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Mexico Cost Structure: The Accountant’s View

Mexico Cost Structure:  The Accountant’s View

Mexico cost structure from the perspective of the accounting function is the topic of this Tecma Group of Companies' podcast.

Tecma Group of Companies:

Welcome to those that are listening to this podcast that is part of a series of continuing recordings of this type that have to do with manufacturing in Mexico and issues that are related to that. We basically have two types of individuals that come in to share their expertise with us. The first would include folks that come in from outside of the Tecma Group of Companies. These are folks that we access to talk about things like legal issues, tax issues, straight manufacturing issues and other topics that are going to be interesting to thos that are going to pursue manufacturing in Mexico. Secondly, we have internal experts We have a wealth of individuals within the Tecma Group of Companies that have a myriad of different expertise areas. Today we are fortunate to have Mark Earley with us. Mark is the executive vice president and CFO of the Tecma Group. Mark, tell us a little bit about yourself, your background and what we are going to talk about today.

Mark Earley:

First I would like to thank you for the opportunity to speak on the topic of the differences between the U.S. and Mexico cost structure. I have more than 30 years of experience in U.S. and Mexico accounting operations. I have also had some experience in implementing various ERP systems in this environment, and also served as logistics manager for a Tier One automotive supplier.

Tecma Group of Companies:

What we are going to talk about today, from an accountants perspective, is the difference of setting things up from a U.S. Mexico cost structure perspective. The first and most obvious question is: Are there any differences in this area?

Mark Earley:

Absolutely. I think the most important difference is that in Mexico, of course, there is going to be an added currency. We’ll be looking at a Mexican Peso currency, and also a U.S. Dollar currency. The one thing that is important to note, from a reporting perspective, is that as you have an entity in Mexico, you now have accounting and tax obligations, and you will be reporting to the Mexican government in Pesos. From the U.S. perspective and the corporate management perspective, when you look at cost accounting functions, all of those things are needed in dollars for comparison purposes and also to roll up to the U.S. entity for reporting, and for tax purposes. In order to do that, you will, for the most part, establish a functional currency as the U.S. dollar, as all the reporting through the managment and, subsequently, all the reporting to agencies in the U.S. is dollars. Then we have reporting currencies as both dollars, which will report out to the U.S., and in Pesos in Mexico. You need to set up a general ledger. The general ledger for your Mexican, entity, for the most part will mirror that of the United States, although there is some mapping that will have to take place. This is because, in Mexico, there are different requirements than there are in the U.S. An example of this is that of fringe benefits. In the U.S., we usually have one to three accounts that we use for fringes, while in Mexico, per the Federal Government’s statutory requirements, we need to track the individual social programs within the general ledger. It is a requirement. We have up to twenty separate sub-accounts that we utilize to track Mexico cost structure in this area. We then map those in to make sure that, when we do the reporting for the U.S., those things do map to the appropriate account. Again, you do have the additional reporting requirements for tax obligations in Mexico. You also have reporting on a monthly basis for your Social Security taxes, your VAT and, of course, income taxes. There are certain filings required for anti-money laundering efforts. These have been set in place by both the Mexican and U.S. governments. Of course, we are now dealing with an international border, so we have Customs requirements for both the U.S. and Mexico, and the biggest one that we want to take advantage is that of the North American Free Trade Agreement or NAFTA.

The Tecma Group of Companies:

After setting up all of those areas that have to do with the social programs in Mexico that you just mentioned, what are the other steps in setting up so that you can track your Mexico cost structure from an accountant’s point of view?

Mark Earley:

The first thing to be looking at when you are setting up the Mexican tax structure has to do with planning. You need to make sure that you have a set plan in place. Once of the first thing that you will do is consult with your internal and external experts. When you are setting up the Mexican entity you must ask from a coporate perspective: Do you have the talent internally that has dealt with a multi-national, and multiple currencies? This is important because the U.S. operation will be managing and overseeing the Mexican entity. The number one step is to determine what type of legal entity you are going to establish in Meixico. You have to decide whether you will take advantage of what is known as the maquiladora, or the IMMEX, program, which most U.S. companies do. Will you have a partnership, an S corporation or a closed coporation? Then, from a tax perspective, you have to look at the implications of operating in Mexico, as well as the related ramifications of that in the United States?

As you set up your Mexican entity, you will find that everything that happens there becomes a “pass through,” from an accounting, and also a taxx perspective, into the U.S. entity. Once you have made the determination as to how you are going to set up and operate, then you need to actually need to create and register the business in Mexico. This is done through local, state and federal agencies. The of registering a business in Mexico is quite tedious to do so, as you have to deal with fiscal, social and quite a number of agencies. Once you get that done, you set up your ERP system to go ahead and set up your general ledger accounting system. You also have to set up what is the logistics side, because now we are sending inbound material to a Mexican location and also we are moving that product out of Mexico. This needs to be set up properly. To do this it must be determined whether or not to partner with, or utilize, a third-party. There are solutions, for instance, for payroll. A lot of our ERP systems will have the ability to run payroll, but the decision then becomes whether to use an internal ERP system’s payroll, or that in Mexico or do we go third-party? A lot of the times it is cheaper and easier to go to a third-party than to develop the appropriate interfaces. Once you get set up, you start up a pilot to make sure that you have operational readiness to begin producing.

