Cash Pooling Explained: Guide for Treasury Professionals (2024)

Ever wondered about the ins and outs of cash pooling? Are you looking for a clearer understanding of why corporations do it, what types it includes, and how to execute it? Then welcome to the Corporate Treasury 101 podcast! Here, our expert Guillaume is eager to guide you through the maze of cash pooling.

Get ready as we present the ultimate guide to understanding cash pooling on the Corporate Treasury 101 podcast. You’ll uncover the “whys” and “hows” of this treasury technique. We’ll dissect its different types, reveal why corporations adopt cash pooling and guide you on how to implement it concretely. By the end of this article, cash pooling will no longer be a mystery but a powerful tool in your treasury toolbox.

So gear up because we’re about to dive into the captivating world of cash pooling.

In this article, you’ll learn:

1. The nuts and bolts of cash pooling and how it could be a game-changer for your business.
2. The differences between physical and notional cash pooling, and how to decide which one is right for your company.
3. The pros and cons of managing your cash pooling in-house vs having your bank do it.
4. The practical steps to set up a successful cash pooling system include the role of daily cash visibility and accurate recording of intercompany loans.
5. The surprising challenges and complexities of cash pooling and how to navigate them.
6. How your company’s size and specific needs can affect your cash pooling strategy.
7. The importance of customization and the role of treasury management systems in optimizing your cash pooling.

Understanding the Next Step in Cash Positioning: Cash Pooling

We’ve previously discussed the idea of cash positioning, which was well-received and appreciated by our listeners. You remember that in corporate treasury, cash positioning refers to gathering data from all of a company’s bank accounts globally and then consolidating that data to get a snapshot of the company’s total liquidity.

In this discussion, we’re diving deeper into a more advanced concept that furthers cash positioning. This is known as “cash pooling”.

What is Cash Pooling?

Cash pooling is a cash management technique designed for treasury professionals. It focuses on understanding how much money a corporation has across various locations or units and centralizing these funds into one place.

In simpler terms, cash pooling can be considered to be gathering all the money a company has in its different bank accounts into one “pool”. It doesn’t mean stacking physical cash in one location – in today’s digital age, all this happens electronically.

How Does Cash Pooling Work?

It’s pretty simple when you break it down. Technically, you could physically gather all your cash, but that would be time-consuming and costly. Instead, cash pooling operates through bank transfers at the end of each business day.

Imagine that you own three cafes. Each cafe has its bank account, where it collects its earnings for the day. At the end of each day, the money from each cafe’s bank account is sent to a single central account.

The central account, often called the ‘header’ account, receives all the money from the other accounts participating in the cash pool. These other accounts are known as ‘participant’ accounts. At the end of each day, the goal is that these participant accounts hold zero cash because all their funds have been transferred to the header account.

You can choose any account to be your header account. It could be, for instance, the account of the cafe that’s the most successful or the largest.

To illustrate, let’s say the most successful cafe is in Brussels because it’s located next to one of the best restaurants in town. You decide to make the Brussels cafe’s bank account your header account. Each day, this account will receive all the money from the other cafes, leaving their accounts at zero balance.

The Concept of “Sweeping”

In treasury lingo, transferring the cash from each participant account to the header account is often called a ‘sweep’. Think of it as ‘sweeping up’ all the cash into one place. It’s an essential part of cash pooling that ensures funds are effectively centralized.

Cash pooling is a financial strategy that takes the concept of cash positioning and adds a layer of active management, centralizing all available cash into a single account. This approach can benefit corporations significantly, including better liquidity management, improved operational efficiency, and enhanced investment opportunities.

Why Should Corporations Engage in Cash Pooling?

Transferring all the cash from your various business units into one central account might initially raise some questions. Why would you want to do this? Wouldn’t this risk affect the financial stability of the individual business units? How would these units pay their bills and employees if their accounts were zeroed out daily?

The answer lies in the strategic optimization that cash pooling enables.

Centralizing Processes

Cash pooling doesn’t just involve centralizing cash; it often goes hand in hand with centralizing various other business processes.

