How Do Cash Advances To Subsidiaries Work?

Occasionally, cash flow issues may provoke the need for related companies to lend or borrow from each other. In terms of accounting, this will mirror the flow or control of cash. There is an exception if the financials are viewed on a consolidated basis, however, as the transactions will appear differently on the balance sheet.

Cash Control

Cash is defined as an asset due to the flexibility and power to control it. When a subsidiary is advanced cash, the subsidiary receiving the cash is effectively gaining an asset as it can be used for any services or asset purchases for the business. There is however, still some expectation to repay, which may or may not be recorded on formal documents.

Asset Classification

Although it may not seem very intuitive, the accounting classification of cash will change for the loaning company once handed to a subsidiary.

As most control over their cash is given up and handed to the subsidiary company, the asset that was cash now takes on qualities of an accounts receivable. It is still classified as a current asset however, as it is probably collectible and easily quantified, just not in hand.

Accounting Presentation

Since the cash accounts for the receiving subsidiary and loaning company will increase and decrease respectively, more specific classifications must be assigned. From the loaner’s perspective, they have just created an “account receivable”, while the borrowers, albeit a subsidiary, will have created an “account payable” section. Depending on the regulations and documentation, the advance can also be classified as a “note payable”.

The accurate accounting presentation is crucial because it allows the related businesses to act on decisions independently. Additionally, this also keeps things organized, as creditors or any outsiders are able to assess the health of these companies accurately.

Summary of Effects

If financial statements are viewed from a consolidated perspective, advances to subsidiaries are unlikely to be present, as it would be combined with all other activities related to entities through an “eliminating entries” adjustment.

However, the unconsolidated information could impact an entity’s reputation if presented to anyone that does not understand the situation. This is because with a consolidated sheet, management may be able to present a particular company as liquid, or asset heavy, skewing bias. That’s not to say however, that there aren’t times where an unconsolidated sheet exposing any cash tightness or asset constraints would be preferred.

Of the highest importance however, is understanding why it was necessary for a cash advance between businesses. If no appropriate reasoning is provided, then this may serve as a red flag for parties that may interested in dealing with the business.