Understanding Intercompany Spend and Working Capital

Spend analysis is all the rage these days but one thing that is important to bear in mind is the amount of intercompany spend that goes on and why that matters. What I call Non Related party trade has significant differences to Related Party (or intercompany) trade.

First some definitions according to the U.S. Foreign Trade Statistics Regulations, who define a related party transactions as one between a U.S. exporter and a foreign consignee, where either party owns, directly or indirectly, 10 percent or more of the other party.

Related party trade is not trivial. The U.S. Census Bureau, U.S. Department of Commerce, collects data which reveals related-party trade accounts for over 40 percent of total goods trade, and nearly 48 percent of consumption imports and just fewer than 30 percent of total exports. Census related party trade data are available through an online database.

This should be no surprise as many of our Fortune 2000 trade with their subsidiaries in other jurisdictions. Why this matters is that intercompany and non related trade impact working capital needs, accounting issues, and payments in very different ways.

Accounting- Intercompany reconciliations can be very challenging with multiple subsidiaries, transfer pricing issues, etc. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. Transfer pricing is a very key area of focus for auditors to ensure profits are not moved around using over or under invoicing.  With Non Related trade, you have the whole Purchase Order / Invoice / Shipment reconciliation process, which can be manually intensive and also involve intensive Dispute Management reconciliation (wrong prices, late shipments, etc.)  I wrote about Optimizing Intercompany Settlement – It’s about cash management

Working Capital and Payment - Intercompany trade is generally financed through netting and internal funding pools. With Non Related trade, the logistics process initiates the payment mechanism. Terms can be from confirmed L/C to extended open account with just a commercial invoice.

It is important to note that intercompany trade is certainly a size thing. Intrercompany trade for middle market companies (under $1b in sales) is not significant. For companies between 250 and 500 employees, related party trade was only 18%. These companies may have a few Joint Ventures around the world for manufacturing support (eg, make a low price product line in China) but they are heavy non related party trade users.

In the world of spend analysis, intercompany trade is an important distinction for the above and other reasons.

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