The Tecma Group of Companies:

How important is getting the set up of the ERP system right up front?

Mark Earley:

Good question. ERP systems are complex and have a lot of what I am going to call “one time flags” that you built in to them. You have to make the right decisions as to which ones are set, because once they are in place it is very difficult to go back and change them. This is because it will go back and change a lot of the underlying data that you have already put into place. Most of the larger ERP systems come with the advice that “once you set a flag, you do not change a flag.”

That being said, it is quite important as you go through, and once you set up the ERP system, you have to make sure that it is operating as purported. To make sure that this is the case, we look at both the “audit through,” and make sure that we look at every step that has taken place with the ERP system in the set up. We make sure that it’s providing the desired results. Then we do an “audit around.” In this operation, you look at all the source documents that are utilized to make sure that the individual steps in the ERP system are providing the desired results. You look at the beginning and the end of the process, and make sure that everything is correct.

The other thing that I want to stress is the logistic side of things. Yes, most companies that come to Mexico will continue to receive materials at their U.S. location that are kitted and sent down to Mexico. In time, however, you will redo your “milk runs,” and, definitely, your freight consolidation points in order to bring down freight and logistics costs.

The big thing to keep in mind when setting up the ERP is that you are looking to make sure that the information generated for both internal and external reporting is correct to express both U.S. costs and Mexico cost structure.

Tecma Group of Companies:

Earlier in our discussion, you mentioned the need to have the internal expertise that is required to navigate an environment in which multiple currencies are utilized. How does that play a part in the Mexico cost structure that we are discussing here?

Mark Earley:

If we take a look at a company that has not dealt with multiple currencies, as in the case of the type of U.S. company that we are discussing today, you are dealing with one currency and one reporting. You are usually reporting out to your local, state and federal agencies. Now that we have multiple currencies, we not only, of course, have the U.S. entity, but we also now have the obligation of reporting through the Mexican entity. The one thing to remember in a multi-currency situation is that you now have an additional treasury function. That is, you are moving monies to and from Mexico. To do these you will deal with a banking structure in Mexico. What usually happens is that the Mexican entity will request funds from the U.S. You will look at what is a favorable exchange rate ratio. Once source, a bank, or various financial institutions can provide assistance in this area. Here at Tecma, we use four different financial institutions, including banks. We look for the best U.S. Dollar – Mexican Peso exchange rate, and we go forward. There is the option of buying futures. Do you look at forwards and try to hedge the exchange rate for Pesos? You know also have the differences in reporting to the fiscal entities in Mexico to meet tax obligations there.

Another very important thing is the issue of internal controls. You know have a multi-national entity, and how now do you control it from an accounting perspective? Simple things that the Tecma Group utilizes include different colored check stock for what is printed in Mexican Pesos and what is printed in U.S. Dollars. This makes it obvious whether you are looking at a dollar check, or looking at a peso check. From a P.O. perspective, you want to make this easy for the individuals reviewing what are peso and what are dollar expenditures. There’s a whole series of things that need to be done to make sure that the controls that you already have in place are extended to the Mexican operation.

The Tecma Group of Companies:

These things could be a little bit daunting for companies making their first foray outside of the United States. This being the case, are there groups, or experts, out there that can help set up the Mexico cost structure from an accounting perspective for folks that don’t have prior experience with this?

Mark Earley:

Absolutely. There are both national and international legal and accounting firms in Mexico in the applicable areas of expertise that can be found throughout. Additionally, there are people involved with HR, environmental, customs issues that will help to do the necessary things. It is highly advisable that, during the planning stage, companies do engage these experts to help to plan, to set up, and, then, to execute the operations. Companies like the Tecma Group of Companies, shelter service providers in Mexico, that is, have and maintain the expertise in all areas of setting up Mexican operations. In fact, that is our strong point. We are, from a shelter service provider’s perspective, we are the administrative arm for companies that are manufacturing in Mexico. So yes, the expertise is there. In terms of consulting, and it is highly recommend that companies utilize these experts if they do not have experience in Mexico.

