As corporations increasing their global net, implementing netting and re-invoicing techniques is becoming a necessity. It saves the companies involved in transactions from different parts of the world, significant costs related to conversion of the currencies into their own.
In case of small companies with just one or two subsidiaries in different nations, the transactions are simple, even when they pay the parent in their local currencies. However, many companies are expanding their global presence and setting up subsidiaries across the globe for marketing, selling, procuring of raw material and product development benefits.
These subsidiaries pay their parent and its other subsidiary transaction money in their local currencies, which the receiver converts to its own. The conversion entails significant wire exchange charges, which can reduce significantly by using netting and re-invoicing techniques.
What is netting?
It is a tactics that multinational use to consolidate fund flows between its subsidiaries across the globe and itself to enable efficient cash management. There are two types of netting – Bilateral netting and multilateral netting.
Bilateral netting involves netting several transactions among two of the company’s subsidiaries such that the net balance that is calculated and transferred periodically. Multilateral netting works similarly, however, involves multiple subsidiaries.
Both these netting forms minimize the number and frequency of the transactions between the parent and its subsidiaries and enable better management of risks related to foreign currencies. Netting mechanisms facilitate the companies to use leading and lagging devices efficiently; these devices ensure payments before schedule (leading) or after schedule (lagging), ensuring smooth transactions. In the event of currency depreciation (relative to the receiver’s currency), leading yields benefits and in the event of its appreciation, lagging.
By implementing adequate netting mechanisms the companies can also improve their cash flows, as the mechanism necessitate proper planning of funds.
What is Re-Invoicing?
Re-invoicing refers to the process of managing risks related to foreign currency by setting up of a subsidiary. Such a process necessitates a company to establish a subsidiary, so that it purchases goods from a subsidiary based in another country and resells the goods to another subsidiary that imports such goods. The payment in such a case passes through a re-invoicing centre that manages the funds from both the units.
Such a process enables better management of the foreign currency and reduces the parent company from fluctuation in the currency rates. The process also improves the company’s liquidity profile by using leading and lagging modes of payment. It is also efficient in getting the company economies of scale, as the company trades in large chunks of foreign funds and therefore obtains cheaper foreign exchange rates.
Besides re-invoicing, there is internal factoring technique that similar to that of re-invoicing but buys the exporting unit’s receivable account.
