Cash Pooling System

Financing of the business sector (and related issues) is an important part of banking. We can say that key areas – development and innovation of banking products, their use and customer satisfaction – are overlapped.

cash pooling

cash pooling

These products are present on banking market since the second half of the nineties, although the expansion is observed only recently. This fact is closely related to changes in bank ownership structure, increasing pressure to reduction of costs of bank loans and changing the structure of major companies. Cash pooling has a positive impact on the economy of company, and thereby it increases the company value and its competitiveness.

The causes of generation of new products in the banking sector

New banking products and services are created due to the increasing pressure of competition in banking. This trend can be observed in the banking sector in recent years, when banks are forced to devote more and more time for creation and development of new products and services that satisfy the client needs. On the other hand, the development of new banking products creates not only the competitive environment but also generates a growing influence of “financial counselors”, who are selected from professionals of financial sector with long-term experience. In particular, large companies can exert pressure on banks and thus force them to create new products and services that would not be offered by the banks under other conditions. Such pressure lead to introduction of “Cash management products”, “Cash pooling” as a tool for optimization of enterprise cash. A problem can occur within the introduction of new banking products related to simple copying of products and prevention of such activity. It is not difficult to create identical or improved product or service by competitive bank in short time after the initial introduction. Despite the issues related to implementation of new products and services, their development and introduction is vital for the development of financial companies and their market position.

Cash pooling definition

Cash pooling belongs to financial tools of cash management that allow multinational companies to gather funds on various bank accounts in different banks in different countries. This fact causes transactions on individual accounts, increasing costs for maintaining these accounts and prevents seeing the overall financial position of the whole group. In such case, a certain degree of centralization is necessary, where the parent company exercises control over cash balance of its affiliates and their relationship with banks. This prevents the situation when e.g. the one affiliate invests surplus funds on financial market and another affiliate needs to take out a loan from bank. The principle of cash pooling is that there is a joint account which shares free funds among all branches. Affiliates that have surplus financial resources can provide these to others with insufficient funds. The goal of cash pooling is to effectively manage the cash on bank accounts and to minimize interest costs and fees related to banking services. Cash pooling is most commonly used in the following cases:

  • Cash pooling systems with centrally maintained account within a single legal entity, owning several bank accounts that are used for different purposes (customer payments, supplier payments, wages etc.);
  • Cash pooling systems that will be used internally within the enterprise (within a single legal entity with its own corporate division accounts);
  • Type of cash pooling, in which individual companies, groups or corporations bring their accounts into the pool (more legal entities involved in the cash pooling).

SWOT analysis of cash pooling

The essence of SWOT analysis is to identify key strengths and weaknesses of the product in relation to the bank and the company. The SWOT analysis characterizes the benefits and disadvantages of the cash pooling application in the enterprise, benefits for banking institutions, future possibilities for company/bank, and threats associated with the use and provision of cash pooling.

SWOT analysis of cash pooling from the perspective of commercial bank

Cash pooling advantages Weaknesses
  • offer of new, comprehensive product
  •  financial stability of bank
  • lower administrative burden
  •  credit risk mitigation
  • need of education for bank employees
  • less need for credit products by client, resulting in smaller interest income from provided loans
  • modernization of bank information system is necessary, which represent additional costs
Opportunities Threats
  • increasing confidence of bank from the perspective of client
  • increase in number of new corporate clients, which are key for the bank business
  • increase in number of retail clients
  • bank will strengthen its position within payment system
  • short-term decrease in interest income, related to weaker economic performance of the bank
  • risk of copying the product by competitive banks
  • risk of losing the client (when the required product is provided by competitive bank)

Based on the SWOT analysis of cash pooling (Table 1) we can conclude that for the bank, as the provider of cash pooling, is quite difficult to implement this product in its portfolio, as it brings the requirement to improve the information system and reducing interest earnings from provided loans. On the other hand, it is a great benefit for the bank to provide clients with such a sophisticated product, because it leads to the growing customer base and ultimately to revenues. Bank, like any business entity, aims to make profit and to ensure a stable market position. To achieve such goals, the bank has to offer products that are demanded from customers and follow the current economic development. For this reason, banks constantly develop new products to satisfy needs of their clients.

The cash pooling is especially important for enterprises due to the ability to improve and optimize financial flows within companies operating in one country and simultaneously manage financial flows of internationally connected enterprises. For these the implementation of such product represents the reduction of difficulties which may arise in cross-border monetary transfers.

