Automated Intercompany Loans
Liquidity management can be a big problem for several companies. This is particularly true if the company has a large number of subsidiaries that are scattered in different places around the world.
Companies that grow via the mergers and acquisitions route tend to face this problem more than other companies. This is because they often have a lot of subsidiaries, the business of which is not tightly integrated with one another.
Over the years, companies have come to the realization that it is quite expensive for individual companies to borrow from the external market.
Also, it does not make any sense for one subsidiary company to borrow money from the market at a higher rate of interest while another subsidiary of the same company is depositing money at a lower rate.
Hence, a system needs to be created wherein one subsidiary of the company can make a loan to the other and both companies are better off in the end.
The borrowing company would have to pay a lesser rate of interest while at the same time the lending company would receive a higher yield creating a win-win situation.
Facilitating intercompany loans as well as accounting for them can be an incredibly complex process. This is because of the fact that it is possible for several regulatory and tax authorities to also be involved in the process.
Commercial banks typically help their clients simplify and automate their intercompany loans process.
In this article, we will have a closer look at how commercial banks are able to add value in the process.
Why are Intercompany Loans Required?
Intercompany loans can help the company drastically reduce the cost of financing. Since the funds are accrued from different subsidiaries within the same company, processing, loan origination and other financing charges do not have to be paid.
Also, there are certain charges associated with borrowing any kind of money from the market. These charges too can be avoided.
Intercompany loans help the company utilize its cash flow to the maximum. It enables the optimum use of cash flow throughout the company.
Types of Intercompany Loans
Intercompany loans can be of two major types depending upon the cash flow arrangement between the companies. The two types have been explained below:
- In the first type of intercompany loan, all subsidiary companies transfer their excess money to a central organization. This central organization then transfers money to other subsidiaries which require cash. This means that the intercompany loans are not directly made.
Instead, every subsidiary deals with the parent company. Many companies like this approach since it removes the counterparty risk for the subsidiaries involved.
- In the second type of arrangement, the centralized approach is not followed. Each company has its own additional funds which they want to lend out. Many times, the parent company encourages lenders and borrowers to bid in a virtual marketplace to ensure that funds are being utilized in the most optimal manner.
Problems Faced While Making Intercompany Loans
When subsidiaries of companies make intercompany loans to each other, they face several problems. Some of the important ones have been listed below:
- It is important to make intercompany loans within a very short span of time. Many companies do not have visibility about the amount of cash that they have on hand.
Hence, they are not sure whether intercompany loans will suffice or whether external funding needs to be sought
- The accounting for intercompany loans can be quite complex. Any intercompany loan is generally followed by a large amount of paperwork. This discourages companies from trying to fund their operations from within since the process seems too complex and error-prone.
How Commercial Banks Help in Making Automated Intercompany Loans?
Commercial banks across the world have realized this problem and have come up with various solutions to make the intercompany loan process better. Some of the steps taken by commercial banks are as follows:
- Commercial banks have created tools that enable automatic disbursement of intercompany loans up to a certain amount.
Banks study the financials of each subsidiary and prescribe a credit limit up to which funds can be easily disbursed at the mere click of a button. Hence, subsidiaries get timely access to funds which makes intercompany lending more viable
- Commercial banks have created web interfaces where a wide variety of loans such as perpetual loans, long-term loans, working capital loans, etc. can be made automatically within a very short span of time at the click of a few buttons.
- Commercial banks have built-in specialized software which helps in automatic tracking as well as the reconciliation of intercompany loans. The software automatically generates accounting entries for interest as well as principal payments.
Since banks often have a connection with the ERP system of their corporate partner, such entries are posted into the accounting books of the corporation with a high degree of accuracy and minimal supervision.
Benefits of Automated Intercompany Loans
The intercompany loan process had two major drawbacks viz. it was slow and it was complicated. Commercial banks have created software systems that can help eliminate these problems.
It is now possible for subsidiaries to obtain intercompany loans almost instantaneously and the recording and reconciliation have also been largely simplified.
Hence, it can be said that commercial banks have become key players in the intercompany lending process.
The fact of the matter is that commercial banks have realized that companies do not always want to borrow from them.
Sometimes, they want to make more efficient use of their own cash flow.
Commercial banks are enabling corporations to do so and have started earning revenue in the form of transaction fees during the process.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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