Group Netting
Internal companies with mutual receivables and payables can use corporate netting to increase their financial efficiency and at the same time significantly reduce risks.
Netting, derived from the English term "to net", is a process in which receivables and liabilities are compared and offset against each other. With the purpose of payment (usually, but not always in cash) reduced to a single amount and offset. However, the greatest benefits are not always apparent at first glance.
First of all, netting in the organized sense is generally only suitable for receivables and liabilities that have arisen within a group structure. Offsetting debtors and creditors is also a common practice, but stops at the individual supplier-customer relationship. However, the basic idea is the same.
Problem / task
Does this example also apply to your group?
- XYZTest Group, holding company in country A with subsidiaries (controlled) in countries A, B, C, D, E and F.
- A delivers to B and E and invoices in currency A.
- C supplies to A and D and invoices in currency C.
- D delivers to E and settles in currency E.
- etc etc.
This gives rise to the following problems and the associated risks:
This has led to the following problems and the associated risks:
A) Quantitative impact
- High costs for payment orders due to a high number of payment transactions.
- Currency risks of the beneficiaries. These are mostly in other countries and/or have income in a different currency than the one invoiced. Conclusion: external risks are built up through internal processes! To be measured quantitatively with e.g. value at risk or cash flow at risk.
- Exchange rate costs: for the same reason as in 2., the service recipient must now pay relatively small foreign currency amounts, often even from an account that is not denominated in the invoicing currency. These additional transaction costs amount to around 2%-4% of the total invoice amount! In today's world, where margins are agreed to the second decimal place in lengthy negotiations, this is a pure waste of money.
- Each individual payment also increases the risk that too much or too little is paid due to incorrect entries, which often results in very labor-intensive clarifications, which in turn are expensive. If these incidents were measured over a certain period of time, some CFOs would be surprised at the high amount that results.
- If the exchange rate risk were centralized through netting, this central office would firstly be able to offset the exchange rate risks against each other in a first step and actively manage what remains in a second step.
B) Qualitative effects
- Counterparty risk also increases with every transaction. Imagine you give a payment order to your bank, which processes it via a third-party bank, e.g. Lehman Brothers (without you knowing about it, which is quite normal in international payment transactions). You bear the default risk, not the bank with which you ordered the payment! As this risk is difficult to quantify, it is categorized as qualitative at this point.
- The time-consuming, risky and therefore also worthy of optimization problem of intercompany reconciliation is a process that can be considerably simplified and shortened with netting. Due to the permanently monitored netting processes, there are extremely rare differences at the end of the month or quarter, which are usually resolved quickly with the help of the central netting point.
Characteristics of the transactions concerned are given by the legal framework: Receivables and liabilities must be due and must also be offsettable in their nature at all. The most common types of IC transactions are
- Local costs prepaid by a company
- Interest from IC loans -Goods from upstream production
- Management fee -Service fee
- orp. recharges with fixed key
From chaos to order
 Before, criss-cross |  Afterwards, coordinated centrally |
Organisation
As already shown in the "After" illustration above, the Corporate Netting Center is a central key point between all Group companies. This basically answers the question of where the netting center should be located. Preferably, the netting center should
a) belong to the treasury department and this
b) in a location that offers as many double taxation agreements and as few regulatory requirements as possible due to tax and other advantages.
Positive examples would be the Netherlands, Luxembourg (taking into account the fact that these are EU countries and taxes can also be an issue), Switzerland and Singapore. Negative examples are almost all African countries, Russia, most Latin American countries, especially Venezuela and Argentina - which have also annexed entire companies, as Russia has done since 2022.
Risks
Nothing in this world is without risk and nothing is free (as Adam Smith noted in Wealth of Nations). Most risks can be identified and kept under control through precise and, above all, professional planning and weighing up strengths - weaknesses - opportunities - threats by means of an accompanied project. For the sake of completeness, the risk of transfer pricing should also be mentioned here, which - correctly recognized - can also be reduced or even avoided by introducing group netting.
Conclusion
The introduction of a central clearing office, the so-called Corporate Netting Center, avoids many costs, reduces expensive risks and significantly simplifies coordination processes with little effort.