It is often difficult for companies with multiple subsidiaries, such as branches in different countries, to gain insight into the current liquid assets. Cash pooling is an ideal solution for this, as part of efficient cash flow management. With cash pooling, all liquid assets are consolidated into a single account. This provides optimal control over the cash flow, with an additional advantage being the speed of transfers. Typically, a cash pool is managed by the overarching organizations of the various branches or subsidiaries, often a parent company or holding.
Why choose cash pooling?
Efficient cash flow management is the main reason to choose cash pooling, but there are several underlying reasons as well. For example, to limit transaction costs of enterprises and minimize financing costs. It may happen that there are business units facing a cash shortage and therefore need to use a current account credit. This may not be necessary if, overall, the business units have a good cash position.
Cash pooling offers a solution by financially assisting the relevant business unit. This eliminates the need for short-term financing. Another important reason is to better manage risks during currency exchange and to optimally monitor the cash position. Another reason to enter into a cash pooling agreement is to maximize the total return on the companies’ cash. The main feature of a cash pool is that the parent company or holding uses the opportunity to optimally distribute the available liquid assets.
What are the possibilities with cash pooling?
When choosing cash pooling, it is important to consider the legal and tax regulations of other countries if there are branches abroad. Moreover, it is important to know that the possibilities for cash pooling depend, among other things, on the corporate structure. The setup of cash management also plays a role in this. Furthermore, there are two options to distinguish, such as notional cash pooling and physical cash pooling.
What is notional cash pooling?
Notional cash pooling, or balance compensation, is characterized by the virtual handling of payment transactions with the aim of offsetting debit and credit balances. No actual physical transfer of money takes place. Within the holding or parent company, interest conditions improve through this form of cash pooling. Interest expenses can be reduced by virtual calculation of the interest payable. Credit interest rates are lower than debit interest rates. Another feature of notional cash pooling is that the use of liquidity is optimized.
What is physical cash pooling?
Physical cash pooling, or cash concentration, involves the monthly or periodic sweeping or topping up of subsidiary accounts by the main account. This involves an actual transfer or debit of accounts, with the money moving electronically. This creates financial balance, also known as target balancing. Zero balancing is most common in physical cash pooling, where the target balance of the relevant accounts is zero.
What is target balancing?
Target balancing involves bringing the book balance on sub-accounts back to the so-called target. This is the amount that has been predetermined, and the frequency can be set at one’s discretion, such as daily, weekly, or monthly. In addition to the predetermined amount, there is also an option to set a minimum limit for the amount to be transferred. This prevents the need to transfer small amounts frequently. An advantage of target balancing is that there is always sufficient money available on the sub-accounts. The autonomy and responsibility remain in the hands of the local enterprise.
What is zero balancing?
With zero balancing, there is a daily currency-neutral transfer of money from the sub-accounts to the central account. This provides optimal insight into liquidity, but also results in higher interest income and lower interest costs.
Are there any disadvantages associated with cash pooling?
In addition to the many advantages, there are some disadvantages associated with cash pooling. For example, it costs money to set up a certain structure with a parent company or holding. Managing the central point also incurs costs. It is necessary, among other things, to align the different banking systems of the companies. Additionally, various legal and tax regulations apply if there are branches spread across multiple countries. It is also possible to outsource cash pooling to a bank, but this makes the situation more complex.
Centralizing cash flow management
The advantages of cash pooling generally outweigh the disadvantages, especially because there is a need to optimally manage cash flow. Cash pooling ensures that the total liquidity per subsidiary or branch is easily and accessibly visible. The balances of the different accounts can be optimally used in all respects, and cash flows can be perfectly managed. This reduces the need for financing and fully utilizes the company’s liquidity.