SWOT analysis of cash pooling from the perspective of company (Table 2) shows that such company has better control of the internal cash flow situation due to the implementation of cash pooling. It has an overview of all transactions within the group through the main account of pool manager. First of all, company reduces its liquidity costs and financial costs and thereby uses the cash more productively. In the view of risk, it is necessary to recognize the fact that certain types of cash pooling may not be permitted in some countries. Thus, companies with international operation consisting of parental company in one country and its subsidiaries in other countries have to verify prior the implementation of cash pooling that it is not prohibited in certain country. This condition can cause complications in the process of implementation ant the company will be forced to work without cash pooling.

SWOT analysis of cash pooling from the perspective of business sector

Steps of cash pooling implementation

Cash pooling advantages Weaknesses
  • reduces the cost of liquid assets
  • more efficient use of cash
  • interest savings
stronger bonds with the bank
in the case of certain tax legislation is the
implementation of cash pooling administratively burdening
Opportunities Threats
possibility to use the acquired available financial resources
better control of internal and intra- holding cash flows
  • possible limitations of control over financial flows
  • possible supply of disadvantageous bank products

When considering the weaknesses we need to clarify the fact that if the company has international presence and connected companies are located in several countries, it runs a risk of spending more time and energy to the implementation of cash pooling. Tax and legislative regulations may vary in different countries, which can ultimately cause higher administrative burden. Threat to the enterprise in the implementation of cash pooling is the disloyalty of some banks that do not properly evaluate the client’s current situation and can offer him a disadvantageous product beyond the client’s expectations.

The process of implementation of cash pooling in enterprises

Implementation steps Activities
1 Evaluation of current status information analysis for the whole group – the structure of bank relationships, cost-benefit analysis
2 Analysis of internal factors capital increase, dividend distribution, internal loans, current payment terms
3 Analysis of external factors review of tax and legal aspects, periodic reports, capital controls at the national level, the choice of banks
4 Analysis of documentation and contracts cash pooling agreement, the intragroup financing (lending) agreement, fixing interest rates and limits
5 Implementation of cash pooling into operation Daily coordinated involvement to the current cash management structures, engaging in in-house (intragroup, internal) banks

The implementation of cash pooling itself and adjustment to the conditions of a particular company can be considered as complex. It may take from few months to several years, given the complexity cash pooling structure. Companies must reassess certain internal and external factors during the implementation:

Internal factors: the company’s strategy, national/international organizational structure of the company, the internal politics of capital, dividend policy, internal loans;

External factors: legal and tax requirements and regulations, banking services, costs, exchange rate risks, currency risks.

Types of Cash Pooling

Cash pooling can be divided according to several criteria and the options of banks. In terms of technical performance, there are two basic types of cash pooling:

  • physical pooling (also called cash concentration),
  • notional pooling.

According to fact whether the accounts are in one or more countries, there are:

  • domestic pooling,
  • cross-border pooling.

In terms of balancing the account equation in one or more currencies, there are:

  • single-currency pooling,
  • multi-currency pooling.
Overview of the main cash pooling structures

Overview of the main cash pooling structures

 

Cash pooling is largely influenced by changing legislation of countries which resulting in its constantly developing modifications. In the Slovak Republic the cash pooling is not a standardized bank product, but rather is “tailored” to client’s needs. Realization of cash pooling can be divided into two basic versions:

  • Physical pooling (cash concentration),
  • Notional pooling.

Comparison of notional and physical TBA cash pooling

Notional cash pooling

Physical cash pooling

Classification of activities

Pooling of resources

Provision of a loan

Transfer of funds

No physical transfer of funds, credit and debit balances are accounted fictionally

Physical transfer of funds to the main cash pooling account.

Country of origin of linked account

The legislation limits the possibility of guarantees for crisis

More liberal legislation

Documentation

Complex documentation, the subject of protracted negotiations is agreement on cross- guarantees

Standard: Agreement on cash pooling

Administrative burden

Fictional transfers – only the accounting of interest paid/received based on the bank statement

Physical transfers – daily accounting of receivables and liabilities

In today’s highly competitive and constantly evolving environment it is essential to seek new ways of achieving savings and finding ways to optimize processes. For each enterprise it is necessary to have funds which tries to use as efficiently as possible. One of the specific tools, which can be used to effectively manage the available resources in the company is the cash management. In the economic environment of company it is quite difficult to determine a reasonable rate of cash, because available cash, which is not used efficiently, does not bring any added value. The company waives the possibility of investing in other forms of assets and thereby also waives the possibility of higher returns. For this reason, the management of liquidity uses cash pooling, where the main benefit is the interest optimization.

Bеnusоvа J.