For instance, when negotiating prices with suppliers, you do so for all your cafes together, not individually. This tactic also applies to other overheads like electricity, cleaning services, and potentially rent.

The essence of cash pooling is to act as a single large entity rather than multiple smaller ones. This approach can offer better negotiating power, improved consistency across your business, and enhanced efficiency.

Simplifying Payments

When it comes to making payments, such as payroll for employees or payments to suppliers, cash pooling makes these processes much easier.

With cash pooling, all payments come from the central ‘header’ account. This simplification means that payroll becomes less complicated, as all employees are paid from the same bank account, regardless of which cafe they work at. Similarly, all suppliers receive their payments from the same account.

Easier Reconciliation

From an accounting perspective, having a single account from which all transactions originate makes reconciliation easier.

Reconciliation is ensuring that two sets of records match – in this case, the transactions recorded by the bank and those recorded by the company. When all transactions come from a single account, it’s easier to match them up and identify discrepancies.

Better Visibility and Control

Finally, by centralizing your cash, you gain better visibility over your finances, as all your cash is in one place. It becomes easier to see how much money the company has, improving financial planning and decision-making.

This centralization also offers better control over your cash. Having all your funds in one account lets you more easily direct where and how it’s used.

To sum up, cash pooling is a strategy that provides benefits in terms of efficiency, visibility, control, and streamlined processes. It helps corporations act as one large entity rather than multiple smaller ones, enhancing their ability to manage their cash effectively.

What Happens if a Participant Account Goes Negative in a Cash Pooling System?

In a cash pooling system, there can be a situation where one of your participant accounts doesn’t have any cash to send to the header account at the end of the day or, worse, goes into negative. This scenario can sound intimidating but don’t fret. Let’s tackle it step-by-step.

Reversing the Cash Flow

When a participant account has no money or is in the red, the system works in reverse. Instead of sending money to the header account, that participant account would receive money from the header account. The goal is to bring all participant accounts back to a zero balance at the end of each day.

The reason for this is simple: centralizing cash as much as possible and avoiding participant accounts going into an overdraft position.

Avoiding Overdraft

You might be thinking, “What’s the big deal with an overdraft?” The fact is, being in an overdraft position means you’re borrowing money, and that usually comes with a cost – interest. By avoiding overdrafts through cash pooling, you save yourself those extra charges.

Lending Within the Group

You’re running a successful chain of 100 cafes across 20 countries. Some cafes might do exceptionally well, accumulating a cash surplus, while others might run at a deficit. In such a scenario, you can use your cash-rich cafes to support those experiencing cash deficits.

In a cash pooling system, the money would flow from the cash-rich cafes (participant accounts) to the ones in deficit, effectively lending money within your company. This strategy helps keep your money within your business without needing external short-term loans, which usually come with additional costs.

Always Better Than External Debt

The major takeaway is that internal lending within your cash pool is always preferable to borrowing from external sources. This strategy allows you to optimize cash management, control your finances, and save on interest costs.

Don’t forget that cash pooling is an effective cash management strategy; it’s crucial to continuously monitor and manage the cash flows between your different participant accounts. Regular cash flow forecasting can help you anticipate potential shortfalls and allow for more effective cash management.

How Do Cash Deficits and Intraday Limits Work in Cash Pooling?

Cash pooling, as we know, is a smart way to manage funds across various parts of a business, such as branches or subsidiaries. However, as this operation continues, you might have to tackle situations involving cash deficits and intraday limits. Let’s understand what they mean and how they function in cash pooling.

Understanding Cash Deficits

In a business context, a cash deficit means you’re short on cash. You might have heard terms like negative cash flow or accounts going below zero, both indicators of a cash deficit.

There can be many reasons for a cash deficit. Perhaps, you have to pay your suppliers, but your business isn’t drawing in enough customers. But your income is less than your expenditure, which is what a negative cash flow is about.

But let’s take a breather and don’t worry too much. A cash deficit doesn’t necessarily mean your business is doing poorly. It only indicates that you must find a short-term solution to return your cash balance to the positive.

