Understanding Operational Transfer Pricing
In order to properly manage your financial statements, you must have a good operational transfer pricing framework or OTP. For many businesses, however, navigating the world of operational transfer pricing is difficult. Here’s what you need to know about operational transfer pricing and ideas for software.
What is it?
Operational transfer pricing is the price charged by the selling division to the buying division for an intermediate product. In other words, it is the pricing and a series of steps that must be taken in order for the company to purchase goods within itself. For example, let’s say a division of a business (Division I) creates batteries, while another division (Division II) needs batteries. The first division can sell their batteries to the second. The price at which Division I sells the batteries to Division II is the transfer price. Let’s assume that Division I sells one battery to Division II for $5. That makes the transfer price $5.
Why does it matter?
Since the two divisions are in the same company, they require a special pricing. So, how much does Division I charge Division II for their batteries? You may be thinking that this shouldn’t matter since both divisions belong to the same company. If the divisions are evaluated separately, which happens a lot in businesses, each division needs to maximize its profit. As a result, they need to charge the other division for the buying or selling of goods. In other words, the transfer price is the price of goods within a company so that all divisions can maximize their profits and benefit the company as a whole.
Operational transfer pricing also helps with financial record keeping. By creating a strict operation for intercompany sales, it’s easy to track all sales and profits for investors and tax purposes. If you forgo OTP, your branches won’t maximize profit, or you may struggle to get investors and get in trouble with the IRS.
What makes OTP successful?
For your operational transfer pricing to be successful, it may be helpful to break it into three different phases: transaction identification; pricing; and reporting. This means identifying the product, setting the price, and recording sales correctly. By approaching OTP in this way, you are sure that every step of the process is monitored correctly. For many people, this process is difficult, especially if you have never designed the framework for yourself. If this sounds familiar, you might want to look into transfer pricing software solutions. These solutions will help mitigate the work so that you don't have to get bogged down by the process. Though transfer pricing software won't solve all of your problems, it will make the job much easier.
All in all, operational transfer pricing isn't as intimidating as it sounds. It is simply the framework through which your company can buy goods within itself. This makes sure that all divisions maximize profitability and the company as a whole has accurate financial record keeping. Since operational transfer pricing is so important, it may be best to get a software to help you out with the process.