting standards.
Why are consolidated financial statements necessary for businesses?
- A consolidated financial statement provides a comprehensive overview (income statement, balance sheet, and cash flow statement) of the company, which is essential for making informed strategic decisions.
- The management team can utilize the financial reports to ascertain the company's performance and identify potential opportunities or risks on the horizon.
- The company's investors can use the consolidated financial statement to evaluate the company's market position and receive financial reports on how operational, financial, and investing activities are currently managed.
- Reporting requirements include the company's financial results group to internal and external stakeholders.
- Assessing the tax liability of the entire group of entities requires consolidated data and ensuring that they are done ensuring they are prepared for filing deadlines.
Financial consolidation best practices
From the start, ensuring the company's financial data collection and data management are maintained in good shape is imperative to a successful financial consolidation and positive business outcomes.
At the most granular transaction level, it's essential to ensure that your company has good accounting software. Using accounting software is the first step in employing best practices to ensure you don't have significant delays due to a company's manual processes and investigate data manipulation issues when there are discrepancies.
At the minimum, companies with a finance team should have well-documented accounting for each entity and make sure that there are also processes for cross-checking transactions that are entered (for human error), and for making sure all expenses are allocated to the correct expense accounts.
Chart of accounts of the entities should all be the same across different entities to ensure that the correct accounts are combined when merging balance sheets. If the chart of accounts is not the same, they will need to be mapped to a common set of accounts so that the consolidation can be performed seamlessly.
When performing financial consolidation for your business, it's important to note that the financial statements for your parent company and all subsidiaries must be prepared with an exact date and consistent accounting policies.
Though, on the surface, consolidating your business' finances means combining the statements from the parent company and its subsidiaries, it's not as simple as adding the figures together in a lump sum.
What is the process of financial consolidation?
The process will entail importing trial balance data, re-mapping your general ledgers into a centralized chart of accounts, and, importantly, ensuring financial compliance. Remember that subsidiary transactions are often complex - so be sure to set aside some time for adjustments.
Intercompany reconciliation: A company can have intercompany transactions, including loans, which need to be documented and reconciled. Interest income and expenses earned between the companies must also be allocated.
The reconciliation of intercompany transactions and eliminating them is one of the most critical parts of financial consolidation processes. This is to ensure that all entities have properly recorded these intercompany transactions as assets and liabilities against the correct business entities on the balance sheet. Transactions are then not double counted and won't incorrectly inflate or deflate assets or liabilities on the balance sheet.
Currency conversion: If entities have bank accounts or operate in different currencies, exchange rates must be considered. Each company should have a standardized reporting currency to which all their entities must convert.
Finding the right financial consolidation software for your needs
Generally, the financial consolidation process is handled by the company's accounting team. As every company is different, there is no 'one size fits all model for how to proceed, but there are some recurring themes regarding the best tools to utilize.
Your choice of software tool may vary depending on your company's preference, processes, and general complexity. While financial consolidations were once a very manual function, these days, there are several types of electronic tools at your disposal to support your reporting purposes. Some of your options are;
Some finance managers opt for the cost-effectiveness, familiarity, and simplicity of Microsoft Excel spreadsheets. However, it has its downfalls - lack of collaboration, version control issues, and the high chance of administrative errors. For this reason, it may be worth considering other options.
A Single ERP system
One approach for large enterprises that can afford a holistic system is to utilize the general ledger component of your existing ERP (Enterprise Resource Planning) system. As far as advantages go, it allows the company to use current technology, meaning no re-training is required. It does have the trade-off of limited reporting capabilities and probably isn't the ideal option for more prominent companies with multiple charts of accounts or ERP systems.
A specialized software solution
You may choose to engage a specialty software alternative instead. Opting for a product optimized to do the very thing you need it to do usually pans out to be the best idea in the long run. You will likely find specialized financial consolidation software to meet your functionality expectations right out of the box. The flexible reporting capabilities and ease of integration with other ERP systems are enormous bonuses too.
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Features of different financial consolidation tools
- Resolving data quality and collection errors stemming from manual entries and lack of integration across processes
- Eliminating the delay in reconciliation due to intercompany transactions
- Improving performance from existing consolidation applications
- Automating heavily manual processes
- Supporting currency translation for international transactions
- Increasing efficiency of audit trails
- Accounting and calculating group ownership
- Capacity to keep evolving regulatory guidelines
- Providing security restrictions in terms of access and ability to manipulate data
- The adjustment of journal entries
- Financial reporting templates
- Consolidated income statement, balance sheet, and cash flow statement.
In summary, when it comes to financial consolidation, there are many paths you can go down according to your business needs. There is no one right solution, and it's a case-by-case situation. Hopefully, armed with all of the pros, and cons you feel more confident in your financial consolidation journey.