This happens among the group of companies. Demirag and Goddard (1994) note that companies within the group can settle interfirm debt in different currencies for the net amount owed in the currency rather than the gross amount. Therefore, it involves associated companies which trade with another.
The netting technique is very simple. As Buckley (1986) explains, group companies merely settle inter-affiliate indebtedness for the net amount owing. The simplest method is bilateral netting (Figure 4). Each pair of associates nets out its position with the other and cash flows are reduced by the lower of each company’s purchases from or sales to its netting partner. Bilateral netting involves no attempt to bring in the net positions of other group companies.
Figure 4. Bilateral Netting
Source: Buckley (1986)
As illustrated in the Figure 4 if a UK subsidiary in a group owes Ff equivalent of $6 million to the French subsidiary, while it owes sterling equivalent of $4 million to the UK company. After the transactions of inter-company accounts would be netted down to the $2 million in agreed currency, it will be paid by the UK company to the French counterpart.
Multilateral netting is more complex than the bilateral netting. However, in principle both of them aim the same purpose. Buckley (1986) points out that multilateral netting involves more than two associate companies’ intergroup debt and virtually always involves the services of the group treasury. This method involves two sides and it is usually undertaken without the involvement of the corporate headquarters.
Figure 5. Multilateral Netting Matrix
Source: Buckley (1986)
Figure 5 shows how the subsidiaries might be involved in multilateral netting. As an example, for the multilateral netting; assume that the UK subsidiary buys $6 million worth of goods from the Swiss subsidiary and sells $2 million worth of goods to the French subsidiary. During the same term, the Swiss company buys $2 million worth of goods from the French company. After the netting, the settlement of the intercompany debt ends up involving a payment of the equivalent of $4 million. It should be in agreed currency and paid from the UK company to the Swiss subsidiary.
Netting reduces the banking costs and increases central control of intercompany settlement.