Managing Cash Deficits with Intraday Limits

So how do you tackle these cash deficits? Here’s where intraday limits come into play.

When you set up a cash pooling structure, each bank account would have an intraday limit tied to it. This limit works similarly to an overdraft, letting you go below zero but only during the day. The goal is still to have the accounts at zero by the end of the day.

The term “intraday” might sound fancy, but it’s just as simple as it sounds – it’s about what happens during the day. Thanks to the cash sitting in the header account or at the group level, the bank trusts your ability to cover any short-term funding needs. It’s a wonderful safety net when managing a cash pooling system.

The Importance of Agreements with Your Banks

All these manoeuvres with cash deficits and intraday limits need specific agreements with your banks. These arrangements enable the smooth operation of your cash pool, ensuring that your money is where it needs to be when it needs to be there.

To wrap it up, cash deficits and intraday limits are crucial to understanding when managing a cash pooling system. They’re the gears that keep the machine running, helping you maintain a positive cash balance while avoiding unnecessary debt.

Why is the Cash Pooling Target Usually Zero, and What are the Alternatives?

You might have heard that in cash pooling, the primary goal is often to reach zero at the end of the day. But why exactly is that? And are there other ways to manage a cash pool? Let’s delve into these questions.

The Magic Number: Zero

The number zero is often emphasized in cash pooling. The reason for this isn’t some mathematical wizardry but a practical approach to cash management. By aiming to centralize as much cash as possible without going into an overdraft position overnight, businesses can avoid extra costs associated with being under zero.

This practice, known as zero balancing, keeps all participant accounts at zero by the end of the day. Being in an overdraft position overnight costs more than just being under zero during the day, so this approach keeps things streamlined and cost-effective.

Alternatives to Zero: Target Balancing

While zero balancing might be the norm, it’s not the only way to manage a cash pool. Another approach is “target balancing,” where you decide how much money stays in each bank account. It doesn’t have to be zero—it could be any amount that suits your situation, like ten, hundred, or even ten thousand.

The reasons for target balancing can be varied. For instance, the company you’re leasing from might require you to keep a certain amount of cash in the bank account as a lease guarantee. Or perhaps some of your subsidiaries have a small intraday limit facility, meaning you want to ensure more cash in the bank in case of unforeseen expenses.

It’s All About Balance

Regardless of whether you’re using zero or target balancing, the ultimate goal of cash pooling is balance. It’s about having the right amount of cash in the right place at the right time, not too much or too little. So, when managing a cash pool, always think about what balance makes the most sense for your business.

What Are the Implications of Zero Balancing for Short-Term Investments and Legal Requirements?

Handling short-term investments and fulfilling legal requirements are crucial parts of treasury management. However, maintaining a zero balance in cash pooling can raise certain questions and implications. Let’s untangle this scenario and understand the implications of maintaining zero balances for branches doing well.

Tying Cash Pooling and Short-Term Investments

Firstly, let’s remember that cash pooling can be a strategic tool to enable short-term investments. Cash pooling might be the strategy if a company wishes to make short-term investments in a specific branch or region or wants to aggregate contracts centrally.

But what happens if a branch is doing exceptionally well, yet its bank balance is always at zero at the end of the day because it’s transferring funds to another branch or subsidiary? This could raise concerns about the financial health of that successful branch, as, on paper, it may appear as though it has no cash at any given time.

Legal Implications and Financial Statements

While I won’t go into the detailed legal implications (that would be the domain of a legal advisor), it’s essential to understand that these cash movements can impact legal requirements and financial reporting.

When cash transfers out of a subsidiary’s bank account, it must eventually be accounted for. When the financial statements are closed at the end of the day or year, the question will arise: where is the subsidiary’s cash earned?

The answer lies in inter-company loans. These are loans made between different branches or subsidiaries of the same company. In the context of cash pooling, these loans record the daily sweeps or transfers of cash.

