Insight & Analysis

The working capital benefits of cash pooling

Published: May 2022

Treasury experts explain why cash pooling remains one of the most effective and valuable strategies for companies aiming to maximise the availability of capital.

Golden coins being dropped into water, creating splash

Cash pooling enables companies to efficiently use their own money, and drives working capital management. As a rule of thumb, companies would rather use their own money rather than borrow from financial institutions, so pooling also reduces the cost of capital. Cash pooling also helps ensure that funds are available when needed, helping to smooth the payments process, says Manish Joshi, Director, Cash & Banking Operations, META, GE Corporate Treasury.

He says as a structured approach, companies can focus on cash consolidation at a country level first. This works best for a country that has multiple entities and business lines enabling better use of cash within the country for the purpose of payments, efficient collection and consolidation. The process also involves defining the optimum requirement for cash at a country level and determining the core surplus which can be utilised by the wider company for cash management around the globe.

Cash pooling drives efficiencies in terms of companies’ ability to use their own funds. For example, in emerging markets in places such as Africa, cash pooling and collections in local currencies are often used for local payments and expenses as soon as possible to reduce FX exposure and protect against the risk of currency devaluation.

Joshi adds that it’s simplest for a company to use one bank for its pooling needs, but this isn’t always possible because banks have footprints in different countries. Different regulatory requirements and product development can also require companies use the services of multiple banks to pool. Companies need to set up cash pooling between these different paradigms. Many countries still prohibit cash pooling, particularly those with low dollar reserves or with economies that are import-dependent.

All companies need cash to support their business and make payments. This liquidity is an important risk mitigant, but excess liquidity can also be inefficient when seen in the context of capital that the company hasn’t deployed to invest either in the company or the yield curve, says Lori Schwartz, Global Head of Liquidity & Account Solutions, JPMorgan Chase & Co.

She says solutions like physical cash pooling connect accounts and corridors of activity, moving cash in between accounts to ensure treasury has cash where it needs it and when, in the right currency, and able to cover short positions or aggregate long positions. Notional cash pooling is similar but doesn’t involve physically moving cash. It creates a fungibility across currencies and provides visibility, control and optimisation. Companies can also integrate virtual account solutions that retain the integrity of data and information on that underlying position.

Cash pooling is vital for optimising cash on account, adds Schwartz Take a multinational with decentralised operating entities running their own businesses. These subsidiaries will keep their own cash buffers to mitigate risk and ensure they can make their payments that when added together, combine to make a significant sum across a global company. Yet not every operating company needs their buffer every day. As companies go on a journey of centralisation, they will create a fungibility in those cash buffers. It means that different entities can have a cash injection according to their needs, creating a central buffer that is optimised – and reduced – at a treasury centre.

Notional pooling achieves a similar result but is accomplished by creating a shadow or notional position resulting from an aggregate of all the accounts, which can be held in multiple currencies, explains Susan Hillman, Founder and Partner, Treasury Alliance Group.

Interest is paid or charged on the consolidated position. There is no actual movement or commingling of funds. It is a seemingly simple, hands-off solution; but the opaque nature of the arrangement in terms of costs and minimal documentation between separate legal entities makes many tax directors uncomfortable.

Hillman concludes that most multinationals prefer physical pooling as it is cleaner from a tax perspective because those movements to and from the header accounts are characterised as loans. Cash pooling is day-to-day cash management – if you have an operation that needs funding on an ongoing basis, either handle through a capital infusion or a direct intercompany loan with specific terms and conditions.

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