Avoid Multiple Company Complexities and Account for Cross Selling Practices

This article is relevant if you are thinking about a new business system and / or you believe you need multi-company capacities activated in your NetSuite account.

Extract a Department into a New Company

Many times, organizations grow to develop different service and product lines. Questions may develop surrounding should a new company be constituted to distinguish it from different business departments. There certainly are good reasons to do this. For example, management may wish to extract enterprise value, produce management and operational focus, and diversify risk. Separating a particular business operation from a family of disjointed services may clarify to outside third parties the value of the stand-alone organization. Yet, often times, services between different business areas are complimentary. The same sales people can sell all products; and perhaps many of the same people are involved in fulfillment. Another example of complimentary services may exist between shared general and administration services, such as accounting or HR, that serve multiple business lines.

Suppose you decide it makes sense to have a separate business for some of the reasons above. Before you run off, take the time to consider the meaning of running a multi-company organization.
The business system plays a role in these concerns. When it comes to the business platform, your choice of software and the way you implement it will have implications in your day-to-day operations, reporting, and the amount of administration required to maintain your books. For example, NetSuite’s One World module supports multiple companies with capacities to produce automatic inter-company transactions and consolidated statements. It demands more planning, setup and coordination, yet it can enable organizations to scale. However, there are situations that NetSuite’s One World may be overkill.

The Multi-Company vs. Multi-Department Consideration

Here are some situations that indicate that a departmental approach may be better than a multi-company approach. If you answer no to all these questions, you should be able to use department capacities instead of multiple company:

  1. Does your line of business need a separate legal status? Does it require its own tax compliance structure?
  2. Must your line of business have its own balance sheet?
  3. Are you seeking to inflate and hide the prices of goods and service sold between each line of business as a way to gain tax or other advantages?
  4. Are products and services completely distinct and require different marketing and selling tactics that are not complimentary?

Avoid Multi-Company: How to Powerfully use Offsets for Cross Department Sales and Delivery

If you answered no to the questions above, you have an opportunity to use your accounting system in a powerful way to avoid the setup, cost and operation of a mult-company business system.

Let’s use the example where one business line sells the services of another business line and you want the information tracking to distinguish revenue appropriately. Let me give an example to make this clear:
Consider a company with two divisions: Products and Services. Suppose a salesperson sweetens a prospect deal by throwing in (giving away) services on a product sale. The salesperson’s logic is that there is enough margin in the product deal to pay for the services. Yet, the business typically sells services separately and is a accounted for as a profit center. In typical deal accounting fashion, the numbers may look like this:

We have clients that perform this practice. For tactical selling reasons, the salesperson needs to have a single order / invoice that shows only the product information, even though services will be provided. The reason is that some customers are fine with large equipment purchases but may have trouble having the purchase approved when there are services included; often this may be due to the need to account for capitalization, the length of implementation crossing annual budget boundaries, or other internal corporate policy reasons.
Yet, these selling techniques often cause havoc on performance reporting especially if management isn’t paying close attention to the mechanisms they are using to account for these “hybrid” sales.

If you were to break this deal respecting departments, here is how things may look:

When looking at the opportunity through a department lens, you can more clearly see issues in the deal. It appears that the Product Department made good margin while the Services department had a loss. Respectfully, you could argue that the Service department “sold” services to the Product department. For illustration purposes, assume during the prospect negotiations, the services offered were really valued at $3,500 in the market; but because this deal was an “internal sale”, the services revenue is not picked up. Without proper accounting, it is hard to make this interpretation. Poor interpretations may mean that you will mis-allocate sales credit (commissions, quota contributions, etc.) where it is due ultimately upsetting department managers, and other team members.

The Department Offset Concept

The way to solve this is to use an offset concept that accounts for each departments’ “buying and selling” of other departments’ offerings. Under department offset accounting, we setup the departmental income statement as follows:

Under this presentation, we see a different story:

  1. The Product Department bought services from the Service department at an agreed upon value (here, $3,500).
  2. The Product Department Sales is lower (here, $6,500) now reflecting the offset to Services.
  3. The Product Department’s margin is now lower because the salesperson elected to take the inflated margin to purchase services and sweeten the prospect deal; it worked and the prospect accepts the offer.
  4. The Services Department sold services (here, $3,500) to the Product Department distinguishing it from traditional Service sales. Net sales for Services is correct for the Services department.
  5. The offset helps management understand how each department contributes to the complimentary aspects of the other department offerings.
  6. The Services department produced positive margin (here $1,000); not the loss as previously exhibited.
  7. Sales Offsets generally should always have a negative amount (or debit). Overall margin by department is properly reflected.
In a subsequent article, I will show you how to perform the accounting for offsets within NetSuite. If this article is relevant to you and you would like to have a discussion of how your NetSuite system can be configured for offset accounting, contact us.

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Marty Zigman

Holding all three official certifications, Marty is Southern California's NetSuite expert and leads a team of senior professionals at Prolecto Resources, Inc. He is a former Deloitte & Touche CPA and has held CTO roles. For over 25 years, Marty has produced leadership in ERP, CRM and eCommerce business systems. Contact Marty to set up a conversation.

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