Startup expansion isn’t a restrictive movement. For some startups, expansion means launching subsidiaries to keep brand identities separate. Managing multiple startups means managing multiple sets of financial statements – which gets complicated quickly.
While it's enough to make your head spin, not having a solid system to organize multiple financial files can cause investors to lose confidence in your business.
Fortunately, there's a solution.
Startup founders with subsidiaries can combine all their financial records into one statement, tracking and monitoring each subsidiary's progress. Consolidation of financial statements helps simplify the accounting process while providing founders and investors with an accurate overview of each company's worth.
What Are Consolidated Financial Statements For Business?
Consolidated financial statements refer to aggregated reporting of a parent company and subsidiaries. These reports include financial information from two or more companies into one document set, such as assets, liabilities, revenues, and expenses.
Startup founders may create subsidiaries to launch different services or products through a different brand name. However, each subsidiary's earnings still go to the parent company for allocation. If you’re in this boat, you’ll find that consolidated statements are essential for organizing the financial information of each of your subsidiaries.
Overall, this consolidated documentation provides a better view of the parent company's finances.
Combined vs. Consolidated Statements
It's worth noting that “consolidated” is not the same as “combined.” The most crucial difference between combined vs. consolidated financial statements is that combined statements don’t present a unified view of all the company’s financials.
Consolidated statements help investors better understand the risk and reward potential of the company as a whole. However, your decision to use consolidated vs. combined financial statements will depend on how you plan to present your companies to the investor.
For example, you would use combined financial statements if an investor wants to see how each subsidiary performs as an individual entity.
Benefits Of Consolidating Financial Statements
Organized financial statements should be a top priority, including consolidated statements. Consolidating your financial statements provides startup founders with valuable benefits.
1. Gain Insight Into Complete Economic Wealth
Utilizing consolidated financial statements allows you to control and measure the entire economic wealth of a company and its subsidiaries. When reported together, founders can see precisely how much money they possess and how much capital they would need to raise for another project.
2. Reduce Paperwork
Since all the company's information is in one place, you don't have to spend time aggregating data from multiple sources. Furthermore, consolidated reporting can help streamline compliance processes because it is accurate and reliable.
3. Accuracy Through Automation
Like other types of accounting software, consolidation software automates the entire process of creating consolidated financial statements. In tandem with consolidation software, bookkeeping automation lowers the error rate and speeds up the process. Overall, automating saves time and money, eliminating your need to enter data manually.
Which Types Of Financial Statements Do You Need For Consolidating?
A well-organized and accurate consolidated financial statement requires specific information. You’ll need the following records:
- Income statement – The income statement reports a company's performance over a period by recording gains, expenses, revenue, and losses.
- Cash flow statement – The cash flow statement monitors the inflow and outflow of money from the company's operations.
- Balance sheet – Your financial statement should have a list of what your company owns (assets), owes (liabilities), and what it’s worth (equity).
Methods Of Consolidation Of Financial Statements
Parent companies don’t always own 100% of their subsidiaries. Investors hold ownership but may not have investments in the parent company. The percentage of ownership the parent company has determines the proper consolidation method.
Let’s look at the different methods available.
In this situation, the parent company owns over 50% of the subsidiary and fully controls reporting and accounting. The parent company’s balance sheet reports each subsidiary's assets, equity, and liability. The income statement houses the subsidiary's expenses and the reported income.
Assets, equity, expenses, and liability are distributed per venture contribution. All income and expenses of the joint venture (parent-subsidiary) show on the income statement and balance sheet. Any joint venture can use this method regardless of percentage ownership.
For example, if company Y owns 65% of company Z, company Y would claim 65% of company Z’s assets, liabilities, expenses, and revenue. Company Y would then show their financial data added to the 65% to get their total.
In this situation, an investor has significant influence despite owning a small amount. To use this method, the parent company/investor can only own between 20% - 50% of the subsidiary.
Usually, founders use this method when the parent company or higher subsidiary wields substantial power over the lower subsidiary.
To use this method, you assess profits earned through investments in other companies.
