Picture this – you’ve built your company from the ground up, and now you’ve got multiple legal entities, separated for tax purposes, tracking purposes, and maybe you want to sell off one of the entities one day. Let’s call them entities A and B. Company A sells widgets on an ecommerce site. You used to get the widgets from a third party, but as you grew, you started manufacturing the widgets yourself, and thus formed Company B. When you sell finished goods from Company B to Company A, you probably record revenue on Company B (it was a sale of a widget, after all). Company A then sells the finished widget on their website, and also records revenue. That single widget has revenue recorded on both Company A & B now, but really cash only came into the company in one instance (from Company A’s sale). When you consolidate your books for both entities, you’d need to account for the intercompany transaction so that it doesn’t look like you’re doubling up your revenue. If you do, you’re inflating your sales and you could even be paying more in taxes.
Often, business owners with multiple entities will also have money flowing from one to the other due to cash flow issues or ease of operations. Company A will pay a bill on behalf of Company B, because Company A has the cash to do so. When this happens, it’s important for owners to understand that the expense should still be recorded on the appropriate company, resulting in a Due To/Due From balance for each Company. At the end of the month, be sure you’re reconciling the balance sheets of both Companies and make sure the Due From balance on Company A ties to the Due To balance on Company B!
Intercompany transactions are a regular occurrence with entrepreneurs. It’s important to know how to handle them to ensure you have the most accurate financial picture of how each business is performing, you’re reporting your results appropriately for taxes, and you’re able to tell the full story of each company should you choose to exit one day.