Cash Pooling 101

When managing the cash of several entities under the same corporation, businesses often turn to cash pooling. Cash pooling helps businesses to manage complex cash management tasks like managing their credit and debit status, reducing costs, and much more.

Let's dig deeper into the types of cash pooling, the pros and cons, and ways to implement it properly. 

What is cash pooling?

It is a centralized cash management system that a company or a group of companies use to 'pool' cash balances together to optimize their cash balances. With cash pools, companies can take care of their legal entities and cash effectively without resorting to short-term debt.  

In the case of a large group that comprises a powerful holding and subsidiaries facing a cash deficit, cash pooling will allow corporations better to serve the interest of each of their subsidiaries.

What are the types of cash pooling?

There are two types of cash pooling techniques - physical cash pooling and notional cash pooling. 

Physical cash pooling 

In physical pooling, the cash is periodically transferred between each subsidiary bank account and a master account.

This approach focuses on the actual or physical cash flow between the primary and subsidiary accounts. At the end of the business day, the cash balances are swept to the primary or master account. 

There are several types of physical cash pooling;

Zero balance account cash pooling (ZBA): Here, the subsidiary accounts' balances are reduced to zero daily. It gives an assurance that the accounts are not overdrawn by mistake. 

Target balance account cash pooling (TBA): Here, a minimum balance threshold is set, and when this amount is exceeded, the excess cash is swept onto the master account. 

Fork balance account (FBA): It's a daily process where the accounts of all the subsidiaries are brought up or down to a specific amount (but always above zero). In this case, the amount in the accounts is set in advance. 

Notional cash pooling 

This type of cash pooling involves combining all the merged statements from all the subsidiary accounts.

Notional pooling facilitates the calculation of interest on the combined debit and credit balances of all the subsidiary accounts. Unlike physical cash pooling, no actual transfer of funds takes place in notional pooling, thereby lowering transaction costs. 

The benefit of the notional pooling approach is that it allows each company to operate with its own credit lines without moving the funds from the master account. 

Further, by merging interest statements, each of the subsidiaries benefits from more attractive interest rates than they would have had as a separate entity. 

Takeaways

• Physical transfer of funds is possible in zero or target balance structure. But not with notional pooling.
• Zero or target balance structures don't have bank accounts using different currencies. However, the notional structure can include them.
• Bank accounts in different banks are allowed under zero or target balance structures. At the same time, the notional structure cannot have bank accounts in multiple banks. 
• Zero or target balance structures can have bank accounts in different countries. Which allows for cross-border cash pooling. 

What are the benefits of cash pooling?

When cash pooling is in place, it helps businesses to centralize their balances. Thereby, the optimization of interest, as well as managing accounts, is done effectively. Let us look at the benefits of the cash pooling technique that make it so popular among businesses: 

• Cash pooling technique helps companies to minimize their bank fees.
• The financial needs are optimized by considering a business's debit and credit accounts. Furthermore, using internal corporate cash reduces the need for corporations to take on debt.
• As the balances are bifurcated across several accounts, the financial resources can be used in a better way. It further helps in reducing external banking fees, costs, etc.
• The businesses can opt for good bargaining techniques with the banks. It helps in reducing the financing costs based on the subsidiaries or groups.
• Treasury retribution is possible with the help of cash pooling techniques 
• Risks are averted, and businesses can manage them effectively. It happens because the interest rates are being monitored continuously.
• Return on investment (ROI) improves because of the economies of scale.

How does cash pooling work?

Cash pooling is a technique where the cash is centralized and then bifurcated across different subsidiaries or groups. It takes into consideration the issues such as cash deficit and cash surplus. It is usually carried out by the treasurer, who is usually the financial director of the parent company. From implementing this technique to managing the cash, we have to follow several steps.

We already talked about the different types of cash pooling - physical and notional pooling. Now, let us look at the prerequisites for the effective cash pooling technique. 

• Check the statutes of a company: Each company involved should allow cash pooling. For this, you need to check the status of each company. 
• Maintain the interest of each company: With cash pooling, not all fund movements are authorized. There should not be any misuse of assets, abnormal usage of management rights, or inappropriately using shareholder power. 
• A cash management agreement is needed: Whenever the fund transactions occur, one should keep the risks as minimal as possible. The cash management agreement states the terms and conditions of cash pooling. It includes the following:
  • A business holding the master cash pool account or header account 
  • The group of companies or subsidiaries concerned
  • Terms and conditions of the cash management agreement
  • Mandatory clauses such as early termination and suspension clauses
  • In a dispute, the stated place of law and jurisdiction is applicable.

Bottom line - The purpose of cash pooling 

Cash pooling can help reduce banking costs, avoid taking on too much debt, optimize interest rates, and improve risk management and cash concentration. It also helps in minimizing the trapped cash flow, thereby optimizing liquidity. With cash pooling, you can take care of potential issues before they arise in the future. 

Whether you experience a cash deficit or cash surplus, the cash pooling technique will ensure better funds management for your business. 

Always ensure that the cash pooling operation is working smoothly. Your business can choose the appropriate cash pooling structure tailored to your needs. Furthermore, implementing a proper cash pooling system will help manage tax and accounting implications.