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Tackling intercompany expenses

Tackling intercompany expenses

Problems we see in Banks

A decade has passed since the financial crisis, but its effects are still being felt. Banks continue to face pressure on margins in light of changing customer habits and new regulations. There is a high level of scrutiny on cost bases and cost management, particularly at group level, and intercompany expenses remain a problem for management and Finance teams in Banks. 

This is due to the fast-paced economic and competitive environment in which Banks operate. With so much upheaval they are struggling to keep their systems and processes up to date. This has led to several issues, such as a lack of a clearly defined cost allocation methodology, inadequate controls, a lack of e2e ownership and poorly integrated legacy systems – all of which are key to successfully tackling the intricate web of intercompany expenses.

 

Why is the focus on intercompany expenses higher now?

Intercompany expense allocation is important if Banks hope to accurately determine the profitability of each of their entities. Those that address these challenges early tend to get more out of their strategic and operational decision making. 

The lack of cost allocation transparency and an appropriate control process can lead to significant internal disputes, typically in relation to invoicing, billing and payment. Some entities may in turn find it difficult to fully recover their costs. Remedying this under recovery after the event requires a ‘fire drill’ exercise, a process that would not only increase the already significant year end workload, but also cost a bank an unnecessary amount of time and money. 

An increased focus on both cost optimisation and structural reform has led to many Banks migrating their costs to service companies. However, if the allocation process is broken, the problems of under recovery could magnify following this migration. Profitability and liquidity problems could ensue and also lead to greater regulatory scrutiny for a service company. 

 

What are the two main operating models for intercompany expense allocations?

cross the banking industry there are two popular operating models for tackling intercompany expense issues. The distinction between the two methods lies in the degree of centralisation. The ‘local model’ takes a decentralised approach, while the ‘global model’ takes a centralised approach. 

The local model requires each entity to run its own intercompany expense process, from allocations through to recovery. This is typically the first model implemented by Banks and, when run effectively, can remain a sustainable long term model. The advantages of this model are a shorter governance structure, entity level ownership of cost recovery and an increased flexibility in the local operating model. Assuming there are strong processes, effective local ownership of activities and sufficient tooling, the local model offers scalability to the bank with multiple entities. As the number of entities offering services to other group entities grows, so does the business case for the global model.

The global model is typically more effective. In this model, each entity that incurs intercompany expenses can recharge the entire amount of the cost to a global entity. This moves the cost allocation and recovery effort to a centralised entity. This model is most valuable for a global bank with a complex entity structure and significant inter-company expenses to recharge. This is due to the additional recharge which can result in increased cost, driven by regulatory, transfer pricing requirements. 

With sufficient complexity and recharge volume, however, this additional cost can be recovered through standardisation and streamlining efficiencies. Issues such as cash management, ensuring compliance with legal and regulatory requirements and under recovery will become global. They can also be managed centrally by technical SMEs. Furthermore, as the bank grows and more entities are established, they can leverage the existing structures and processes by plugging in to the existing global model.

Deciding which model to adopt is based largely on the operating structure of the bank. Key considerations should revolve around complexity of the entity structure and the magnitude of intercompany expenses.

 

How to improve intercompany expense management?

Regardless of the strategic choice of operating model, the key to successful intercompany expense management is effective process, with strong governance and controls to maintain data quality and in turn reduce the risk of cost leakage.

 
Operating model chart

Principles for successful management of intercompany expenses

To ensure the successful management of intercompany expenses it is necessary to have a well defined process supported by clear and meaningful communication. It is particularly important to get messaging right between the incurring and paying entities. Banks should also consider setting clear accountability across the e2e process, standardising key documentation and incorporating 

formally defined validation and escalation loops. Budget holders will want to see accurate and timely MI to provide stakeholders with better transparency on the flow of intercompany expenses. 

Once a well governed process with controls is in place, and cost allocation data across all involved systems is cleansed, the final step is to future proof the process by implementing an automation tool. 

Automating repetitive, production heavy activities will reduce key personnel risk and labour in the e2e process. This will enable cross functional, cost effectiveness and enable Finance to focus their time on activities that add strategic value to the bank. 

 

Click below for more perspectives on the transformative role of the Finance functions in banks.