Cash Pooling

Cash pooling is a cash management strategy that involves consolidating a company’s multiple cash accounts into a ‘pool’ or single account and utilizing it to manage the business’s overall cash position. It enables a company to easily manage its cash flow and utilize the available interest income.

Typically, large corporate groups use this strategy as it requires certain in-house resources and a specific level of structuring. However, any group consisting of multiple subsidiaries can utilize it. The holding company acts like a central strategic unit, distributing liquidity to serve all subsidiaries’ interests better. There are two main types of cash pooling — physical and notional.

Table of contents

• Cash Pooling Meaning
  • Cash Pooling Explained
  • Types
  • Example
  • Benefits
  • Cash Pooling vs. Cash Concentration
  • Frequently Asked Questions (FAQs)
  • Recommended Articles
• The cash pooling definition refers to a centralized cash management technique for companies with various subsidiaries. This strategy helps a group efficiently optimize the cash balances of every legal entity under its umbrella.
• There are various benefits of cash pooling. For instance, this strategy reduces banking costs, offers better bargaining power with financial institutions, and provides higher interest income.
• Notional and physical pooling are the two main types of cash pooling techniques.
• One of the key purposes of using this cash management tool is to minimize overdrafts among subsidiary operations with varying daily cash positions.

The cash pooling definition refers to a strategy that involves concentrating or centralizing cash management by balancing the accounts for the subsidiaries of a holding company. This strategy aims to ensure optimal liquidity management throughout the group. It enables the group’s subsidiaries, acting as a sole unit, to automatically fund each other. Moreover, it allows a single entity to manage the cash pool balances, restricting external financing and centrally allocating funds, leading to higher returns.

By utilizing this strategy, subsidiary companies can use internal corporate cash rather than borrowing funds from a bank to meet the daily working capital requirements. Moreover, cash pooling provides the holding company’s chief financial officer with a 360-degree view of the group’s global cash position.

Despite balancing all subsidiaries’ bank accounts, a few entities may face deficits and have to opt for short-term cash flow financing. Simultaneously, other group subsidiaries may have surplus cash sitting in their account.  

The centralized cash management strategy solves the following issues:

• First, in the case of a deficit, it allows the group to help subsidiaries facing financial trouble and restrict the banking charges by ensuring that only one bank account is in deficit.
• If there is a surplus, the strategy allows the group to make the most of all profits from every subsidiary by increasing interest and making improved investments.

Thus, cash pooling involves centralizing cash and redistributing it among subsidiaries. The subsidiaries transfer the balance surplus amount to the master bank account. If there is a deficit, the master transfers the required cash to the entities requiring it.

Let us look at the two main approaches to this strategy in detail.

#1 - Physical Pooling

Pooling cash via physical funds transfer involves real cash flow between subsidiaries’ accounts and the master account. Physical pooling can be automated or carried out manually via a bank or by utilizing TMS (treasury management system) software. The main benefit of using this approach is that it has a great degree of control over the overall cash flow.

There are different pooling techniques where the accounts’ balances are leveled. They are as follows:

• Zero Balance Account Pooling: Zero Balance Account or ZBA pooling involves zeroing subsidiaries’ account balances daily, typically as part of the automated procedure performed by specialized software or the bank.
• Target Balance Account Pooling: TBA or Target Balance Account cash pooling involves setting a minimum balance threshold. Any amount in the subsidiary’s account that exceeds the minimum balance limit is swept to a master account.
• Fork Balance Account Pooling: It is a daily procedure involving increasing or decreasing subsidiaries’ account balances up or down to a predetermined amount.

#2 - Notional Pooling

It allows for computing interest on the combined debit and credit balances of accounts part of the pool. All accounts in the group operate independently and manage their credit lines, and each subsidiary’s accounts are virtually merged.

The primary benefit of this approach is that every entity of the holding company stays independent within the group. But, at the same time, they benefit from the more attractive interest rates for lending or borrowing than they would have if they negotiated as a separate entity.   

Let us look at this cash pooling example to understand the concept better.

Suppose Amacon Group comprises one parent (Company X) company and four subsidiaries (Company D, E, F, and G). All of these companies’ bank balances change owing to business activities. In addition, the turnover of these organizations is often subject to significant fluctuations because of the market in which the group operates. Because of such reasons, ABC has decided to opt for the cash pooling strategy with zero balancing at XYZ Bank, which offers favorable conditions.

Because of the excessive expenses and low sales, Company D’s current account slides into debt worth $800,000. However, the remaining three companies (E, F, and G) have a stable financial position, having accumulated credit balances of $500,000, $600,000, and $700,000, respectively. All four companies’ account balances are consolidated each business day through cash pooling on a master account held with the parent company’s bank.

The resulting overall balance is positive $1 million; Company D utilizes it to balance liquidity. The bank calculates the respective interest earnings and expenses, and based on that, the settlement of liabilities and intra-group receivables takes place. Companies E, F, and G receive the interest amount from Company D. As a result, the financial resources remain within Amacon Group, thus eliminating the requirement for external capital.

The following are the benefits of cash pooling:

• Cost Savings: The centralized cash management technique can help companies save money by minimizing the need for opening multiple bank accounts, thus reducing the associated charges. Moreover, it can help organizations get more favorable terms from banks.
• Increased Visibility: A company can increase its visibility into its overall cash position by consolidating multiple bank accounts into a single one. This enables it to manage its liquidity better.
• Improved Interest Income: This arrangement transfers the surplus cash to a central account, which offers interest. As a result, the company’s total interest income increases.
• Offers Flexibility: Pooling offers a company more flexibility as it conveniently transfers funds between accounts. This is extremely useful for companies conducting operations in multiple currencies and nations as they can move funds easily.

Lastly, this strategy involves cash flow management.

The following are the differences between cash concentration and cash pooling:

• Cash pooling centralizes cash management by all accounts of a parent company’s subsidiaries. At the same time, cash concentration involves transferring funds from a business’ various accounts into a central account, improving cash management efficiency.
• Cash pooling is a strategy used by holding companies having multiple subsidiaries. On the other hand, any organization with multiple business accounts can use the cash concentration strategy.
• Cash pooling allows companies to manage cash flow more efficiently and optimize liquidity. That said, cash concentration prevents cash from sitting idle in a bank account and enables companies to utilize the excess cash to fund short-term investments.
• Some cash concentration methods are range-based balancing, minimum balance/ target balance, and investment sweeps. In contrast, cash pooling is primarily of two types — physical and notional.

This has been a guide to Cash Pooling and its meaning. We explain its example, benefits, types, and differences with cash concentration. You can learn more about finance from the following articles –

• Cash Value Life Insurance
• Investment Trust
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