What is behind the term “cash pooling”? Which companies need cash pooling? What types of cash pooling are there? What difficulties arise in the implementation of the cash pooling system in the corporate treasury?
What is behind the term “cash pooling”?
One of the tools of groups of companies to optimize liquidity management, the Bank offers today is cash pooling (Eng. Cash pooling system ). It cannot be said that it is widespread, since the need for its application should be conditioned, first of all, by the presence within the group or holding of companies with both excess and lack of liquidity in order to apply the synergy effect.
Also, the question of the legal registration of the pool often arises, i.e. justification of payments between the accounts of its participants and intracorporate loan agreements, since the question arises as to whether, for example, a non-financial commercial organization can regularly provide financing to other companies.
In addition, the introduction of cash pooling is impossible without the presence of a single treasury center , which will take over the administrative function and will also forecast cash flows. However, any professional treasurer today should at least be well versed in the types of this instrument and know the main features of its application. Let’s consider them in more detail in this article.
Which companies need cash pooling?
Cash pooling in the most general sense is the consolidation of funds of a group of companies in a single account in order to use temporarily free funds in the accounts of some participating companies to reduce the need for short-term loans from others. Depending on the form in which (real or virtual) this happens, there are:
- Physical cash pooling (Eng. Physical cash pooling system ) and
- nominal cash pooling (Eng. notional cash pooling system ).
Cash pooling can be used by groups of companies with different structures: they are separate legal entities united into a group under the management of a single treasury center, network companies with a developed branch network or large corporations with a large number of subsidiaries.
Regardless of the structure and type of pooling, this tool is implemented if necessary:
- increase income from the use of temporarily free funds of the group;
- minimize the cost of financing to cover cash gaps.
Cash pooling allows you to get away from the situation when at the same time some companies in the group are forced to take loans to finance current operations, while others have excess liquidity, placing free funds on deposits. At the same time, the excess of the lending rates of some group members over deposit rates for others (often also in different banks) negatively affects the overall financial result of the group.
It should be understood that under the general name Cash Pooling , a particular bank can hide a number of products of this line. At the same time, even within the same bank, individual settings will be applied for each client. Therefore, the process of choosing and implementing cash pooling can be safely called creative. After all, all large network companies and corporations have complex structures that differ from each other in the degree of centralization, the development of the treasury function and geographic distribution.
However, there is one important and common condition for all types of cash pooling : all accounts of the companies participating in it must be opened in the same bank. Therefore, despite the relatively low level of the banks’ commission for this service, they nevertheless develop this product in order to attract large holdings with high turnover among their clients.
Types of cash pooling
As mentioned above, two types of pooling are fundamentally different : physical (real) and nominal (virtual) .
Nominal (virtual) cash pooling is easier to implement in terms of paperwork, accounting entries and administration, because it does not physically transfer money from one account to another, which does not lead to the need to draw up intracorporate loan agreements between the group companies. Virtual cash pooling is essentially an interest compensation, where the bank charges the company with increased interest on positive balances on some of the group’s accounts (by automatically transferring balances to a smart account with increased rates in an amount equal to the total amount of negative balances) for the interest paid on the overdraft on other accounts (by accruing standard overdraft rates to accounts with negative balances).
In other words, in the nominal cash pooling, all accounts of a group of participating companies are considered by the bank jointly, calculating the total liquid position for the group of companies and determining the total debit and credit balances for all accounts.
Virtual cash pooling is usually used by groups of companies in which subsidiaries (branches) have relative autonomy in the field of financial management and treasury operations, since this type of cash pooling does not mix the liquidity of different lines of business, and there are no documented financial relationships. between participating companies.
In addition, since there is no real movement of funds between individual companies, there is no need to justify payments between their accounts, record the operation of issuing loans and reflect the transfer of funds from the current account to the Master account in the bank and vice versa. In the company’s accounting, nominal cash pooling operations will be reflected only in terms of recognition of income and expenses for balances on account 51 in the bank.
However, nominal cash pooling has a number of significant drawbacks that significantly limit its use:
- First, virtual cash pooling requires the obligatory establishment of credit lines by the bank with an overdraft limit to the accounts of participating companies. This leads to the need to collect a large number of documents to go through the procedure for approving a credit line, and also increases the commission compared to physical cash pooling , since it includes a fee for the risk that the bank assumes, as well as additional costs associated with opening and maintaining credit lines of group enterprises.
- Secondly, virtual cash pooling allows each participating company to use only liquidity within its credit limit and available funds on its own accounts (as opposed to a physical pool, where each company has access to overdraft and temporarily free funds of the entire group located on the master -account).
- Thirdly, the financial result for the virtual pool is usually worse than for the physical one, due to the difference between the overdraft rates and the rate charged on the positive account balance.
