Consolidation is the bringing together of all financial statements of affiliated companies within a group. It is important in order to present the overall financial situation of the group in a transparent way. Here we show you what consolidation involves, how it is done and what it means for companies.
Consolidation: Definition
In the corporate sector, consolidation is the preparation of a group-wide annual financial statement. In the process, a balance sheet is prepared in which all the results of the subsidiaries and the parent company are included.
Consolidation is mandatory for a group to be able to transparently present its complete financial position. If the consolidation results in profits or losses, these are the profits or losses of the group, even if a subsidiary has contributed significantly to them.
This consolidated overall balance sheet of the group is not relevant for the tax authorities and does not have to be submitted to them. However, it is mandatory for joint-stock companies and other companies that receive capital from investors. With the consolidated balance sheet, the group fulfils its documentation and information obligation towards its investors.
Consolidation of loans
Consolidation of loans is a special form of consolidation. In this process, several loans are combined into one loan. For example, a company that has two current loans with different interest rates can take out a new loan and thereby pay off the other two loans.
This makes sense if the interest burden of the new loan is lower than that of the two separate loans. This allows a company to save costs. In addition, it has a better overview of its debts because it only has to repay one loan and not several.
If a company belongs to a group, it is also possible for the group to give the company a loan. This has the advantage that more favourable conditions can be agreed, e.g. a lower interest rate.
Consolidation in accounting
Depending on the size of the group, consolidation is a complex process because all the balance sheets of the subsidiaries have to be combined into a single overall balance sheet.
For this purpose, intra-group transactions must be eliminated from the results if, for example, intercompany transactions have taken place between two affiliated companies. Only this offsetting ensures that the overall balance sheet shows the actual economic power of the group.
Consolidation examples
Company A has two subsidiaries, B and C, in which it owns a 100% interest. To consolidate, it needs the following statements from the subsidiaries at the end of the financial year:
- Balance sheet
- Income statement
- Cash flow statement
In the accounting of company A, one must now look at the annual financial statements of companies B and C and, if necessary, offset items against each other or remove them from the annual financial statements.
Income statement & cash flow statement
On the consolidated income statement and cash flow statement, all transactions are recorded which companies B and C have carried out externally. For example, if they have purchased services or goods from other companies.
In contrast, so-called intercompany transactions are excluded from the income and cash flow statement. For example, if company B has purchased goods from company A or C, the payment for these goods must be deducted. In principle, intercompany transactions are not taken into account in the annual financial statement, as they represent neither a profit nor a loss.
Balance sheet
The consolidated balance sheet shows the assets, liabilities and shareholders' equity across company A, company B and company C. If Company A has assets worth £1,000,000, Company B has assets worth £300,000 and Company C has assets worth £500,000, the consolidated balance sheet shows assets worth £1,800,000.
Consolidation: Meaning for businesses
The consolidation is important for a group to present its group-wide financial situation in a transparent manner. In this way it fulfils its duty to provide information to investors. Banks can also get a better picture of the group's financial situation when granting loans.
The consolidated financial statements can also be presented to clients when it comes to concluding a major contract. This allows them to assess the risk as to whether the group is financially able to fulfil the order.
With the help of consolidation, the group can better see how it is positioned financially. This enables it to better plan its group-wide activities and strategically align its business.
