A Step-By-Step Guide To Financial Consolidation

Nicola van Rijn

Introduction

Financial consolidation can be a complex process, and many don’t know where to start. That's why we wrote this article providing a step-by-step guide to help you understand the financial consolidation process and what it takes to successfully consolidate your finances.

Read on for more information about the different steps involved in this important financial management task.

What is Financial Consolidation?

Financial consolidation is the process of combining the financial statements of multiple entities into a single set of numbers. The goal of financial consolidation is to give management a clear picture of the financial health of the entire organization, as well as to comply with statutory and tax filing requirements.

When is Financial Consolidation necessary?

The first step in financial consolidation is identifying the need for it. Statutory requirements, filing regulations, tax optimization, and external financing are important factors that often require consolidated financial statements. If your company is growing rapidly, it may be difficult to keep track of your finances without efficient consolidation. You should also evaluate your company's financial statements against industry norms and competitors.

If you're not sure whether or not you need to consolidate your finances, you should always consult with a financial advisor. They will be able to help you assess your company's financial situation and best practices to move forward.

The Fundamentals

The process of consolidation can be divided into several steps, which include:

1. Establish a consolidation policy: This step involves understanding which accounting principles and methods to use in your consolidation process. This policy should be consistent across all subsidiaries, and should be in compliance with Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
2. Establish a time schedule: Consolidation can be done on a monthly, quarterly, or annual basis, depending on the needs of the business. Once you determine the needs, you should set a time schedule for all subsidiaries regarding the preparation and submission of their data. This schedule needs to be strictly followed to ensure an efficient and timely process.
3. Collect financial statements: This step involves obtaining the financial statements of all subsidiaries, including balance sheets, income statements, and cash flow statements. These statements should be in compliance with the consolidation policy established in step 1.
4. Currency conversion and FX results: This step involves translating balances from subsidiaries into the common reporting currency of the parent company.
5. Eliminate inter-company transactions and balances: This step involves eliminating any transactions or balances that occur between subsidiaries, such as sales or loans. Where margins or profits have ocurred on intercompany transactions, these have to be eliminated. This is necessary because these transactions can create a double-counting effect that skews the consolidated financial statements.
6. Adjust the financial statements for any differences in accounting methods used by different subsidiaries: This step ensures that all data is presented using the same accounting standards and valuation methods, and that the consolidated financial statements are consistent, accurate, and comparable.
7. Eliminate shareholding and equity positions: This step involves eliminating all equity relationships between parent companies and their subsidiaries.
8. Calculation of non-controlling interest (also known as minority interest): This step involves using the equity method or the cost method to calculate the non-controlling interest, which is the portion of the subsidiary that is not owned by the parent company. This is necessary because it ensures that the consolidated financial statements accurately reflect the proportion of ownership of each subsidiary.
9. Make necessary group adjustments or reallocations of balances. For example, the value of certain investments, goodwill, and inventories on the Balance Sheet may need to be adjusted in the consolidated statements.
10. Preparation of consolidated financial statements: This step involves preparing a consolidated balance sheet, income statement, and cash flow statement that includes the financial information of all subsidiaries. This step should be performed in compliance with the consolidation policy established in step 1.
11. Review and analysis: This step involves reviewing and analyzing the consolidated financial statements to ensure that they are accurate and complete. This step should ideally be performed by a qualified person who was not involved in the preparation of the consolidation.

The Need For Good Process

It's important to note that financial consolidation is not a one-time process, but an ongoing one. It should be performed on a regular basis, usually at the end of each accounting period, to provide management and other stakeholders with useful and reliable financial information.

Consolidation Methods

A company can consolidate its financial statements in several ways depending on how much control it has over the subsidiary and how much ownership the parent has. The 3 financial consolidation methods are:

• Method 1: Full consolidation
  The full consolidation method combines 100% of all assets, liabilities, and revenues of a subsidiary with those of the parent company. If the parent company has a controlling interest in the subsidiary based on its voting rights (e.g. typically more than 50% of the shares or a majority board representation), this qualifies as the VOE method (Voting Interest Entity). If VOE does not apply, but the parent company meets certain criteria, the VIE method (Variable Interest Entity) may be applied instead. For further information on VIE, please refer to this PWC guideline.
  
  In case of a controlling interest which is not 100%, a liability for Minority Interest (also known as Non Controlling Interest) will have to be reported in the consolidated statements. This represents the difference between 100% of the subsidiary's equity versus the actual share that the parent company owns.
• Method 2: Equity method
  The equity method does not fully consolidate a subsidiary's financial statements with its parent company. Instead, the investment is recorded at cost and adjusted as the subsidiary value changes. A portion of certain transactions within the entity may also be consolidated with the parent company's financial statements, representing the change in the value of that investment.
  
  This method is typically used when a company owns a significant part of a subsidiary, but not a controlling part (i.e. 20-50%).
• Method 3: Proportionate method
  Proportionate consolidation involves adding a portion of assets, liabilities, equity, revenue, and expenses of a subsidiary it has invested in to the financial statements of the parent company. It is done in much the same way as a full consolidation, but based on the percentage of the subsidiary's values.
  
  This method is typically used when a company owns a significant part of a subsidiary, but not a controlling part (i.e. 20-50%).
  
  Please note that this method is no longer accepted for external filings under both US GAAP and EU IFRS, and the equity method should be used instead. However, you can still use this method for internal management reporting.

If no consolidation method applies, the subsidiary value is typically recorded at cost in the financial statements of the parent company, and received dividend are booked as income as and when these occur.

Once the financial statements have been consolidated, it is important to review them carefully. This will allow you to identify any areas where there may be discrepancies between the records. If any discrepancies are found, it is important to correct them before finalizing the consolidation process.

By following these steps, you can ensure a successful financial consolidation process for your business.

Benefits of Financial Consolidation

When it comes to financial consolidation, there are a number of benefits that businesses can enjoy. For starters, consolidating your finances can help you get a better handle on your overall financial picture. This, in turn, can help you make more informed decisions about where to allocate your resources.

Consolidating your finances can also make it easier to track your progress over time. By keeping all of your financial information in one place, you can more easily identify patterns and trends. This information can be invaluable when it comes time to making strategic decisions about your business.

Finally, financial consolidation can also make it easier to obtain financing in the future. When lenders see that you have a solid track record of managing your finances, they will be more likely to approve loans or lines of credit. This can give you the capital you need to grow your business and pursue new opportunities.

Tips To Keep In Mind With Financial Consolidation

When you are consolidating your finances, it is important to keep a few things in mind:

• Always be clear about your goals. What is the purpose of your financial consolidation and what type of financial statements do you need to prepare?
• Develop a plan of action and set a strict time schedule for all parties involved. Communication is essential.
• Be aware of the potential risks involved in consolidation. What could go wrong? Do all companies use the same Chart of Accounts? Do they adhere to the time schedule and agreed accounting policies? Do they adequately separate different types of transactions?
• Do realize that consolidation is not a quick fix or a one-off process. It is something you need to be able to follow on a recurring basis, using clear process steps, consistent methods and reliable tools.