All about cash pooling: definition, method, advantages

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Cash pooling is a cash management technique employed by a corporate group made up of several entities. There are a number of cash pooling methods, such as physical cash pooling and notional cash pooling, and the process can be managed either in-house or by your bank. So, what is cash pooling? How do you implement it? What are the pros and cons? Everything will become clear in this comprehensive article.

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Cash pooling – definition

Cash pooling (sometimes also written as cashpooling) is a centralised cash management technique that is used by companies made up of multiple subsidiaries. It helps groups optimise the cash balances of all the legal entities as efficiently as possible.

Generally speaking, cash pooling is implemented mostly by large corporate groups because it requires a certain level of structuring and in-house resources, however it can be used by any group made up of several companies. The holding company or parent company acts as a central strategic unit that distributes liquidity to better serve the interests of each subsidiary.

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What is cash pooling?

The principle of cash pooling is to centralise cash flow management with the holding company and to balance the bank accounts of all the subsidiaries. Indeed, some entities of a group may be experiencing cash deficits and have to resort to rather expensive short-term cash flow financing options (high-interest loans, overdrafts that are subject to fees or bank commissions and so on), even though the group is financially healthy on the whole. At the same time, other entities within the group may have cash surpluses that just sit in their accounts and yield little.

Cash pooling solves this problem:

  • If there is a cash deficit, cash pooling lets the group help those subsidiaries in difficulty and limit banking charges by having just one bank account in deficit
  • If there is a cash surplus, cash pooling lets the group capitalise on all of the profits from each subsidiary by making better investments and increasing interest

Cash pooling is therefore a way of centralising cash, then redistributing this among subsidiaries. Subsidiaries will transfer their balance surplus to the master bank account (known as an upstream movement). If the balance is in deficit, the master account in the structure will send the necessary cash down to the entities that need it (a downstream movement).

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Difference between netting and cash pooling

Netting and cash pooling are two different financial concepts. Netting is a payment technique that can be implemented between independent companies that are not linked to each other. Legal entities in the same group that have implemented cash pooling measures may also implement netting; it is a way of offsetting a group’s internal balance. Netting is a way of optimising and easing a group’s financial flows by reducing the number of transactions, however it is not a banking operation.

Benefits of cash pooling

Cash pooling offers several benefits for the group and its entities, for example by: -Ensuring better management of each company’s liquidity requirements and surpluses -Reducing the level of short-term debt -Improving self-financing and reducing reliance on loans -Receiving better bank interest rates due to higher volumes -Ensuring better visibility of each company’s cash flow situation and a - consolidated group overview, allowing financing- and investment-based decisions to be made -Ensuring better liquidity risk management

Prerequisites for cash pooling

The use of cash pooling is set out by HMRC in its manual “INTM503100 – Intra-group funding: Cash Pooling”. Any company can implement cash pooling, regardless of their organisation, provided that this is permitted under the companies’ statutes. However, cash pooling does involve a number of steps and practical obligations before it can be implemented.

Check the statutes of the relevant companies

The business purpose of the companies concerned must allow cash pooling, so you need to check the statutes of each company. Be careful: the statutes of the company holding the master account must specifically mention a cash pooling option.

Maintain the interests of each company

Not all cash movements are permitted in cash pooling! The interest of the group should not be prioritised at the expense of those of the entities that comprise it. Be careful not to fall into: -Misuse of corporate assets -Abnormal acts of management -Abuse of majority shareholder power -Confusion of assets

Set up a cash management agreement

In order to minimise risk, the parent company and its subsidiaries should conclude a cash management agreement. This will formalise the cash pooling and set out the terms and conditions.

The cash management agreement must include:

  • The company holding the master account
  • The group companies concerned
  • The purpose of the cash pooling
  • The term of the agreement
  • Early termination clauses
  • Suspension clauses, where applicable
  • Applicable law and place of jurisdiction in the event of a dispute

Conclude a cash pooling agreement (optional)

A cash pooling agreement is an optional agreement concluded between the company holding the master account and the bank, if cash pooling is automated and managed by a credit institution.

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How is cash pooling carried out?

Cash pooling is managed by the treasurer, the financial director or the chief financial officer of the parent company. It involves regularly transferring the bank account balances of all entities to a single master account.

