The financial consolidation process is one of the most common denominators among most businesses, regardless of whether they’re big or small or the industry they serve. However, it’s often not a completely smooth process for many organizations, and one of the trade-offs in growing quickly is the fact that financial consolidation can become more complicated as you scale. That’s why it’s important to look for ways to standardize consolidation accounting in a way that ensures accuracy and consistency from one close to the next.
Think of this page as your one-stop shop for getting a handle on this topic and providing education for other members of your team across the organization so that if someone asks what are the rules of consolidation, everyone has the same answer. We’ll look at everything from the potential mistakes some organizations make to the accounting standards, such as IFRS, that largely inform how consolidation tends to happen within finance and accounting groups.
People often take a closer look at this area when things aren’t going as well as they could be. Consolidation might be taking too long to complete, for instance, straining your employees and taking away time that could be better spent on other projects.
In other cases, the steps involved in consolidating financial data might get greater scrutiny in response to a specific business event. An obvious example is following the close of a merger or acquisition (M&A) when the time comes to weave in an additional set of numbers into what is already processed by the accounting team.
What Does Consolidation Mean in Finance?
In a nutshell, we’re talking about the process of combining financial statements from multiple entities into a single set of statements. The resulting statements should show the consolidated entity’s financial position, and cashflows and provide a window into its overall performance as a business.
By providing a clear picture of an organization’s financial health by bringing together what’s happening across its subsidiaries, a parent company can see if it is making the right decisions for all stakeholders. This could include:
- Areas where the company has made investments, such as the development of new products, expanding into new markets or regions, or adding additional staff
- Areas where the company is reducing expenses or optimizing its costs for the long-term benefit
- How the company’s financial position helps it navigate potential competitive threats
- How the company’s financial position is allowing it to whether forces that may not be fully within its control, like fluctuations in the global economy
What Are the Rules of Consolidation?
Though there is always going to be some variability in how a specific finance and accounting group will tackle a process like this, consolidation will generally encompass the following stages:
Rule #1: Collection
Looking across whatever number of general ledger (GL) systems the organization manages, the team will gather together data such as assets, liabilities, revenue, equity, and expenses. This data is then mapped to a chart of accounts.
Rule #2: Consolidation
Fortunately, organizations don’t have to develop a unique approach to consolidation. Depending on the nature of the business and its sector, the finance and accounting team consolidates the number according to the most relevant regulations. The most common sets include international reporting financial standards (IFRS), or the U.S. generally accepted accounting principles (GAAP) standard. In consolidation accounting, IFRS has become increasingly recognized for assisting with areas such as how well an organization adheres to sustainability disclosure standards.
Rule #3: Reporting
Once the finance and accounting team has crunched the numbers, the results need to be shared with several parties. This can range from internal stakeholders such as the management team and board, as well as external stakeholders such as auditors. In either case, the numbers have to be consistent, up-to-date, and error-free.
The report formats you need to prepare as part of this exercise include a balance sheet, a statement of cash flows as well as an income statement.
What Are Some Consolidation Journal Entry Examples?
Overseeing a successful consolidation exercise means more than totaling up a set of numbers in a spreadsheet. It involves performing a series of specific calculations – and making adjustments in some cases – based upon the data collected about subsidiaries as well as the parent company itself.
Depending on the organization, its growth rate, and the number of entities it oversees, for instance, finance and accounting teams may have to consider the elimination of intercompany transactions and balances. Journal entries often have to be adjusted. For organizations that are active in multiple global markets, there are often foreign currencies that must be taken into account.
Ownership stakes can be another factor. Some firms also have to adjust accounting for partial ownership of some entities, for instance. There is where an equity accounting approach most likely makes sense, where reporting focuses on revenue equal to the parent company’s minority interest or share of the subsidiary’s revenue.
In companies that own more than a 50 percent controlling interest in an entity, the entity’s revenues, expenses, assets, and liabilities all roll up into the consolidated financial statements of the parent company. This can be relatively straightforward when companies have few subsidiaries, but consolidation becomes more complex as the parent company continues to grow, scale, and pursue additional M&As. There are also security risks to bear in mind: organizations can get fined for failing to properly safeguard data culled from multiple entities.
Intercompany transactions pose one of the other most common consolidation hurdles. Even though a pair of subsidiaries are owned by the same parent firm, they might occasionally do business together. One may become the customer of the other, for example. When this happens, it’s important for the finance and accounting teams to avoid unconsolidated financial statements – in other words, where they overlook intercompany transactions and fail to remove the relevant profit and loss information from their reports. This not only includes lateral transactions between two subsidiaries, but transactions between a subsidiary and its parent (also known as an upstream transaction) or “downstream” transactions where a parent does business with the subsidiary.
