Demystifying consolidation of financial statements: A simple guide

A consolidated financial statement is a unified statement that provides a comprehensive overview of the financial health and performance of the entire group of companies owned by one business, enabling finance and accounting teams to:

• Provide accurate information to stakeholders for better transparency and accountability
• Comply with accounting industry-accepted  standards and any applicable regulations
• Make more data-driven, strategic decisions

Broadly, the purpose of financial consolidation is to represent the business accurately and in its entirety in terms of its assets, income, liabilities, expenses, cash flow, and equity. 

Let's take a closer look at how they do that.

Understanding consolidated financial statements with a simple example

Consolidation of financial statements refers to combining the financial statements of multiple "child" companies or entities to understand their relative contributions and overall financial health to the "parent" company. 

Let’s say we have a company called Acme Enterprises, which has three subsidiaries, each of which functions as a separate business: 

• Acme SaaS, a software business with $2M in annual net income
• Acme Consulting, a technology consulting services business with an annual net income of $250K
• Acme IT Services, a staff augmentation business making $750K in annual net income  

All three subsidiaries produce their own financial statements including an income statement reflecting their annual income noted above. Individual financial statements are important for the different leaders and key stakeholders in each subsidiary company to understand its financial health. 

However, for Acme Enterprises to accurately reflect its financial health, it must produce a consolidated income statement for all three of its subsidiaries. 

To do this, the Acme Enterprises finance team must add up the combined income reported on each of their income statements. So in this example, the consolidated income statement for Acme Enterprises would report an income of $3M.  

Always remove intra-entity transactions

Note that when preparing a consolidated financial statement, it is critical to remove all intra-entity transactions. These are transactions that occur when one of the parent company’s entities exchanges goods, services, or assets with another.  

For example, if Acme IT hired Acme Consulting to provide IT consulting services to one of its clients, that transaction would need to be removed from the consolidated statement. While the resulting financial transaction would impact the individual income statements for both the subsidiary companies, it had no real effect on the partner company’s bottom line. Rather, it just moved money around within Acme Enterprises.  

Requirements for consolidated financial statements

Preparing consolidated financial statements is a fairly complex task, involving the technical expertise and capabilities of experienced accountants and data analysts.

Common requirements for consolidated financial statements of publicly-traded companies include:

• Control over entities: If the parent company does not have control over the subsidiary but significantly influences its financial and operating policies, the subsidiary has to be included in the consolidated financial statement.

• Common reporting period: A common reporting period must be defined to prepare the financial statements of the parent company and its subsidiaries.

• Consistent accounting policies: Both the parent company and their subsidiaries must use consistent accounting policies.

• Intercompany transactions and balances: It is crucial to eliminate any intercompany transactions and balances in the consolidation process to avoid double-counting.

• Minority interests: The portion of the subsidiaries not owned by the parent company must be adjusted for minority interests (also referred to as non-controlling interests), which is the portion of an entity’s stock not owned by the parent company.

• Disclosures: The consolidated financial statements must disclose relevant information, including the basis for consolidation, the percentage of ownership in each entity, and any changes in the ownership structure during the reporting period.

• Compliance with accounting standards: The consolidated financial statements must comply with applicable accounting standards and regulatory reporting requirements.  

Tip: When creating consolidated financial statements, always refer to relevant accounting frameworks that your business uses to keep track of updated rules and principles.

Understanding IFRS regulations 

International Financial Reporting Standards (IFRS) — issued by the International Accounting Standards Board (IASB) — are a set of accounting rules for public companies preparing consolidated financial statements to make them consistent, transparent, and easily comparable worldwide. It has been adopted in over 160 jurisdictions across Europe and Asia. 

As a CFO in the parent company, especially if that company reports internationally, you would need to use “uniform accounting policies for like transactions and other events in similar circumstances,” as mandated by the IFRS 10 Consolidated Financial Statements. 

The United States, on the other hand, uses a different system known as Generally Accepted Accounting Principles (GAAP).

Understanding GAAP regulations

GAAP is an accounting framework, developed and maintained by the Financial Accounting Standards Board (FASB) for public companies in the U.S. to compile their financial statements. The aim is to ensure that these consolidated financials or accounts are comprehensive, consistent, and comparable. GAAP is also used for governmental accounting matters.

Are private companies required to consolidate their financial statements?

