Cash & Liquidity Management

Optimising Centralisation of Cash Management

Published: May 2006

Every company wants to control its cash. But how? Is it simply a matter of centralising control of the bank accounts? If you listen to the experiences of those companies that have undertaken projects to centralise cash management, they will tell you it is not simple. Gaining control of the bank accounts and getting control of the balances is only one part of the story. So what else needs to be considered? In this business briefing we look at cash management in an international context and examine the trade-off between central and local cash management for corporates. In the wake of corporate governance legislation, demonstrating control may be an imperative in any company but how can this be achieved centrally without increased costs and inefficiencies?

Central vs. local cash management

The objective of centralising cash management is always to make better use of the company’s liquidity. It makes no sense to have cash balances sitting on a subsidiary’s bank account if the cash can be used more effectively elsewhere in the group – either reducing the need for borrowings or being invested more effectively. And if the company is cash poor with subsidiaries that need funding, this may also be better centralised with all the economies of scale that will result. Put another way, good cash management is also part of good working capital management.

However, achieving control by centralising cash management is not easy. Physical movement of cash from one company to another creates inter-company loans that can give rise to corporation tax, withholding tax and many other legal and regulatory issues – such as thin capitalisation, VAT and transfer pricing considerations. Notional pooling may be no easier.

Then there are practical issues as to what else should be centralised as a company centralises cash management. What happens to accounts receivable and creditor control; supplier relationships and accounts payable? These functions may be left at local level, but they still create entries on the bank accounts and have an effect on the cash flows.

Some companies choose to centralise these functions into shared service centres, but there is still a need for information and input at the local level. Payment creation will always involve input from the local unit. Has the supply been received as ordered? Is it satisfactory? Is the invoice correct?

Often it is useful to start with an introducing netting to set-off receivables and liabilities. This procedure results in a reduction of payment creation.

Then there is the issue of the operating unit still having an incentive to generate cash when it no longer has the cash and ‘looses’ control to the centre. This can be addressed relatively easily if financial targets and incentives are aligned, but it is still an issue.

At the extreme, centralisation of cash management means that all control over an operating unit’s cash passes to the centre. This includes control of all collections and payments/disbursements. However, few companies achieve this. In practice, partial centralisation is often the pragmatic solution – which facilitates some of the benefits of centralisation without many of the difficulties. The degree of this centralisation will depend on the structure and the culture of the company.

Relevant factors for deciding a company’s appropriate degree of centralisation

  • Corporate culture
    • How is the company structured?
    • Are the operating units autonomous or is there already a large degree of central control?
    • Are they all in the same business?
    • Do they have similar needs and characteristics?
  • Resources available
    • How is cash managed today?
    • What systems are available to assist in the process of centralising cash management?
    • What do the company’s bankers offer?
    • Are the necessary skills and resources available centrally?
  • Business requirements
    • What amount of cash is needed and where?
    • Where are surpluses and shortfalls?
    • Are they permanent or seasonal?
  • Size of cash flows
    • What are the average balances on subsidiaries accounts?

Different forms of organisation for cash management

Then a decision can be made on what degree of centralisation is appropriate.

  • Decentralised cash management

    A few companies find that the costs of centralising are simply too great or the gains too small. They prefer to remove surpluses from operating units periodically and may organise some central funding but day-to-day cash management is left to the operating units. Most corporates, which have only recently become international, also fall into this category.

  • Regional cash management

    Most companies operating in multiple locations move quite quickly to some form of regional cash management, responsible for treasury activities in a defined set of countries.

  • Global cash management

    The largest companies are moving or have already achieved a global cash management capability.

    Often companies would like to establish a cash management solution with a single bank but, in practice, it may be necessary to maintain one or two local banks for country specific needs. However, with the use technology, visibility across global and local cash flows can be achieved.

Outsourcing – the next step?

Outsourcing of cash management has fallen out of fashion but is far from dead.

The high costs of implementing a treasury management system or having a full in-house treasury team mean that some corporations will look to outsource the basic functionality. Others see it as a means to meet corporate compliance requirements.

Case study

ERCO

Portrait of Urs Müller-Ortolf

Urs Müller-Ortolf

Deputy Head of Finance

ERCO is a leading manufacturer of lighting equipment, including indoor and outdoor luminaires, as well as lighting control systems. The company is the global market leader in museum lighting. Its lighting technology is used in the world’s most famous museums – such as the Louvre in Paris or the Guggenheim in Bilbao. The company has 1,000 employees, most of whom are based in the headquarters in Lüdenscheid, Germany, working in the fields of R&D, production, sales and administration. In addition, ERCO has wholly-owned subsidiaries in all major markets globally, charged with sales and the distribution of the group’s products. The family-owned business generates a consolidated turnover of €140m.

ERCO runs a centralised treasury at the group’s German headquarters, but traditionally much of the company’s finances were managed in a decentralised structure. This meant that subsidiaries worldwide not only managed their cash, but were also exposed to currency exchange rate risks. The subsidiaries were billed by the group in euros, but received most of their sales income in local currency. Intragroup payments were effected via banks using regular cross-border credit transfers. This incurred high charges and the bank float reduced liquidity.

The company wanted to achieve a more efficient and centralised financial management structure by implementing a cross-border cash pool. Urs Müller-Ortolf, Deputy Head of Finance, explains the different steps the company had to take: “At first we started with the development of an info-pool. In order to get a consolidated view of our cash, we collected the bank statements of the subsidiaries using Commerzbank’s COTEL program. This information was then processed further in our ERP system.”

