What is Cash Pooling?

In companies with multiple subsidiaries, such as branches in different countries, obtaining real-time visibility into current liquid assets can be challenging. Cash pooling, as part of efficient cash flow management, provides an ideal solution for this. Cash pooling involves consolidating all liquid assets into a single account. This ensures optimal control over cash flow, with an additional benefit of faster transfers. Typically, a cash pool is managed by the overarching organizations of various branches or subsidiaries, often the parent company or holding.

Why Opt for Cash Pooling?

Efficient cash flow management is the primary reason for choosing cash pooling, accompanied by various underlying considerations. This includes minimizing transaction costs for businesses and reducing financing expenses. In cases where business units face a cash deficit and rely on overdraft facilities, this may be unnecessary if an overall positive cash position exists across all business units.

Cash pooling provides a solution by assisting the specific business unit financially, eliminating the need for short-term financing. Another crucial reason is to better manage risks during currency exchange and optimize cash positions. Entering into a cash pooling agreement aims to maximize the overall returns on the companies’ cash funds. The key feature of a cash pool is that the parent company or holding utilizes the opportunity to distribute available liquid assets optimally.

Cash Pooling Options

When choosing cash pooling, it’s essential to consider legal and tax regulations in other countries if there are foreign branches. Additionally, cash pooling options depend on the company’s organizational structure, with cash management setup playing a role. Two distinct options are notional cash pooling and physical cash pooling.

What is Notional Cash Pooling?

Notional cash pooling, or balance offsetting, involves virtual payment processing to offset debit and credit balances. There is no actual physical transfer of money. Within the holding or parent company, interest conditions improve through this form of cash pooling by reducing interest expenses through virtual calculation. Notional cash pooling optimizes the use of liquidities.

What is Physical Cash Pooling?

Physical cash pooling, or cash concentration, entails the monthly or periodic consolidation or replenishment of subsidiary accounts by the main account. This involves actual transfers or withdrawals, moving money electronically. This establishes financial balance, also known as target balancing. Zero balancing, where the target balance is zero, is a common approach in physical cash pooling.

What is Target Balancing?

Target balancing involves reducing the book balance on sub accounts to a predetermined target. This amount is set in advance, with the frequency determined at the company’s discretion, such as daily, weekly, or monthly. Setting a minimum limit for transferred amounts prevents the need for frequent small transfers. Target balancing ensures sufficient funds are always available in subaccounts, with autonomy and responsibility remaining with the local business.

What is Zero Balancing?

In zero balancing, there is a daily currency-neutral transfer of funds from sub accounts to the central account. This provides optimal insight into liquidity, increases interest income, and reduces interest costs.

Are There Disadvantages to Cash Pooling?

In addition to numerous advantages, there are some drawbacks to cash pooling. Setting up a structure with a parent company or holding incurs costs, as does managing the central point. Aligning the various banking systems of the companies is necessary, along with adhering to legal and tax regulations when operating in multiple countries. It’s also possible to outsource cash pooling to a bank, but this adds complexity to the situation.

Centralizing Cash Flow Management

The benefits of cash pooling typically outweigh the disadvantages, especially considering the need for optimal cash flow management. Cash pooling ensures easy and accessible visibility into total liquidity for each subsidiary or branch. Balances across various accounts can be optimally utilized, and cash flows can be perfectly managed. This reduces financing needs and enables full utilization of corporate liquidity.