While publicly traded companies are required to prepare  consolidated financial statements on a quarterly basis, private companies are not mandated to do so. 

However, most private companies that act as a “parent company” to multiple  businesses also generate  their own consolidated financial statements. 

The need to fully understand your finances is universal among all businesses, large or small, public or private. 

Creating consolidated financial statements provides the same benefits for private companies as they do publicly-traded companies.

What information should be included in a consolidated financial statement?

Both GAAP and IFRS cover a range of accounting activities and require clear, transparent, and comparable consolidated financial statements. However, there are certain guidelines for consolidating financial statements under both frameworks:

• Income statement: Sometimes referred to as the profit-and-loss (P&L) statement, this is a recap of the revenue earned during the reporting period, along with any corresponding expenses. Income statement includes revenue from operating and non-operating activities, allowing all the relevant stakeholders to evaluate the company's financial cycle and results.

• Balance sheet: This is a snapshot of the company's assets and liabilities at a given point in time.

• Cash flow statement: This is a record of cash as it enters and leaves the company via transactions conducted in the given period. The cash flow statement separates cash flow into operations, investing, and financing, allowing investors and lenders to see how effectively the company maintains liquidity, makes investments, and collects its receivables.

Additionally, IFRS also requires companies to provide 1) a Statement of Changes in Equity (a statement of retained earnings), which reports changes in the company's earnings or profit in a given period, and 2) a summary of its accounting policies. 

‍Tip: It’s important to stay on top of any changes in the parent company’s structure, ownership, and operations, so you can correctly reflect those in consolidated financial statements.

Benefits of consolidated financial statements

The main benefit of consolidated financial statements is to provide an accurate and comprehensive picture of a parent company’s financial position and performance — including assets, expenses, profits and equity — and how each subsidiary impacts the parent company. 

Some of the other benefits of consolidated financial reporting are:

• Reduced manual interventions and paperwork: Since all the company's information is in one single document, it eliminates the need to gather data from multiple sources manually or prepare separate financial statements for all entities and subsidiaries. Further, the use of consolidation and accounting/bookkeeping software can also help reduce manual errors and speed up the entire process.

• Simplified business view: Eliminating intercompany transactions provides a simplified view of business performance.

• Increased transparency in evaluation: As consolidated financial statements continue to evolve, the process of evaluating a parent company will become more accurate and transparent, as all the financial information would be aligned with standard accounting frameworks, such as GAAP or IFRS.‍

Broader applications and benefits of consolidating financial information 

Companies can also apply the concept of financial statement consolidation to better understand their business in other ways, too, by consolidating financial information for different dimensions of their business, such as departments, products, regions, and market sectors. 

While the result is not a consolidated financial statement in the strictest sense, the purpose is the same – to accurately reflect how the finances of different dimensions of the business are contributing to the whole. 

For example, companies often have different product offerings or operate in  different markets, and/or geographic regions. 

In these cases, each different dimension of the business could be treated as an “entity” for the purposes of financial reporting. You could develop a separate income statement for each region (e.g., India and the U.S.), each market you sell into (enterprise vs. SMB, for example), and/or for individual products. 

Let’s look at geographic regions for example. To fully understand the financial health of your business in terms of the different geographic regions in which it operates, and how each region is contributing to the whole, you would need to combine the individual income statements for all the regions into a single consolidated income statement. 

You can do this for any dimension you want to look at. Just remember that each dimension must be treated like a separate “entity” for the purposes of consolidation. This type of multi dimensional reporting can be difficult to put together with spreadsheets, especially the more complex your business is. However, there are financial reporting tools on the market that can make it much easier.

How technology improves efficiency and accuracy of consolidated statements 

Many companies continue to rely on spreadsheets to consolidate their financial statements. Pulling and compiling data from multiple source systems and checking to ensure its accuracy requires a lot of time and energy on a task that could be easily automated with a financial management software like Drivetrain.  

With 200+ integrations, Drivetrain can consolidate your financial data from all the different sources in which it resides into a single platform. 

Drivetrain not only makes creating consolidated financial statements a breeze, as a multi-dimensional modeling software, it also allows you to slice and dice your data in any way you need to understand your business–in any and all its different dimensions.

With industry-leading visualization capabilities, such as dynamic dashboards, and automated, real-time reporting on demand, you can easily share your financials with stakeholders any time. 

Explore Drivetrain to see how easy it can be to level up your financial analysis and reporting.