Global corporations that span multiple business units tend to have a big mess of inter-company transactions to clean up. Not wanting to spend a lot of time, money and effort on individually carrying out reconciliation, a lot of companies rely on netting centers.
Multi-lateral netting is the process by which buy/sell transactions between different operating units in a company get settled. Typically, one unit may be buying (generating payables) from another unit while at the same time selling (generating receivables) to this same unit. At the end of the day, there are numerous complexities with foreign exchange exposure, float management, and inter-company receivables that need to be addressed.
The costs of these inter-company transactions extend from cross border flows, to redundant banking charges to currency exchange fluctuations. On the other hand, I don’t know if there is a lot of benefit to be gained from inter-company transactions – they’re just a cost of doing business. The key is to use multi-lateral netting to reduce this cost across the company.
The netting cycle is a key component of liquidity management. If carried out properly, the savings can be substantial and also drive improvements in global cash forecasting. At a high level, the netting cycle follows this process:
- The trading business units send their transactions over to the netting center. For example this would be the receivables, payables, and backup documents (inter-company Purchase Orders and Sales Orders)
- The netting center reviews all sent transactions within a fixed time period. These are then process further in the cycle
- The netting center uses currency exchange rates to a common currency. Since the two business units could be in different countries, this is an important step
- This common currency (indicative rate) tries to be in line with market fluctuations, but is not always 100% representative. These variances need to be taken care of during the full iquidity management fucntoion. This idicative rate is used to normalize all buy/sell transactions for the participating business units and then the “netting” process occurs. The result is the net payment or receipt per business unit
- Based on the netting cycle period, the netting center notifies each business unit when their payment or disbursement will occur. In addition, taking into account the currency rates, a decision is made on how much the net payment or receipt is for.
- The netting center then contacts the banking institution and spot buys or sells its currency surplus or shortfall to cover the transaction.
- The settlement occurs where the netting center appropriately carries out the net transaction between the participating business units
I’m going to talk about the benefits of this process next and also some of the challenges of dealing with the FX exposure. Also, the netting schedule is clearly a factor that needs to be taken into consideration during cash forecasting.
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