The Biggest Financial Consolidation Process Pitfalls
Given how integral it has become to companies across almost every conceivable market, you might assume that businesses ensure their finance and accounting teams are given everything they need to consolidate their finances as quickly and easily as possible.
In many cases, unfortunately, you would be wrong.
Instead of seamlessly bringing together all the data they need to prepare their final reports, finance, and accounting teams are often buried in manual tasks that take far longer than they should. Here are just a few common scenarios:
· An important document makes mention of a price that doesn’t quite look right. Someone has to go on a hunting expedition through myriad databases, trying to find the original contract and double-checking that the price listed is correct.
· In the effort to eliminate an intercompany transaction or adjust a journal entry, it becomes clear that the only place the necessary details are mentioned were within an e-mail message. This means an accounting team member has to hound a coworker whose inbox is key to resolving the mystery. This can be even worse when the data is locked in a spreadsheet and there is uncertainty about which one is the most recent version.
· All the details about the parent company’s subsidiaries are up to date and close at hand – but the global nature of the organization means the revenue is listed in dollars, Euros, the British pound, and even Japanese yen. Like it or not, the accounting team will have to do all the currency conversion the old-fashioned way, keeping in mind all the possible exchange rate changes.
This is probably a good place to stop and reflect on the fact that finance and accounting teams are not machines. They’re people. No matter how well-trained and experienced they are, to err is only human. The more extra steps they need to take as they consolidate the books, the more they might inadvertently introduce errors or overlook a discrepancy in the data.
Why ERPs Don’t Work As Financial Consolidation Software
To be fair, many finance professionals are working within systems that are not necessarily manual but have their own set of drawbacks. Just take enterprise resourcing planning (ERP) platforms—those enormous, do-it-all pieces of software that many companies spent significant sums and in some cases years to properly deploy.
ERPs are great for handling certain tasks, such as managing payroll data, supply chain data, or even some of the records used by human resources departments. From a consolidation perspective, however, they can represent a cumbersome piece of technology to extract the data accounting teams need. It’s often a case of downloading data in batches, and the process can take hours – or even an entire night. ERPs were also never designed for financial reporting and analysis, so arguably the biggest and most difficult part of the job will continue to fall upon the talented people on your accounting team.
Adding to the problem is the fact that many fast-growing companies wind up with not one but several ERP platforms, based on the subsidiaries they’ve taken on through M&A activity. Plus, most of the older ERPs out there in the wild are strictly on-premise software installations. That means it’s harder to update the platform or to decentralize the data in ways that benefit the company. Although there is a cottage industry of high-priced software consultants who will gladly take on these tasks, it may not be the best way to make use of an organization’s IT budget.
Key Features of the Best Financial Consolidation Software
In response to this growing need for tools that are purpose-built to assist with consolidating financial statements, technology vendors are beginning to offer platforms that can overcome all of the challenges and bottlenecks we’ve listed in this post.
For starters, the kind of financial consolidation software Gartner and other market research firms tend to recommend is cloud-native. Instead of being hosted and managed locally within a company’s data center, in other words, these platforms work on a software-as-a-service (SaaS) model. That can bring considerable advantages in terms of accessing data, providing a flexible way to manage compute resources and even costs.
Rather than taking months or even years to work before companies see the value, meanwhile, consolidation software systems for finance departments can offer out-of-the-box functionality. The accounting team can take advantage of the platform’s key features quickly and easily, with minimal training or disruption to their existing business processes. It just takes away the grunt work while improving the overall quality of the results, such as their consolidated statements and financial reports.
These kinds of cloud-based finance and accounting platforms aren’t limited to consolidation, either. They can often assist with other key tasks such as the financial close, regardless of whether you’re closing the books quarterly, monthly, or even aiming for a continuous close. The best of the bunch even make reporting more dynamic, so that finance and accounting teams can tweak or customize the way they present information depending on whether it’s an auditor, the management team, or some other important stakeholder.
What Does Consolidation Mean in Business?
Developing a better process for putting together financial statements regularly isn’t just good for those in finance. It benefits the overall business.
Trustworthy consolidation allows anyone in the company, no matter their function or role, to have a single version of the truth about the company’s financial health. That can inform everything from the budgets that are allocated to a line of business to whether expanding into a new market or acquiring another firm is the best idea.
As much as we often associate startups with being agile and quick-moving, meanwhile, those are traits businesses of all kinds would like to develop. A solid approach to consolidation helps by cutting back on the time it takes to get the information you need to respond to changing market conditions.
What is consolidation in simple terms? This process could prove central to transforming from a company that reacts to what’s happening around it to one that can get ahead of opportunities, and move towards a brighter future.
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