Cash Pooling
Increase liquidity, improve net interest income and reduce borrowed capital.
The easiest way to do this is with cash pooling. Be it with zero balancing, target balancing or notional pooling
The primary objective of any cash pooling is to optimize and use the surplus liquidity of all companies in a group. Furthermore, interest rate advantages in particular are generated in many ways for the pool participants. This can be the case both on the investment side and on the borrowing side.
Option 1: Zero or target balancing cash pool (physical)
Zero balancing, also known as cash concentration or sweeping, is the simplest form of cash pooling. The concentration of all balances in one account also reduces the balance sheet total and improves various key figures. However, there are also some disadvantages compared to notional pooling. For example, liability issues (see “Bremer Vulkan”, “Swissair” or “Erb Group”) and a higher administrative burden, as the cash flows are physical.
Attention must also be paid to tax hurdles, keyword transfer pricing. This is because the “classic” cash pooling mentioned above is nothing more than automatic intra-company loans on a daily basis. Some countries, even in Europe, have laws that either do not allow interest payments in one or both directions or even do not allow physical cash flows from the mostly foreign subsidiary to be transferred to the parent company - which is usually not in the same country - without further ado. 1) BLUM, (fn 12), 712; BRAUCHLI ROHRER/HÜNERWADEL (fn 10), 154; JAGMETTI (fn 12), 94 and BGer 4A_248/2012 of January 7, 2013, E.2.
Procedure / functionality of a zero/target balancing cash pool
The participants' pooling accounts can be managed in two ways, both fully automatically:
- Zero balancing: all participating accounts, except for the header account of the pool leader, are set to zero (0) at the end of the day. Credit balances are debited, negative balances are credited.
- Target balancing: Basically the same as zero balancing, but with a large number of extended parameters relating to the end-of-day balance. For example, a certain balance can always remain at the end of the day, which may be required to cover rent deposits or similar.
Payment processes and information flow for a cash pool
For processing reasons, the transfers are usually not posted until the following day, but with the correct value date. Here is an example of how the daily communication for the balance transfer could function technically via the (depending on the bank, there may be individual deviations). Depending on the pool size and complexity in relation to different countries (keyword, see below), in addition to the house bank with which the header account is held, third-party banks with which some pool participants have their account must also be involved. This scheme here is of course highly simplified and does not include internal connections, for example, which are always mandatory in a cash pool.
Option 2: Notional cash pool (no physical cash flows)
The term “notional” already reveals the characteristic of this pooling variant: it contains an imaginary account. There are no physical transfers. This makes this type of pooling ideal for companies that do not want to take any financial risks from receivables. As with zero balancing, the primary aim here is to keep the difference between debit and credit interest within the group or community of interests. In short: material interest advantages without the character of a loan.
An extended version of this pooling allows the linking of different currencies without the physical flow of funds, thus eliminating the transaction risk of the currencies and optimizing interest rates at the same time!
Complex topic: Cross border cash pooling
Setup of a multicurrency cross-border cash pool
A well-coordinated cash pool structure can not only execute automated cash transfers across national borders, but also in different currencies! For example, it is possible to set up one cash pool each for EUR, CHF and USD, whose cash flows all flow together in the parent company on a daily basis and are exchanged there by the treasurer as a portfolio in daily or weekly swaps into another currency as required, without any exchange rate risk arising!
Cross-border pooling is certainly the biggest challenge for a cash management company that generates maximum benefit from cash pooling. However, the risk also increases and with it the need for absolute care when setting up and maintaining a cross-border pool. By definition, the more parameters that have to be taken into account, the greater the risk. The advantages and disadvantages vary from company to company, depending on the task at hand.
Therefore, here are just a few points in the following SWOT analysis that need to be examined with great care when setting up the pool:
Controlling
However, cash pooling can also become a burden if the rights and obligations are not clearly regulated. A meaningful and practiced treasury policy is recommended, see here. You can also read our specialist article on treasury controlling here.
Software support
Adequate support and the daily operation of a cash pool can very quickly become complex and unmanageable unless sufficient support is available in the form of suitable software. The usual standard programs are capable of mapping cash pooling structures and, above all, efficiently accounting for them. However, it is also possible to make use of special customized database applications. Ask us, we know our way around!
Country-specific restrictions
Depending on the country, it may or may not be possible to automate cash pooling. Based on our experience with cash pool projects, we have created a manuscript that provides an overview of the various country specifications. Read more here.
A frequently occurring restriction is the return of deposits, where only as many assets may be made available unsecured as a loan (i.e. also by means of cash pooling) as the free reserves (sometimes plus share premium) provide. In October 2014, the Swiss Federal Supreme Court issued a leading decision in this regard, which we have made freely available on our download page as a court ruling and as a schematic diagram.
Interest
Interest within the cash pool is often a particularly tricky issue, as it has a direct impact on the participants' taxes. In principle, the at-arms-length principle should be applied, although a certain amount of leeway is usually possible if justified. Another question to consider is in which direction the majority of the cash flows will go: downwards or upwards. Last but not least, special cases such as negative interest rates should also be considered. Read our special article on this topic here.
Reasons for cash pooling
- Optimal allocation of internal liquid funds and thus maximum reduction of borrowed capital
- Reduction of financing costs at group-wide level,
- Improvement of the return on investment by exploiting economies of scale,
- Simplification of liquidity management at local level,
- Reduction of expenses for banks through centralization,
- Improving cash flow planning by coordinating financing cycles,
- Break-even from as little as approx. 300,000 financing requirements.