Table of Contents
Definition of subsidiary
A subsidiary is an organization that is controlled by another company. Control is defined here as the ability to direct the financial and operational business, including management, in order to derive greater benefit from its activities.
This also means the possibility of voting on the company's position in the event of an objection in a subsidiary. This ability results in most cases from owning at least 50% of the voting shares. In some cases, however, there may be cases where control can be exercised with an amount less than 50%, which is known as minority control.
The subsidiary has its own legal personality. In contrast, the branch has assets and liabilities that are part of the parent company. Owning a subsidiary comes with some ineffectiveness (e.g. duplication of resources).
Reasons for establishing subsidiaries
The main reasons for establishing subsidiaries are:
- Activities in separate markets
- financing or sharing the risks between the owners
- Protection of the parent company from the exit of the subsidiary's creditors
- Diversifying the decisions of the Board of Directors
Reporting by a subsidiary
The financial statements of most of the subsidiaries are consolidated in the financial statements of the parent company. They represent the situation of both companies as one economic unity When it comes to financing, parent company's lenders want to have a measurable way of seeing the impact of parent company's cash flow on dividends or management fees collected by an affiliate.
For the parent company, the subsidiary's shares represent value, but only to the extent that they can be sold in the market. This is just a potential source of money as the liquidity of such stocks is sometimes questionable. The lender can only treat both units as one unit if a subsidiary has guarantees from the parent company.