For instance, if cash moves out of a cash-rich subsidiary to a central account (the header account), and this account then lends to a cash-deficit subsidiary, these movements need to be recorded. The cash-rich company is essentially lending money to another subsidiary at any given moment. This is captured as an inter-company loan and settled regularly, perhaps every few days, weeks, or months, depending on the company’s setup.

What Are the Different Types of Cash Pools, and How Do They Work?

There are different types of cash pools. Let’s understand the differences between the two main types: ‘Physical Cash Pool’ and ‘Notional Pooling’.

The Ins and Outs of Physical Cash Pooling

First, let’s talk about the physical cash pool. The concept of zero balancing falls into this type of cash pool. Here, you transfer cash from the participant accounts (these could be different branches or subsidiaries of your company) to a central or header account. The same happens in reverse if a participant’s balance falls below zero.

“But wait,” you might be thinking, “Physical? Do we have to physically move the cash?”. Not quite. ‘Physical’ here can be misleading. Nobody is going to the bank, withdrawing money, and physically moving it to another bank. It’s a digital transfer of funds from one account to another at the end of each day.

An Introduction to Notional Pooling

The second type of cash pooling is called notional pooling, and it’s pretty much the opposite of physical cash pooling. In notional pooling, no cash is physically transferred between accounts.

So, how does it work? You start by looking at all your bank account balances and participating in the pool at the end of the day. You then calculate the consolidated balance and end up with your notional (theoretical) offset balance.

“Why is that important?” you might wonder. The main reason is interest calculation. Some accounts might be in a negative position and paying potentially high interest because they borrow short-term money. On the other hand, other accounts might be cash-rich. If the consolidated balance is overall positive or close to it, you either pay no interest or much less. This strategy keeps a certain level of flexibility at the local level, allowing subsidiaries to maintain some autonomy.

Remember that physical cash pooling and notional pooling aren’t authorized in all countries due to varying local legal requirements. This means that your choice of cash pooling strategy will depend on the regulations of the specific regions in which your company operates.

How Does Notional Pooling Benefit a Company, and Can Cash Pools Be Set Up Between Different Banks?

Understanding how notional pooling benefits a company and whether cash pools can be set up across different banks is critical to making sound treasury management decisions. Let’s break down this concept to help you make informed choices in your role.

The Benefits of Notional Pooling

At first glance, notional pooling might seem like it’s all about “what could have been” with your cash position. And you’re not entirely wrong. Notional pooling does indeed involve an assessment of what your cash position would be like if you had pooled the cash. This simulated scenario, however, serves a valuable purpose.

The key benefit of notional pooling is it allows for the management of interest payments on negative balance accounts without having to physically fund those accounts and negate the interest rates. It sounds like a win, doesn’t it?

Why would you want to do this? First, notional pooling requires much less setup. You can wave goodbye to the need for constant communication between different bank accounts and daily transfers. On top of this, it allows subsidiaries to maintain a degree of autonomy.

Moreover, it’s possible you might not be able to set up a physical cash pool in the first place due to restrictions on physical transfers. In such situations, notional pooling becomes an appealing alternative.

To give you a real-life example, let’s imagine you have two cafes, each with its bank account. One cafe consistently has a negative balance, while the other is cash-rich. Instead of paying hefty interest on the negative balances, you could consolidate these balances through notional pooling, resulting in a positive balance overall and lower interest payments.

The Intricacies of Setting Up Cash Pools Across Different Banks

Now, let’s tackle a tricky question: can you set up cash pools between different banks? While technically possible, it’s not a walk in the park. Setting up cash pools across different banks comes with more complexities and limitations.

Ideally, you’d want to set up cash pools within the same bank. This way, you can seamlessly manage interest calculations and other processes. Unfortunately, if you attempt to establish cash pools between different banks, the ability to calculate interest efficiently would be compromised.

Understanding the Mechanisms and Benefits of Physical and Notional Cash Pools

Both physical and notional cash pools are automated systems, meaning you aren’t manually making daily transfers. Instead, they involve setting up all your different bank accounts across regions, subsidiaries, or branches. But the way they function is slightly different.