The company holding the master account may be the holding company, the parent company or any group company concerned, such as a sister company. It may even be a financial company specially established by the corporate group for this purpose or may be established as a bank. There are several methods of cash pooling but the overall principle remains the same. A group company’s cash surpluses are transferred into a master account in a movement known as a sweep. Conversely, group companies with balances in deficit can benefit from this cash flow, which is known as a cover.

There are two main methods of cash pooling:

  • Physical cash pooling: this is when a real cash amount is swept to the master account; it is often automated by the bank

  • Notional cash pooling: this is when cash is centralised virtually by merging interest statements, which allows each entity to operate its own credit lines without funds being moved from the master account; it is generally only used by very large corporate groups

Some groups use a combination of the two methods, which is referred to as hybrid cash pooling. This is often the approach taken by large international groups.

Physical cash pooling

Pooling cash through the physical transfer of funds involves real cash flows between the master account and the accounts of the subsidiaries. There are several methods of physical cash pooling where the balances of the accounts in question are levelled.

ZBA cash pooling

Zero balance account (ZBA) cash pooling is when the accounts of subsidiaries are zeroed on a daily basis, and generally as part of an automated process performed by the bank or by specialised software. ZBA gives you the reassurance that none of your subsidiaries’ accounts is overdrawn. The downside may be that the subsidiaries feel a lack of independence in terms of their own cash management.

TBA cash pooling

Target balance account (TBA) cash pooling is when a minimum balance threshold is set and any amount in the subsidiary account that exceeds this minimum is swept to the master account. If an account balance is in deficit, the balance is systematically replenished. If the balance is below the minimum threshold, no sweeping will take place.

FBA cash pooling

Fork balance account (FBA) cash pooling is a daily process where all of the subsidiaries’ accounts are brought up or down to a specific amount (that is not zero) that is set in advance.

Physical cash pooling can be done manually or can be automated, either using treasury management system (TMS) software or via your bank. The advantage of physical cash pooling for the group is that it has more visibility and control over the overall cash flow. However, this comes at the expense of subsidiaries, which find themselves with little autonomy.

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Notional cash pooling

Unlike physical cash pooling, notional cash pooling does not involve the physical transfer of funds. Instead, it involves consolidating the merged statements from all bank accounts (with the same currency and in the same country) of the group companies involved in the cash pooling process. It is also referred to as notional pooling.

The purpose of this merging is to facilitate the calculation of interest by notionally offsetting a mirror account that shows the positions of the different accounts. An indicative amount is determined for each subsidiary and is correlated with the transactions that the entities operate in line with their requirements and surpluses.

Notional cash pooling allows each entity to operate with its own credit lines, without the movement of funds from a master account. By merging interest statements, the subsidiaries benefit from more attractive interest rates for lending and borrowing activities than they would have had individually.

Benefits of notional cash pooling

Notional cash pooling has several advantages:

  • Attractive interest rates: the bank-offered interest rates for lending and borrowing are more attractive for all the subsidiaries together than those negotiated individually

  • More autonomy for subsidiaries: they continue to operate autonomously with their own credit lines

Example of notional cash pooling

Here is an example of a company with three subsidiaries with sterling accounts.

Account A in GBP Account B in GBP Account C in GBP Notional offset balance
Balance 500 -400 -200 -100
Lending interest rate of 5 % -20 -10
Borrowing interest rate of 3 % 15
Interest on the offset position -5
  1. First, the lending interest (less any deductions) for the various accounts is paid: this corresponds to account A, so in this case is £15. Similarly, the lending interest is deducted: this corresponds to accounts B and C, so is -£20 and -£10 for a total of -£30.

  2. Second, the bank calculates the lending interest and borrowing interest that would have been received for the notional offset position: this corresponds to the sum of (£15-£20-£10) for -£5.

The net difference between the sum of the interest actually posted and the notional interest is repaid to the group of participating companies by the bank.

REBATE = (individual lending interest - lending rate on the offset position) - (individual borrowing interest - borrowing rate on the offset position) = (£30-£5) - (£15-£0) = £25-£15 = £10 In this example, the rebate is a (partial) refund of lending interest previously paid. It is therefore not deductible. There are two solutions for redistributing the rebate to the participating accounts:

  • Automatically distribute the rebate on a pro-rata basis between the accounts of the subsidiaries
  • Post the rebate in the master account (in this case, the group will then have to distribute the rebate itself between the different participating accounts)

International cash pooling

When a company has subsidiaries around the world, the cash pooling methods that are possible in the United Kingdom are not always an option. Rules surrounding cash pooling differ across countries, particularly with regard to remuneration and interest rates. Some foreign laws do not allow intra-group treasuries to be centralised, while others enforce different rules from those applicable in the UK. In Poland, for example, the law prohibits cash pooling.

