Transaction Cost Economics and Financial Consolidation Software: Why Firms Invest in Digital Coordination

A similar fundamental challenge exists for all large organisations: how to coordinate increasingly complex activities while avoiding administrative costs that exceed the benefits generated by operational growth. A major area of economics that has greatly affected our current understanding of what motivates organisations to consolidate their financial operations has been transaction cost economics, developed by Ronald Coase, winner of the 1998 Nobel Prize in Economic Sciences, and later built upon by Oliver Williamson. Transaction cost economics argues that organisations coordinate economic activity internally when doing so is more cost-effective than relying on the market. The costs associated with transaction cost economics include far more than simply the cost of purchasing and selling many goods or services. Additionally, these costs include the time and resources required to locate and evaluate information, negotiate an agreement, monitor performance, and coordinate decision-making.

The development of financial consolidation software serves as a primary example of transaction cost economics being utilised today. As companies expand across multiple subsidiaries, countries, and currencies, the cost of obtaining, verifying, and consolidating the financial information from these entities continues to grow exponentially. By investing in digital tools that provide a means for potentially lowering the costs associated with coordinating financial data among multiple subsidiaries and countries, companies can increase their operational efficiency and the quality and speed of their financial reporting.

The impact of transaction costs may be the most pronounced for large organisations with a growing number of employees. For example, a multinational corporation may possess dozens, if not hundreds, of different legal entities that produce separate financial statements in various accounting standards and local regulations. In order to report the financial information for the total group, the accountant must coordinate their efforts with those of other accountants located in various countries and departments to reconcile intercompany transactions and consolidate the financial results. In addition, the accountant must ensure that all of the inter-company transactions are properly recorded in each entity’s records, eliminate duplicate revenue and expense amounts, convert currencies, and verify that consistency exists in the reporting format. Each of these actions involves the need for coordination of activities between people, departments, and systems.

As the complexity of organisational structure increases, the cost of maintaining an efficient organisation plays a role in driving the investment in financial consolidation software. As companies expand, the density of their communication network increases and the overall number of requests needed for reporting expands, leading to an increase of the total number of missed opportunities or coordination failures.

As companies continue to expand into a global society, the average size and geographic reach of companies has increased rapidly. In fact, the UNCTAD has reported that thousands of multinational firms across the world are controlling millions of affiliates from around the world and therefore generate many of these complex communications and financial coordination requirements. As a result, these companies are required to provide their regulators and investors with timely, accurate financial information. In response to demand from the financial market, many countries are shortening the time frame for annual and quarterly reporting. With the increase in complexity of this information, the time available for finance teams to consolidate and prepare these data has decreased.

By combining many transaction costs into one category through the use of financial consolidation processes, this has reduced the overall level of transaction costs. Financial consolidation systems allow companies to centralise their financial records into one central database. Because of this, the cost of searching for financial records and monitoring activities has been greatly reduced. Companies can develop standardised reporting templates, thus reducing the costs of coordinating multiple subsidiaries with disparate reporting systems. By allowing companies to provide consolidated financial information at a faster rate, this will also improve executive decision-making speed. Consulting firms have conducted research to demonstrate that organisations that implement a modern financial close and consolidation platform can shorten their financial closing processes by several days and decrease significantly the number of manual journal entries and spreadsheet based processes used. While the initial implementation cost is high, the decreased cost of repeated coordinated support leads to long-term efficiency benefits for companies with complex corporate structures.

For instance, Unilever operates in over 190 countries and has multiple legal entities to manage. Coordinating financial reporting for such a global business using disparate systems across each subsidiary would be extremely cost-prohibitive, but through investment in a single enterprise financial platform, Unilever can automate much of the consolidation process so that finance and accounting professionals can focus their time on analysing business results instead of creating financial reports.

Another example of this concept is Siemens; they manufacture and sell industrial automation, energy infrastructure, healthcare technology and transportation. Each of these segments has businesses operating in different currencies and under different regulations, therefore using digital consolidation systems allows them to consolidate financial results at a lower transaction cost than they would incur if they continued to assemble consolidation information manually. Additionally, the use of standardised digital consolidation systems will improve reporting consistency.

Transaction cost economics also provides an explanation for why firms are less likely to rely on spreadsheets for financial consolidation as they grow increasingly larger. While the initial cost of creating a spreadsheet is relatively low, the total coordination costs associated with multiple users, subsidiaries, and reporting requirements will increase over time. In addition, issues such as version control, manual reconciliations, duplicated effort, and inconsistent formulas all compound the cost of managing financial information within an organisation. Financial consolidation software eliminates many of the disparate processes utilised in traditional financial closings with standardised workflows that minimise uncertainty and improve governance.

The implications of implementing a digital financial consolidation system extend beyond financial accounting efficiency. The reduced transaction costs associated with these systems make it easier for firms to grow by acquiring new businesses because it will take less time to integrate newly acquired businesses into existing reporting systems. In addition, investors benefit from receiving more timely and accurate financial information which decreases information asymmetry between corporate executives and capital markets. Finally, as firms continue to grow more complex, digital coordination will lower the administrative costs associated with managing complex organisations, freeing up resources for innovation, investment, and productive activities rather than internal financial information management.