The Tecma Group of Companies:

You and I have a positive prejudice as regards the Mexico shelter company business model, because we’ve both worked in Mexico for a couple of decades or more. We’ve both seen the differenes of setting up in Mexico as a stand-alone entity, which under certain circumstances is an appropriate way for a company to do so. Cultural and/or functional issues often play into this choice. Then there is the shelter model in Mexico, of which we have intimate knowledge. There are several shelter companies in Mexico that offer quality services out there. From your perspective, dealing with this particular issue (Mexico cost structure), how would the shelter business model and the stand-alone route stack up in terms of both of their pros and cons.

Mark Earley:

I have worked for thirty years in Mexico, and during this time have worked for several manufacturing companies that have both used and not used Mexico shelter business model services. One of the barriers to operating in Mexico for many companies is that of “know-how and knowledge.” When you set up a manufacturing entity in Mexico you want to make sure that you do things correctly in terms of taxes and customs. This is because the penalties related to such errors can be very, very severe. The advantage of using a Mexico shelter company is that doing so eliminates the need to take the time and make the expenditures necessary to assemble the expertise that will give a company the internal capacity to “do business in Mexico.” The only thing that is needed in terms of knowlege is on the logistics side, and it related to how to get things to and from the border. In terms of the U.S. and Mexico cost structure, the shelter business model is simple to use because it is creates an environment in which a company can set up, essentially, what is another U.S. cost center. Doing it in this way can capture all the costs that are related to a Mexican entity.
Under the Mexico shelter business model, are there currency concerns? The answer to that question is “no.” This is because manufacturing operations that are conducted under the Mexico shelter business model will be invoiced for services in dollars. The invoice is such that you can then take what is your labor, in terms of wage and fringes, you can take all of that which is MRO and facility related costs and import them right into your company’s existing general ledger for that cost center, without going through and creating a new general ledger in Mexican Pesos. Additionally, the anti-money laundering requirments, tax filing and all other items related to fiscal reporting in Mexico go away. These issues are dealt with by the shelter company in Mexico on the behalf of their manufacturing firm clients. Under the shelter company in Mexico business model, manufacturers are operating under the service providers entity, and, therefore, do not have to deal with previously mentioned Mexican reporting obligations. Again this enables companies to use their ERP systems under one currency. The new entity will only be considered a cost center. Once again, it is just the logistics portion of shipping things to and from the U.S. – Mexico border that companies need to do.
In summary, shelter companies eliminate the need to fulfill any Mexican reporting requirements, to deal with multiple currencies and eliminates the need to make filings with the federal, state and local governments in Mexico.

Tecma Group of Companies:

Would it be safe to say that, for companies that may not have the deep pockets, like the big multi-nationals, to replicate just what they want in just about any location on the globe the Mexico shelter business model might be a much cleaner and easier way for them to go about setting up and maintaining manufacturing operations in Mexico?

Mark Earley:

Yes. That is correct, but what we have found is that even some of the very large multi-national companies use shelter company services. When they are going to move something to Mexico, in many instances, they are going to have a smaller operation. It really doesn’t make sense or them sometimes to do it themselves form the ground up. Although they have international expertise, they may not have Mexico specific expertise. We find that we have some very large companies that will utilize the Mexico shelter business model, because of the costs involved in setting up a Mexico specific operation.

The Tecma Group of Companies:

Also, there is a cost that is associated with retaining the personnel that holds that knowledge.

Mark Earley:

Absolutely.

Tecma Group of Companies:

Again, this is a company specific consideration, and everyone has
look at their own set of circumstances and decide which is the best way for them to go.

Mark Earley:

That is correct. It is an important decision that must be made during the planning phase to determine whether to use a shelter company in Mexico, or a stand-alone operation.

Tecma Group of Companies:

Mark, this has been something that we’ve spoken about, Mexico cost structure, from the perspective of an accountant. Would you be willing to follow this discussion up with a second one that examines Mexico cost structure from the vantage point of an operations executive?

Mark Earley:

Absolutely. I think that this leads into that. You can’t understand Mexico cost structure on the manufacturing side of things, if you do not understand it from the accounting side.

The Tecma Group of Commpanies:

Thank you for speaking with me about this topic today. Usually, at the end of these podcasts, we offer the contact information of our guests in case listeners have questions. How can people get into contact with you?

Mark Earley:

There are two ways to do that: (1) listeners can go directly to our webpage (www.tecma.com), and submit a question there, or (2) they can feel free to contact me by email at mark@tecma.com. I would be happy to reply to any questions that I may receive.

Tecma Group of Companies:

Mark, thank you for making yourself available for questions, and thanks for taking the time to speak on the topic of Mexico cost structure that we’ve covered today.
Mark Earley:

Thank you for having me. I appreciate it.

Remember, relevant and useful Mexico manufacturing content is available at one’s finger tips by downloading the Tecma Group mobile app from the Google Play Store, interested parties can also receive Mexico manufacturing information on a weekly basis by SMS Texting the word Tecma to 96000

Photo credit: 401(K) 2012

 

 

 

 

 

 

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