Your Companies Do Business With Each Other. Are You Counting the Same Money Twice?
Owning several successful businesses can create a financial reporting problem that is surprisingly easy to miss.
Company A sells products or services to Company B. Company B pays Company A. Perhaps Company C provides employees, equipment, management services or other resources to both.
Each company keeps its own books. Each reports its own revenue and expenses. Everything may appear perfectly reasonable.
But what happens when you want to know how your businesses are actually performing as a whole?
Suppose Company A bills Company B $100,000.
Company A records $100,000 of revenue. Company B records $100,000 of expense.
Both entries may be correct.
But the businesses collectively did not earn $100,000 from an outside customer. The money simply moved from one company you own to another.
If management combines the companies without properly identifying and eliminating intercompany activity, revenue and expenses can be overstated and margins, profitability, KPIs and other performance measurements can become distorted.
And intercompany sales are only the beginning.
Management fees. Shared payroll. Rent. Equipment. Inventory. Loans. Reimbursements. Due-to and due-from accounts. One company paying another company's bills.
The more related businesses interact, the more important it becomes to determine whether both sides of those transactions agree—and whether management is seeing the economic performance of the enterprise rather than simply the sum of several QuickBooks files.
Where Problems Can Hide
Intercompany problems are not always sitting conveniently in an account labeled “intercompany.”
They can be buried throughout the books—in ordinary customer and vendor transactions, journal entries, management charges, shared expenses, payroll allocations, loans, asset transfers and owner accounts.
A transaction recorded as revenue by one company may not match the corresponding expense recorded by another. Amounts may differ. Transactions may fall into different accounting periods. One company may show a receivable while the other does not show the corresponding payable. Cash transferred between companies may be characterized differently on each set of books.
Shared employees, facilities, vehicles, insurance, software and administrative costs can create another layer of complexity. So can equipment or inventory moving among related companies.
Individually, each company's books may still balance.
That does not mean the companies reconcile with each other.
And when they don't, simply adding their financial statements together may not tell management what the overall business actually earned, spent, owns or owes.
Then There Is the Tax Return
Financial reporting and tax reporting are not the same thing.
The fact that several LLCs ultimately flow into the same owners' tax reporting does not, by itself, resolve intercompany accounting issues.
Entity classification, ownership, basis, deductions, capitalization, timing and the nature of the transactions can all affect how activity should ultimately be reported.
That creates an important question:
Do the transactions recorded between your companies reconcile all the way from the individual books through the financial statements and into the applicable tax reporting?
What Should Management Know?
For businesses operating through multiple related entities, the objective is not merely to determine whether each company's books balance.
Management should be able to understand whether intercompany revenues and expenses correspond, whether reciprocal balances agree, whether shared costs and transfers have been consistently accounted for, and whether the resulting combined financial information accurately reflects the economic performance of the businesses.
Where material differences exist, they should be identified, quantified and understood.
Because the real question isn't whether you have several sets of balanced books.
It is whether all those individually balanced books, taken together, tell you the truth about what your businesses are actually earning.
That is the difference between maintaining several sets of books and having financial intelligence you can actually use to run the enterprise.
FPG-USA — From the Bookkeeping Desk to the Boardroom™
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