A physical cash pool involves the automatic execution of transfers. Here’s what happens: At the end of each day, your bank zeros all the balances of your linked accounts into one master account. This process is performed automatically, so you don’t need to lift a finger.

On the other hand, a notional cash pool works a bit differently. You tell your bank, “Hey, I don’t want you to send all this cash to the master account, but can you consider all these accounts when you’re charging me interest as if they were one account?” In other words, you’re telling the bank, “Let’s pretend I transferred all the money, but without actually doing it.”

Why Would You Use Physical or Notional Cash Pools?

The choice between a physical and a notional cash pool depends on your needs.

You might prefer a physical cash pool if you pay out everything from your master account. For example, your accounting team, HR team, and suppliers might all get paid from this central account. The other accounts in the pool, in turn, take care of their day-to-day expenses. This setup could help you streamline your payment process.

On the other hand, a notional cash pool might be more appealing if you wish to maintain the autonomy of the accounts in the pool. You might not want each account’s balance to hit zero daily, but you also don’t want to get charged interest on each account daily. With notional pooling, you can agree with your bank to treat all your accounts as one when calculating interest.

What About Interest?

We’ve discussed negative interest rates, but let’s not forget the positive side. If your accounts have a lot of cash, you might earn interest from the bank. By consolidating all your cash into one account through cash pooling, you might be able to earn more interest.

It’s important to note that this principle applies to both physical and notional cash pools. You could say it’s all about leverage. If you can show your bank that you have substantial cash consolidated in your accounts, you’re more likely to get favourable conditions on both positive and negative interest rates. After all, the bank doesn’t want to lose you to the competition!

Understanding the Limitations and Drawbacks of Cash Pooling

Like all good things, cash pooling also comes with a few limitations. Let’s dissect these drawbacks to get a clear picture.

Currency Limitation in Physical Cash Pooling

Physical cash pooling might seem the perfect solution to manage your company’s multiple bank accounts. But remember, it only works smoothly when the bank accounts share the same currency. So, if you have Euro and USD accounts, you can’t simply lump them into a single physical cash pool. You’d need to have separate pools for each currency – one for Euro accounts and another for USD accounts. This limitation doesn’t apply to notional cash pooling because there are no actual money transfers between accounts.

Multicurrency Notional Pooling

Notional cash pooling offers a feature that physical cash pooling lacks – it allows you to merge and consolidate accounts in different currencies. This is known as multicurrency notional pooling. Remember, no actual cash transfer occurs here. It’s more about considering multiple accounts as one, regardless of the currency they hold.

Setup Effort and Legal Implications

Setting up a cash pool, whether physical or notional, is not a walk in the park. It requires much effort, particularly in understanding and dealing with tax and legal implications. Different countries have varying local requirements for setting up cash pools, and navigating these rules can be challenging. Therefore, ensure you’re well-versed in the relevant regulations before diving in.

Loss of Autonomy at the Subsidiary Level

Cash pooling might work wonders for the big picture at the group level, but it might not be as rosy at the subsidiary level. A subsidiary controls its cash to the group-level management by joining a cash pool. This loss of autonomy could be a downside for some businesses, especially those who like to maintain tighter control over their funds.

Technical and Cost Impact

Setting up a cash pool in-house with your systems or completely managed by the bank. If you choose the in-house route, you’ll need a robust treasury management system and a seamless bank connectivity structure. This requires significant resources and knowledgeable people within your company.

If you choose to have the bank manage the cash pool setup, it would mean fewer resources are needed internally. But don’t forget, the banks will charge you for this service. Depending on your company’s structure and needs, these costs can add up and might make cash pooling a pricier option than initially anticipated.

Setting Up In-House Cash Pooling: How Does It Work?

After delving into the benefits and limitations of cash pooling, you may wonder about the technical aspects of setting it up, especially if you decide to do it in-house. Let’s break down the step-by-step process to better understand what it entails.