In a second step, ERCO implemented a cross-border cash pool, which included zero balancing for all subsidiaries banking with Commerzbank. Based on historic cash flows, Müller-Ortolf agreed specific cash levels with the other subsidiaries that were using third party banks and Commerzbank connected the accounts in a target balancing pool.

“This works very well and Commerzbank is also willing to work with other banks. We have spoken to competitor banks that would only set up cash pools using their own accounts, but we could not force our daughter companies in all these countries to change their bank relationships.”

According to Müller-Ortolf, the main obstacle to the implementation of the cash and information pools was to convince the management in the participating countries to give up some of their responsibilities. However, the new cash management structure offered a number of benefits for ERCO on the group level, as well as for the subsidiaries.

“Due to the automation and improvement of processes, our subsidiaries came to realise that they would not miss any cash discount deadlines and would always have enough cash to meet their liabilities. In addition, the savings in terms of bank interest and charges are significant. It is important to know that now, due to the implementation of the cash pool, we are no longer in need of any bank loans. The group is self-sufficient as far as its funding is concerned and this of course saves a lot of money.”

Subsidiaries in need of funding are now funded via the cash pool. Payments within the group are netted and the group bills its subsidiaries in their local currencies. As a result, the currency exchange risk is transferred to the mother company, which is in a better position to manage this exposure. Overall, the group has more control over its finances worldwide and its liquidity situation has improved significantly.

While the implementation of the information and cash pools was decided from the outset, Müller-Ortolf admits that initially he was not entirely certain how far the centralisation would go. “We started with a euro cash pool to exclude any currency issues and to learn how the system works, but when everything went fine, we included other currencies.

“However, we did not take away the subsidiaries’ ability to make and receive payments locally. This means that payments necessary to run the business in the different countries – such as salaries, payments to suppliers and payments from customers – are still effected locally. This is necessary because (for example) Spanish customers do not want to make payments to Germany. They would like to make the payments in Spain, where they bought the product from what they believe is a Spanish company. In my opinion this is where centralisation has to end. You should not interfere too much with the business locally.”

Optimising centralisation of cash management

Each company must maximise the advantages but pay attention to the possible costs and risks that arise.

Potential benefits

  • Better overview and optimised use of the company’s cash. Funds deposited to the pool by companies in a cash surplus position will be used to fund companies in a cash deficit position before drawing against external lines of credit.
  • Transparency, visibility and control, less opportunity for fraud.
  • Internal economies of scale as control is centralised and automated wherever possible.
  • External economies of scale in banking charges and borrowing costs.
  • Increased income from higher investment income.
  • Better control of cash flow as well as subsidiaries.
  • Standardised pricing, terms, and conditions for banking services. Bank relationships managed centrally will result in more consistent pricing across the group. The company will be in a position to offer a significantly larger portion of business to its preferred banking partners and thereby gaining volume discounts and other cost savings.
  • Centralised administration of all bank records and documentation permitting instant and efficient access to information without having to request and consolidate data.
  • Forecasting can be improved if actively managed.
  • Reduction of the number of bank relationships and bank accounts.

Possible costs and risks

  • Reduced role for local banks.
  • Local regulation and taxes may prevent full centralisation.
  • Slow response to local changes and regulations.
  • Local supplier relationships can be damaged/affected.
  • Centralisation may slow payables (discounts missed) and receivables (DSO – days sales outstanding may increase).
  • Resistance from within the organisation (local units are deprived of their independence; objections to new processes and new technology).
  • Cost of necessary investments in systems and implementation.
  • Resources needed to implement.

Conclusion

Many companies need to manage cash both centrally and locally, which provides banks with some interesting opportunities. The most important point in optimising centralisation of cash management is to convince the subsidiaries of the advantages and get them involved in the process. Banks can help companies to achieve this goal by designing systems to meet the needs of the local operating units while providing the centre with visibility over all the cash, allowing it to exercise better control.

Every company has to consider what degree of centralisation is appropriate in order to benefit from controlling its cash more effectively.

Commerzbank/a major integrated bank

With a consolidated balance-sheet total of more than €440 billion, Commerzbank is Germany’s third-largest private-sector bank and one of Europe’s leading financial institutions. Its 33,000 employees, 7,700 of whom work outside Germany, look after almost 8 million customers. Apart from the parent bank, Commerzbank AG, the Group consists of numerous subsidiaries in Germany and abroad.

Commerzbank sees itself as an efficient provider of financial services for sophisticated private customers in Germany and also as a creative relationship bank for successful German Mittelstand firms, for major corporates and institutions in Europe, and for multinational companies throughout the world. Commerzbank intends to expand its market shares in these core target groups. Above all, it intends to become the number one address for Germany’s Mittelstand.

Commerzbank Cash Management Solutions

Commerzbank has been offering ‘domestic’ cash pooling services to its customers since 1983 and was one of the first banks to offer ‘cross-border’ services in 1994. To date more than 25,000 accounts are balanced daily via Commerzbank’s cash pooling services.

Commerzbank’s specially designed solutions reflect the specific corporate structures and flows of payments: for Commerzbank accounts in Germany and elsewhere in Europe and also for accounts held with other banks. Thus, the customer can integrate its existing bank relations abroad into its central treasury operations.

Contact details:
Jasmin Maraslioglu
+49 (0) 69 136 46966
www.commerzbank.com
www.companyworld.com
Commerzbank AG

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