Intercompany Loans: Smart Cash Management

Intercompany Loans: Smart Cash Management


Sometimes liquidity management is a challenging
problem for many companies. Particularly in case of companies that have many
subsidiaries located in different parts of the world. Companies that upscale
via the mergers and acquisitions route face this problem more. This is because
they generally have many subsidiaries, the business of which is not perfectly integrated
with one another.


Over the years, companies realized
that it is very costly affair for individual companies to borrow from the
external market. Also, it is not a worthy decision for one subsidiary company
to borrow money from the market at a higher interest rate while another
subsidiary of the same company is having cash overflows and depositing money at
a lower rate of interest. Hence, there is a need of system wherein one
subsidiary of the company can give loan to the other and both companies are in
win-win situation. Such loans are called intercompany loans.


Intercompany loans are loans from one subsidiary
to another, within the parent company. These Loans are operated in the same manner
as any other traditional loans. The borrower is under a legal obligation to repay
the money with interest to the lender. Interest is deducted during loan tenure
each time from each recorded loan payment. Intercompany transactions generally have
a fixed interest based on the existing market rate with a loan term agreement
from one year to five years. Intercompany lending has many benefits, such as
quickly shifting cash between subsidiaries or avoiding bank fees and charges.
The loan should have an appropriate business purpose and be of interest for
both parties to the transaction.



Why Intercompany Loans?

Intercompany loans are loans made from
one entity of a company to another, usually for one of the following reasons:

To shift cash to a business entity that would
otherwise experience a cash shortage

To shift cash into a business entity (usually
corporate) where the funds are pooled for investment purposes

To shift cash within business entities that
use a common currency, rather than transferring in funds from a foreign
location that will be subject to exchange rate fluctuations

Intercompany loans can help the company to reduce
the cost of financing to a great extent. Since the funds are accrued from
different subsidiaries within the same company, loan processing, loan
origination and other loan charges do not have to be paid.

Companies use this type of funding as a ready
cash flow problem solver. For example, a subsidiary can fix financial issues or
launch a new product without burdening costs by borrowing from a parent

A parent company can also release this stress
by investing in the form of loan. The income earned is invested towards the
loan, and the creditor takes their share from owning the subsidiary as net
income grows.

Both entities also reduce enormous paperwork
associated with bank loans. ‍


Types of Intercompany Loans

Intercompany loans can be of two major
types based upon the cash flow arrangement between the companies. These two
types are explained below:

The first type of intercompany loans
is hub spoke model, all subsidiary entities (spokes) companies transfer their
excess money to a central organization (hub). This central organization then
transfers money to other subsidiaries which are in need of funds. This means
that the intercompany loans are not directly made, but indirectly. Every
subsidiary deals with the hub (parent company) in this arrangement. Most companies
like this type of intercompany loans since it removes the counterparty risk for
the subsidiaries involved.

In the second type of intercompany
loans arrangement, the centralized approach is not followed. Each company has
its own excess funds which they want to lend out. Many times, the parent
company encourages lenders and borrowers to place a bid in a virtual
marketplace to ensure that funds are being utilized in the most optimal manner.


Problems Faced While Making
Intercompany Loans

Intercompany loans are to be made within
a very short span of time. Many companies do not have correct data about the
amount of cash that they have on hand. The accounting for intercompany loans
can be quite complex at times.


Role of Commercial Banks in Automated
Intercompany Loans?

The fact is that commercial banks have
come to realization that companies do not always want to borrow from them. Most
of the times, they want to make more efficient use of their own excess funds.
Commercial banks are helping such companies to do so and have started earning
revenue in the form of transaction fees during the process.

Commercial banks have realized this
problem and have come up with different solutions to make the intercompany loan
process more . Some of the steps that commercial banks take are as follows:

Commercial banks have created tools
and software that enable automatic disbursement of intercompany loans up to a
certain threshold amount. Banks scrutinize the financials of each subsidiary
and set a credit limit up to which funds can be easily disbursed at the click
of a button. Hence, subsidiaries get access to funds in time which makes
intercompany lending more viable.

Commercial banks have also created web
interfaces where a wide variety of loans such as perpetual loans, long-term
loans, working capital loans, etc. can be automatically made within a very
short span of time by click of a few buttons. Commercial banks have built-in
specialized software which assists in automatic tracking as well as the
reconciliation of intercompany loans.


Advantages of Intercompany Loans

Intercompany loans are highly useful,
because no credit application is needed, the cash can be made available on
short notice, and repayment terms may be much longer than would be required by
a commercial bank. No need to fill out long irritating loan applications with
multiple banks or assent to high-interest rates. Intercompany Loans process is
typically done through third-party software. Investment capital raised by the
parent company can be transferred directly to the subsidiary. Banks or
outsourced companies take a share of the loan. Companies make full utilization
of cash flows.



Intercompany reconciliation and settlements: Though
both the parties are related but one party may question the interest
recordings, a payment could be logged as missing, or for different accounting
periods can cause problems with proper reconciliation.


Inability to pay: If the
subsidiary or borrower takes a brutal financial setback, the cash flow problem
can percolate to the issuer. This can negatively impact the financial worthiness
of both companies and affect overall credit ratings, which can make bank
borrowing harder in the future.


Complex Tax issues: Intercompany
accounting is a complex, multi-dimensional process that involves a number of
stakeholders, including Accounting, Tax, and Treasury. For companies, getting
started may seem very much overwhelming.
The interest rate, payments and
transfers must be recorded, and each is subjected to individual tax
regulations. Tax issues are very complex for both the entities. It is possible
that the use of intercompany loans may cause tax problems or other issues if
not handled properly. The subsidiary receiving the loan will have interest
expenses, while the creditor entity will have interest earnings. This is
subject to tax rules and regulations. The main challenge here is that the
interest rates should be market driven in accordance with an at arm’s length
price. Intercompany loans are guided by specific principles to derive the at
arm’s length price, which are laid down in the OECD Guidelines. A very important
aspect of the new guidelines is the inclusion of more methods to determine the
at arm’s length interest rate of intercompany loans, such as credit default
swaps and economic modelling.


Tips for Intercompany Loans

Perfectly defined roles: All
person/legal entity involved in transferring and receiving intercompany funds
should have a clear and well-defined job with specific responsibilities to
avoid wire-crossing.

Proper tools and software: Implement
time-saving tools and software that seamlessly integrates funds with an
accurate reflection of different metrics. This is very important when
accounting periods do not line up between companies.

Cash management: This loan
is most likely for a specific business purpose. Ensure that the parent company
or the subsidiary know where the money is going.



Intercompany loans have many
advantages and that’s why many companies are engaged in these loans to make
optimal utilization of cash flows. The use of intercompany loans can also cause
tax problems, since the issuing business unit should record interest income on
the loan, while the receiving unit should record interest expense – both of
which are subject to tax rules and guidelines. When an intercompany loan is made,
it should be well documented, including the amount of the interest rate to be
charged and principal repayment terms. Otherwise, the loan might be considered
an investment by the issuing business unit in the receiving unit, which can
create other tax problems. Intercompany loans are recorded in the financial
statements of individual business entities, but they are eliminated from the
consolidated financial statements of a group of companies of which the business
units are a subsidiary, using intercompany elimination transactions. With a
bunch of both pro and cons of intercompany loans, it is more sensible decision
for a parent company to make a balance between intercompany loans and external
bank borrowings.


Author: Vineet Bhardwaj


Vineet Bhardwaj is Chief Manager
(Faculty) at Union Learning Academy for Strategy and Finance at Gurugram. He
can be reached at


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author/s in the article is/are their own. Bank promotion Study
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