Multilateral netting is a payment mechanism whereby accounts payable can be offset against accounts receivable among three or more counterparties, leading to fewer transactions and invoices. At the hub of the netting system is a netting center that determines the net amount due or owed between multiple parties and facilitates funds transfers. Centralizing the payment system in this way leads to an easier settlement process and lower transaction costs.
How the Netting Process Works
Intercompany settlement goes through four basic steps in a netting arrangement:
- Counterparties send their invoices to the netting center. This is the facility that is responsible for the settlement process and overseeing funds transfers.
- Invoices should be verified. If there are any disputes during this invoicing process, they should be resolved during this step.
- Once all the intercompany invoices have been tallied, the netting center will determine how much each counterparty owes or is due. This is the offsetting calculation.
- Now it is time for intercompany payments and the settlement process. Entities that owe money will send funds to the netting center. With this cash pool, the netting hub will send payments to the netting participants who have a positive net balance. This cash flow is monitored closely by the netting center using risk management protocols.
Intercompany netting typically follows a precise schedule where payments come in and go out on clearly defined due dates. This payment mechanism allows for predictable money movement, reducing the burden of many AP offices.
Treasury Management of Netting Solutions
The treasury department of a company can utilize a netting system to oversee and scrutinize the organization’s cash management. By adopting a netting process for invoice management, the treasury ensures less cash in transit, which of course makes bookkeeping an easier task. And because there are fewer transactions involved in the netting process, cash spends less time in-between payees and payers.
With a netting system, treasury is also able to see which organizations are struggling financially, and to supply liquidity if a payer needs an influx of cash. With such supervision, intercompany transactions are less likely to experience problems.
Besides multilateral netting among several companies, it’s also possible to perform intercompany settlement between two businesses. Known as bilateral netting, this arrangement settles invoices between two firms by offsetting their invoices through a netting center.
For either bilateral or multilateral netting, the processing cycle is usually one month; although shorter and longer cycles are also sometimes used. For the month-long cycle, invoicing is closed on the last day of the month. During the first week of the following month, the netting center verifies and resolves any problems with the invoices. Then it settles all invoices during the second week.
Under a different method, invoices can be created and collected within the same month. The netting period will follow at a later date that is specified in terms of payment that are clearly spelled out in each invoice. An invoice could state terms of 30, 60, or 90 days, for example. The longer the terms, the further the invoice can be extended into its netting cycle.
An invoice with terms of payment of 60 days that is collected in September would be processed in November and paid, along with other invoices, in early December.
When a netting cycle ends, a final netting statement is sent to every party. This document contains the balance due or owed.
There are several other methods a netting center could potentially adopt to process invoices. In all cases, the netting system should be clearly understood by all parties involved. Adjustments can be made to account for holidays or unforeseen events.
Besides domestic netting, it’s also possible to set up an intercompany payment system across national borders. There are several advantages of multinational netting, including:
- The cost of moving money across borders is reduced because there are fewer transactions.
- With less paperwork, it’s easier for auditors and accounting departments to follow and investigate transactions. In some situations, there could be hundreds of transactions consolidated into just one.
- Reduced forex exposure, which means counterparties will not have to go into the currency market and make hedges.
- Invoices and netting agreements can stipulate currencies and FX rates, which helps to reduce risk in foreign exchange transactions.
- By knowing exchange rates in advance, counterparties can make appropriate financial decisions.
- With fewer monthly transactions and less guesswork, FX deals are more likely to be consistent.
An associated concept in cross-border netting is currency netting. Under this arrangement, a business can agree to settle an invoice in a specified currency instead of making an FX conversion using its local currency. The netting center handles all necessary FX transactions under a currency netting agreement and receives and sends all appropriate currencies to participants.
Technology’s Role in Netting Transactions
Modern software helps to streamline multilateral netting, producing automated and smooth transactions for all parties involved. The following tools are notable resources:
- Enterprise Resource Planning (ERP) software that already works with accounts receivable and payable is a good solution for netting transactions.
- Treasury Management System (TMS) also can be used in conjunction with ERP to effectively manage uploads and downloads of data.
- Spreadsheets can be used in the netting process if the number of transactions is small, and there are only a few invoices involved.
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How Netting Processes Can Help Resolve Disputes
Many of today’s advanced netting software programs offer tools for dispute management and AR/AP matching. Statements from accounts receivable and accounts payable departments can be matched against one another, and agreements are often quickly processed.
In cases where a disagreement is not swiftly resolved, a dispute process is enacted. The standards and rules in this situation are clearly defined by the netting center, and both parties can plead their cases to an arbitrator.
Additional Advantages of Netting
Besides dispute resolution, businesses that adopt computerized netting practices will gain many other benefits, not least of which are:
- Faster and easier methods to rectify accounting errors.
- Risk becomes centralized.
- Easier to follow and enforce a preset payment schedule.
- The reconciliation of accounting ledgers is easier.
- Reduced daily cash flow.
- Financing procedures are standardized.
AP offices that find themselves overburdened with paperwork will discover that paying invoices digitally at the end of the month in batched transactions results in greater efficiency and fewer mistakes. The netting system also allows the overall firm to improve cash flow.
Disadvantages of Netting
Despite the advantages of netting, it does come with some notable drawbacks. Among them are:
- Netting doesn’t alter foreign currency rates. It merely aids in their management.
- Netting doesn’t reduce tax liabilities that businesses may face for their myriad transactions.
- Because risk is distributed across an entire netting transaction, the risk of a single invoice may be overlooked.
- Some bilateral netting payment systems may come into conflict with local law.
- Netting could require a large outflow of cash at the end of the month.
Multilateral Netting Offers Busy AP Offices More Advantages Than Disadvantages
With the many digital AP management tools available on the market today, busy offices shouldn’t have to pour through hundreds or even thousands of invoices every month. A netting system makes processing large volumes of intercompany payables faster and easier, thus resulting in more efficient AP departments.