Before implementing international cash pooling, it is best to learn about or receive professional guidance with regard to the fiscal and regulatory issues associated with cash pooling.

How international cash pooling works

International cash pooling (in a defined currency) requires pooling at two levels. A clearing bank in each country where accounts are held completes the first level of pooling. An international, cross-border bank then manages international pooling. The first level of pooling is completed at a country level, then the resulting balances are pooled at an international level.

Multi-currency cash pooling

While physical cash pooling is typically used with just one currency, it can also be applied to multiple currencies. If the cash pooling is managed by the bank, the scope is restricted because bank-managed cash pooling is generally limited to single-bank and single-currency processing.

Therefore, it is necessary to reproduce the cash pooling systems for each currency handled by the group. Multi-currency cash pooling is only possible using notional cash pooling with the help of a dedicated tool.

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In-house cash pooling or bank-managed cash pooling?

When pooling their cash, companies can choose either to engage one or more banking partners or to rely on the capabilities of their cash management system to manage their sweeps manually.

Bank-managed cash pooling

Bank-managed cash pooling can be adapted to all types of companies. SMEs, mid-caps and large corporate groups can all use and benefit from the specialist services with high added value that banks offer. Bank-managed cash pooling is best suited for companies that do not have treasury management system (TMS) software or have not deployed it on a large scale. Bank-managed cash pooling is generally only for single-bank and single-currency cash pooling.

The advantage of bank-managed cash pooling is that it requires few in-house resources. All it involves is signing a cash management agreement detailing the lending-borrowing relationship between the participating entities and signing a cash pooling agreement with the bank. It should also be noted that bank-managed cash pooling adds value to the overall relationship between the bank and the company.

The costs of bank-managed cash pooling must be negotiated with each bank. They are usually calculated based on the number of accounts involved, so the company may have to streamline the upstream banking structure; reducing the number of accounts helps to optimise the cash pooling processes and costs. Before signing with the bank, the company must also check whether domestic and international transfers between accounts within the same banking group are included in the cost of cash pooling.

In-house cash pooling

In-house cash pooling is carried out more by large corporate groups that are structured for and used to managing their cash, their investments and even their payments centrally. This method is best suited for companies with a large number of bank accounts and a TMS that is designed to meet their requirements.

The advantage of in-house cash pooling is its flexibility: the group is autonomous in its cash pooling and can modify the rules it imposes on its subsidiaries. It does, however, require in-house resources that are able to correctly set up and use the TMS, which manages the cash pooling, on a daily basis. Groups often use the TMS to execute daily manual account levelling movements, but it also allows them to define management rules to automate cash pooling. Another advantage of in-house cash pooling is that it can be implemented across multiple banks and currencies.

The costs of in-house cash pooling come mainly from wire transfers fees. These costs can be very high, especially for international flows, so it is essential that groups negotiate these fees with each banking partner.

These two methods can also be combined: it is certainly possible to set up a hybrid structure, where accounts belonging to the same banking group are centralised by that bank and the clearing accounts are managed from the TMS.

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Limitations and disadvantages of cash pooling

Cash pooling is certainly an attractive method for managing directors, finance directors and treasurers of a group made up of several entities.

But several obstacles can make cash pooling difficult to implement:

  • If a group operates internationally, the legal and fiscal situation in each country can make cash pooling difficult – if not impossible
  • At a group level, cash pooling enables highly specific control of the cash situation of each subsidiary, but from the perspective of the subsidiaries this leads to a loss of autonomy. Therefore, they are often reticent and can see cash pooling as an unwelcome intervention by the parent company in the management of the subsidiary

-Implementing cash pooling requires auditing and rationalisation of banking practices to be carried out in advance. This step can be tedious and time-consuming and takes up in-house capacity

  • If cash pooling is completed in-house, it requires a specially designed information system that must be uniform and accessible across all subsidiaries. Rolling out such a system requires interfacing, deployment and then the consolidation of the information of each subsidiary

So, implementing cash pooling is a major project for a company. It is synonymous with good financial performance but it does take time and resources to adapt it to the specificities of the company.

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