Netting and Working Capital Management
Netting and Working Capital Management
While a centralised treasury program with a well-run netting program is often the ideal for multinationals, implementing one or starting an intercompany netting program can be daunting.
There are many challenges that arise when setting down the path. There may be hundreds of bank accounts, often with no real visibility. There may be dozens of separate legal entities and just as many currencies to manage across both entities and accounts.
Add in the tendency for businesses to grow via acquisition and as a result operate in a multi-system environment, and it's often difficult to even get visibility into payment processes, much less visibility into accounts, vendors, and payments.
Dealing with these challenges can be as labour-intensive and expensive as they are daunting. Fortunately, there are vendors who can assist in developing netting programs, yielding important benefits that can help make the juice worth the squeeze.
Intercompany Netting
Intercompany netting is often the first step in moving toward a treasury system that operates under ‘best practices.’ Specifically, it is often a first step for:
More Effective FX hedging: “Netting” FX exposures within the group of companies before implementing tools to hedge FX risk can help reduce FX exposures and transaction costs. It can be cheaper and safer to find offsetting exposure before executing a hedging program.
Cash Pooling and Sweep Programs: Intercompany netting can unlock ‘hidden’ cash balances within a group of companies. These cash balances can then be centralised and ‘swept’ to increase interest income as well as improve access to cash and improved working capital management.
POBO (Payments-on-Behalf-Of), COBO (Collections-on-Behalf-Of) & IHB (In-House Banking): Much can be written about this, but a centralised treasury, with an intercompany netting program, is a prerequisite for each of those strategies.
FX Netting Approaches - Bilateral Netting versus Multilateral Netting
Bilateral Netting
The simplest netting process is bi-lateral netting, involving two subsidiaries. Bilateral netting is the easiest to conceptualise; when finance teams think of netting. it is often bilateral netting that they think of first.
Imagine a mid-sized Canadian technology company with USD denominated expenses and revenues. In most cases they would be a net seller of USD, meaning they receive more USD inbound cash than they need to disburse for COGS/COS or SG&A expenses.
In general, a business like this might have one or two legal entities, and a bank account for each currency for receipts and disbursements. Since they don’t need to make conversions to cover USD expenses, they would consider that a ‘natural hedge’. This is a form of bilateral netting within the firm.
Multilateral Netting
In large organisations with multiple legal entities operating in multiple jurisdictions and currencies, a bilateral netting program is unlikely to suffice. Trying to identify offsetting currency exposures between individual entities is a laborious process, and you may ultimately miss netting opportunities within the group.
Thus, multilateral netting is the standard for many companies with multiple subsidiaries.
Getting To Brass Tacks – How Is It Done?
As mentioned earlier, it is typical that businesses looking to develop netting programs are likely to be encumbered by a multisystem environment across many legal entities, currencies, and accounts. Knowing where to start can be a challenge: One might be tempted to do a deep forensic dive into their bank accounts and account ledgers, but it ultimately may not be necessary to do all that.
At Corpay we have our own intercompany netting system that is much more straightforward to implement, and can help in facilitating visibility into FX positions, accounts and transactions without necessitating a deep dive.
The first key step is extracting Accounts Payable (AP) and Accounts Receivable (AR) data from all the systems, and consolidating them into one database. From there, netting engines like Corpay’s will identify and match offsetting transactions across the group and consolidate transactions into one payment per entity, per currency, per payment cycle. These steps can help drive significant cost and risk reductions while unlocking cash.
Results
While often thought of as simply the remit of large corporations with built-out treasury teams, we’ve seen material benefits of netting for mid-market corporations operating in multicurrency environments.
Let’s use the example of a US-based manufacturer, with $400M USD revenue and subsidiaries in six countries with six separate currencies.
As you can see, not only does the organisation realise substantial cost savings in hard costs of wire fees and FX spread, but the organisation is also able to free up cash held within subsidiaries to settle its intercompany transactions.
With treasury yields around 4%, this opens the possibility of generating material interest income on top of proving working capital benefits.
As we will see in our next piece, working capital management has implications beyond treasury: for private equity or credit providers, it can have a material impact on corporate valuations as well.
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