Physical Cash Pooling: The Ins and Outs

As the macroenvironment shifts from higher interest rates to lower interest rates and potentially higher prices due to tariffs, treasurers and cash managers are re-examining their liquidity management strategies and asking questions such as:

• How are we going to absorb currency fluctuation costs?
• If we need to acquire domestic suppliers, will we have the liquidity we need?
• How quickly can we respond when new tariff phases or shipping rates go into effect?

To provide answers and help finance leaders establish strong business continuity plans, treasurers and cash managers must know their company’s precise cash positions. They typically start this process by looking at bank accounts. One of the best methods that helps them know exactly how much cash is where, and when, is cash pooling (the act of consolidating a company’s various bank accounts into a single account or “pool”). This post explores the most common type of cash pooling — physical cash pooling — how it benefits liquidity management and margin growth, and some of the factors treasurers and cash managers should consider before setting up cash pools.

The fundamentals of physical cash pooling

The way physical cash pooling works is fairly straightforward. Typically, a cash pool will be implemented on top of existing accounts — usually within a single bank. One account becomes the “header” account, and cash “sweeps” in and out of it. The other accounts are associated with the header account as sub-accounts — and cash sweeps into and out of those sub-accounts, too. So why have a hierarchy? In physical cash pooling, the aim is to define a target balance for the sub-accounts — which is most often zero — and then the sweeps into and out of the header account ensure that this target is reached.

• Note: A header account is often the account of the head office or the treasury function, but it could also be tied to a shared service center, finance company, or a special purpose vehicle.

Day-to-day banking proceeds as usual, and at the close of a defined period, an upward sweep of the sub-accounts moves all cash into the header account or the sub account gets funded from the header if it is below the target. The net position is then either invested or funded depending on the balance. The resulting cash flow is treated as an intercompany loan or deposit — with many (if not all) of the same controls and requirements of any other intercompany transaction.

How physical cash pooling creates a margin multiplier effect

Treasurers and cash managers rely on physical cash pooling for smarter and faster short-term liquidity management. What’s really exciting is how more and more companies are discovering how liquidity management can create what’s known as the “margin multiplier effect” — compounding operational improvements that have an outsized positive impact on margins.

“There are a number of things our treasury team did — increasing the frequency of cash reporting, focusing on expense reduction, stopping M&A for a period of time, growing working capital. So we were able to weather the storm in the short to medium term. And obviously, we came out on the back of it a lot better than originally anticipated as a result of those strategies.”

— Adam Watts, Senior Treasury Programme Manager, Dentsu International

Here’s how companies can use physical cash pooling as part of their liquidity management strategies to create a growth multiplier, unlocking funds to drive profitable, durable growth:

• Make cash positions more visible and easier to manage
  • By reducing the number of accounts that treasurers need to look at, physical cash pooling reduces the time and effort it takes to get an overall picture of the group’s cash position. Treasurers can also keep a certain amount to cover costs within an account, then sweep up, which yields total available cash instead of total cash position.
• Improve net interest income/expense
  • Cash pooling brings all of the net increases and decreases to group cash balances together, making it possible for all companies to take advantage of the central treasury’s interest terms.
• Reduce overdrafts
  • As accounts are zero balanced, individual accounts will not go into overdraft. Instead, debt will be taken to the central treasury, which can apply its more advantageous interest rates.
• Optimize liquidity management
  • Concentrating funds into a single header account helps treasurers to allocate cash more efficiently where it is needed, reducing idle balances.
• Reduce interest costs
  • Since surplus funds from one account can offset deficits in another, companies can minimize reliance on external borrowing and reduce interest expenses.

Physical cash pooling with a treasury management system (TMS)

A TMS can supercharge your physical cash pooling. If your treasury team is already considering moving to a TMS to gain the visibility into and control over direct and indirect spend that neither spreadsheets nor ERPs can offer, keep these capabilities in mind:

• How much transparency will we have? Along with the overview of all cash pools, the Coupa TMS automatically forecasts all cash pool sweeps based on statement, payment, and all other available forecast information. Treasurers and cash managers will always have transparency on the balance of the header account to avoid overdrafts or show investment potential.
• What compliance support can we expect? The Coupa TMS uses a fully automated process to track all intercompany movements. Let’s say you need to track a loan created by an upward sweep and incorporate it into financial reports for the subsidiary and for the parent company — to comply with regulations and evaluate business performance. The Coupa TMS easily tracks intercompany balances and provides on-demand reports about them.
  • As the subsidiaries are essentially providing loans to the parent, it’s best practice and often legally required for them to receive compensation — just as if it were invested at the bank. Corporations calculate interests on these intercompany balances and allocate interest revenue and expenses, or both, across various subsidiaries. While banks can handle some of this, they usually cannot allocate interest for you.
• What can we configure around what our company actually needs? With the Coupa TMS, you can fully track your bank-managed target balance pools and even create self-managed pools set up across banks and countries. In simplified terms, here’s how self-managed pools work:
  • Define target balances or even upper and lower target limits.
  • The Coupa TMS uses these limits and existing forecast information to suggest which transfers a treasurer or cash manager should make on a regular basis.

The Coupa TMS also fully automates payment creation and execution. It’s capable of establishing an automated physical cash pool with your treasury team in total control.

The complexities of setting up physical cash pooling

Although setting up cash pools with the Coupa TMS is fast and straightforward, you’ll need to manage some administrative work with your bank and do due diligence.

Transactional requirements of the cash pool

Depending on your account structure and how frequently you sweep funds, there’s potential for significantly more transactions per time period than you would have with a regular account structure. Other factors such as the bank itself, the relationship your company has with it, and the interest yield come into play.

Civil law and regulatory considerations

At a fundamental level, you’ll need to know to what extent physical cash pooling is permitted in the regions in which your company operates. In Germany, for example, any cash pooling arrangement must keep up-to-date information on the liquidity and equity of the parent company and the other participating companies in order to assure that the money they contribute will be repaid. Compare this to the situation in Brazil, China, and India. All three nations disallow unrestricted cross-border movement of funds. Other countries have restrictions on intercompany lending and complex taxation rules. This might make pooling with subsidiaries in these nations impossible.

It’s important to keep the legal environment in mind when determining how to structure your cash pooling. These arrangements, such as physical cash pooling, often have important transfer pricing implications. And directors need to be aware of the immediate and significant personal liability risks these cash pooling arrangements carry.

When to revisit your physical cash pooling strategy

Physical cash pooling can help almost any company improve its short-term liquidity management. But if it’s going to work as effectively as it can, treasurers and cash managers need to think carefully about how physical cash pools should be structured in line with their business and where it operates geographically. If you’ve been tasked with introducing physical cash pooling to your company or exploring options for more short-term liquidity, here are some questions to help you and your team get started:

• How often does your company transfer funds between subsidiaries or business units?
• Do you experience frequent cash surpluses in some entities while others need funding?
• Do you have high banking fees or interest costs due to overdrafts in some accounts while others have idle cash?
• How often does your company borrow externally, and at what interest rate?
• How much automation and visibility do you have over cash balances across your entities?