For example, if company Y purchases 10,000 stocks at $50 per share in company Z, company Y records the investment at $500,000. Any profit made through the investment is recorded and reflected going forward.
How To Prepare Consolidated Financial Statements
Whether you have established subsidiaries or are looking to create one, it’s best to follow a simple step-by-step process to ensure you hit all the marks accurately and legally.
- Determine which consolidation method you want to use.
- Allocate holdings to the correlating subsidiaries.
- Gather all relevant financial records from each subsidiary – balance sheet, income statement, and cash flow statement.
- Ensure fiscal periods align for the parent company and all subsidiaries.
- Double-check everything to ensure you have accurate and up-to-date information on each company.
- Use Google Sheets or Microsoft Excel to copy and paste the totals from each entity from the parent company and subsidiaries. Create separate tabs for the three different financial reports and assign each column, total cash, for example, to each entity.
- Compare numbers from the reports against what you’ve input in your sheet.
- Remove duplicate values.
- Create a master balance sheet reflecting the combined net worth, assets, and liabilities of the parent company and its subsidiaries. To do this, add all the separate values from each company's balance sheet.
- Generate a consolidated income statement with the total revenues and expenses of the parent company and its subsidiaries. Add all the amounts from each company's income statement for this step. Be sure to include all money earned and spent over the given period.
- Finally, create a consolidated cash flow statement that records all the money received and paid out by the parent company and its subsidiaries. To do this, add the amounts from each of their statements.
GAAP vs. IFRS Reporting Requirements
One final thing to keep in mind! When preparing consolidated statements, you must adhere to the reporting standards set by the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
GAAP defines how businesses should record, report, and measure financial activities. While only publicly traded US companies must follow GAAP, IFRS is a globally recognized set of rules. However, it is always best practice for businesses at all stages follow GAAP. You can find much more detail on GAAP vs. IFRS in this article.
The GAAP and IFRS lay out specific laws regarding consolidated reporting for parent companies with subsidiaries:
- Disclose stock shares not owned by the parent company.
- Financial statements from both the parent company and subsidiaries follow identical preparation.
- Elimination of intra-group transactions (transactions between companies)
However, there are distinct differences when it comes to financial statements.
1. Inventory Worth
There are three methods companies can use to calculate the worth of their inventory.
- GAAP: Allows companies to use all three methods.
- IFRS: Only allows the first in, first out (FIFO) method or last in, first out (LIFO).
2. Cash Flow
- GAAP: Interest received and paid and received dividends reported under the operating column. Dividends paid belong under the financing column.
- IFRS: All dividends and interests go under the operation column.
3. Balance Sheet
- GAAP: Assets listed by liquidity; most liquid, current assets, fixed assets, non-current assets, current liabilities, non-current liabilities, then owner’s equity.
- IFRS: Assets are listed opposite of GAAP order with the least to most liquidity.
4. Revaluation Of Assets
The value will likely fluctuate during an asset's life, leading to the need for a revaluation. Revaluation can lead to money saved in the case of an asset needing repairs – if it’s at the end of its life, the company can get rid of it vs. paying more for repairs.
- GAAP: Only fair market value for marketable securities ( stocks or investments) are eligible.
- IFRS: More assets are eligible, like property, PPE, inventories, etc.
5. Development Costs For Startups
Startups typically spend more than other companies due to the need for research and product development.
- GAAP: Costs reported as expenses.
- IFRS: Allows companies to amortize and capitalize during multiple periods.
The laws set forth by these entities are to prevent parent companies from misrepresenting their subsidiaries’ worth. Adhering to these laws is necessary when preparing consolidated statements. Distorting your business finances can lead to severe legal and economic consequences.
Is It Worth It To Consolidate Financial Statements?
Consolidated financial statements are the answer if you struggle to track and manage multiple financial records across entities – we understand that it’s an overwhelming responsibility at times! But consolidating your efforts makes reporting more manageable and unifies your entire organization’s financial information into one place.
Plus, you can automate the process with consolidation software for faster, more accurate results. Now that you have the know-how, you’re ready to start impressing your investors and keeping a firm grip on your finances as you move forward.