Physical (real) cash pooling is an automatic concentration of positive cash balances from the accounts of subsidiaries to the master account of the management company during the operating day. It is mandatory to sign an agreement with the bank for the automatic transfer of funds – “Agreement on a special procedure for servicing accounts” between the bank and the owner of the master account, as well as between the bank and each company participating in the pool.
In this case, the companies agree with the bank on the transfer schedule, for example:
a) during the day , and then the participant receives funding from the master account in case of insufficient funds or funds from the master account are used to make payments;
b) at the close of the business day (after the 5th flight of the Central Bank), and then during the day the pool participant does not receive funding from the Master account , and payments are initiated regardless of the current account balance of the participating company. In this case, the treasurer establishes an overdraft line for each participant in the pool .
If the accounts participating in the pool are owned by different legal entities, then the basis for the concentration of funds is the loan agreement on an interest basis, which are in the nature of a revolving credit line (a limit is prescribed in the loan agreement). If the participating accounts belong to branches or divisions of the same company, then the funds are transferred to the master account and back by a simple transfer from account to account.
After completing all agreements and completing the corresponding settings for the accounts, it automatically transfers the balances from the accounts of the participating subsidiaries to the master account. In this case, debiting can be carried out with a zero balance ( Zero balancing ) , or with a minimum technical balance on accounts ( Target balancing ).
Thus, the physical pool makes it possible to automatically concentrate all the group’s liquidity on one master account, which greatly simplifies its management for the centralized treasury. At the same time, the costs of banking services for physical cash pooling are much lower than in the case of virtual ones , since the transfer of funds between accounts opened with the same bank is usually free of charge.
Holding companies may not use physical cash pooling , but instead execute loan agreements with each other and make all transfers manually, without the intermediary of a bank. However, if the need to close intragroup cash gaps often arises, the automation of these operations by the bank can significantly save the working time of accounting and treasury employees. In addition, a significant advantage of physical cash pooling can be the interest rate on the positive balance of the Master account, provided for by the account service agreement.
From an accounting point of view, physical cash pooling is certainly more complex than virtual . In addition, analysts at 51 account, which will be reflected on the sub-account interest accrued on the account 51 in correspondence with a score of 91, to reflect the transfer of funds from the escrow account to the Master bank account and, on the contrary, a special sub-account to be used to account 55. To account for the transaction for the issuance of loans, sub-account 55 will be used in correspondence with account 58 ” Financial investments “, and interest paid will be recorded on account 76 ” Settlements with various debtors and creditors “.
It is important to cancel that the intra-corporate loan agreement should not be interest-free. The interest rate used must correspond to the market level and be the same for all participating companies. The procedure for repayment of interest on a loan between companies is not spelled out in any of the agreements with the bank, but is done by the companies independently. Since these loans are short-term in nature, the accrued interest should be included in other income of the reporting period. To simplify the calculation of interest and debt amounts, banks provide companies with electronic statements to automate the corresponding postings.
Cross-border cash pooling
Physical cash pooling can include accounts of non-resident companies, as well as use different currencies. Transfers of funds abroad ( cross-border cash pooling ) are not excluded , however, they are associated with difficulties in processing documents in accordance with the requirements of the currency legislation of the Russian Federation for processing documents for cross-border transactions (transaction passport + requirements for repatriation of loans issued to foreign residents) , which significantly slows down and complicates the process of transferring funds between accounts and, as a result, reduces the effectiveness of the use of cash pooling . However, some banks do offer cross-border physical cash pooling (for example, UniCredit), while fully automating the provision of documents for currency control.
When deciding on the use of cash pooling , it is important to assess the impact of intracorporate borrowing on the increase in the tax base due to interest received under such agreements.
In addition, almost all transactions between related parties are subject to tax control (especially with the participation of foreign companies), and loans can be controlled. Operation cash pooling due to significant speed (as is most often used by large holdings) in most cases fall under the provisions on transfer pricing, which will necessarily require conformity size of the market level of interest rates.
Therefore, the treasurer, as part of the preparation of the project for the introduction of cash pooling, must consult with the tax authorities, so that later not to fend off accusations by the Federal Tax Service of obtaining unjustified tax benefits. The Tax Service may not only charge additional interest to the pool participants at market rates and recalculate the bank’s income and expenses, but also recognize the expenses of the owners of main accounts to cover overdrafts of other pool participants unreasonable.
Despite all the above features of the implementation of this tool, cash pooling has firmly entered the list of the most effective liquidity management tools for large groups of companies. Moreover, it is constantly evolving. One of the most promising areas of its development, in our opinion, is cross-border pooling, since it allows subsidiaries to be financed from the funds of the non-resident parent company, which, as a rule, have cheaper sources of financing than their foreign subsidiaries.