Step 1: Consolidate Bank Accounts

The first step in setting up in-house cash pooling is to consolidate your bank accounts as much as possible within the same bank. This step is crucial as it helps avoid complications and limitations when dealing with multiple banks. It’s about streamlining and rationalizing your banking landscape. Think about it like this – if you were organizing a game in your neighbourhood, wouldn’t it be easier to coordinate with one team at a single location rather than dealing with multiple teams scattered across different areas?

However, consolidation doesn’t necessarily mean cutting down on the number of bank accounts. You might need to maintain different accounts for different regions or currencies. But try to keep these within the same bank as much as possible.

Step 2: Keep a Daily Overview of Cash

Next, you need a robust system to keep track of your cash balances in all the different bank accounts. This system should provide end-of-day bank statements showing the final balances of all accounts. It’s like getting a daily report card of how much money is in each account.

Step 3: Initiate Payments Using Your System

Once you have a clear picture of your cash balances, you initiate transfers from your different accounts. The amount to be transferred is based on the information you received on your bank statements.

Here, having a strong treasury management system is key. You want a system that can handle the intricacies of managing multiple bank accounts worldwide. It’s like having a skilled conductor leading an orchestra, ensuring each musician plays their part at the right time and in harmony with others.

Step 4: Accurately Record Each Transfer

The final step is accurately recording how much money is transferred from each subsidiary daily. This is important for keeping track of intercompany loans. Doing so ensures transparency and accuracy in your records and avoids any discrepancies that could create issues down the line.

To summarize, setting up in-house cash pooling involves rationalizing your banking landscape, maintaining a daily overview of your cash, initiating transfers through a robust system, and accurately recording each transfer.

In-House vs Bank-Managed Cash Pooling: Which is Better?

When we start talking about setting up a cash pooling system, one of the first things you might think is, “Why not let the bank handle it?” After all, it seems a lot easier, right? Just hand over the reins to your bank and let them manage the whole thing. But is it the best option for you?

Customization and Control: An Edge for In-House Cash Pooling

The bank-managed route might seem appealing, but it does have its drawbacks. First of all, your options are somewhat limited. With in-house cash pooling, you have more control and the ability to customize the system to your specific needs. This might not be something smaller companies need to worry about, but if you’re running a large corporation, that customization can be invaluable.

With in-house cash pooling, you can decide on the specific nuances of your system, such as the exact time of day when you want to calculate end-of-day balances. That level of control is not possible when you let the bank manage everything.

Costs and Infrastructure: Weighing the Trade-Offs

Bank-managed cash pooling isn’t free. Banks charge for their services, and those costs can pile up. On the other hand, setting up in-house cash pooling requires significant upfront effort and a solid infrastructure. However, larger companies often already have the necessary systems, including a strong enterprise resource planning (ERP) system, a robust treasury management system, and perhaps even a payment hub. These companies may find it more cost-effective to leverage their existing infrastructure to set up and manage cash pooling.

Size Matters

The size of your company and the complexity of your operations can influence which option is better. If you’re running a smaller business, the simplicity and convenience of bank-managed cash pooling might outweigh the benefits of an in-house system. But if you’re a larger corporation, you might benefit more from the customization and control offered by in-house cash pooling.

Opting for in-house or bank-managed cash pooling isn’t a black-and-white decision. It depends on various factors, including the size of your company, your need for customization, the complexity of your operations, and the cost-effectiveness of each option.

Wrapping Up

Well, that’s a wrap! We’ve taken a deep dive into the world of cash pooling, something that could be a game-changer for your treasury management.

Remember, there’s no one-size-fits-all solution. What works for one company might not work for another. You must evaluate your company’s needs and resources and choose the cash-pooling approach that works best for you.

Whether you opt for physical or notional cash pooling or decide to manage it in-house or let your bank take the reins, it’s all about making your cash work for you. It’s about optimizing your resources, reducing your costs, and keeping your business financially healthy.

So, take the plunge, explore your options, and start making your cash work smarter, not harder. Good luck on your cash-pooling journey. You’ve got this!