Cash-Pooling as a way of centralising the cash account

Manuel Romera. Professor. IE Business School

1 July 2008

Lope Vega en Fuenteovejuna was the first to point out the benefits of “all for one”. In much the same way, centralizing the accounts of a company and its different branches using a cash polling system can bring enormous advantages.

Cash-pooling is a system whereby certain enterprises automatically centralising all the bank accounts of their subsidiaries and parent company into one single bank account called a centralised account.

Cash-pooling can only be implemented if the enterprise has a computer system that is sufficiently developed to use a good cash-account management tool.

The advantages of cash-pooling

Not surprisingly, the enterprises that adopt this system tend to be large. After all, if the company has not reached a certain size, the idea may not make sense. However, if we base our analysis on the fact that it can, in theory, be used by all kinds of companies, we find two main advantages:

•First, the single account is used to compensate debit or overdraft balances with credit balances or surplus cash. The advantage of this is obvious and, by compensating some balances with others, the interest rate differential between the debit and credit balance interest rates does not have to be paid.

•Second, centralised management has various advantages that range from a greater organisational capacity to a greater negotiating power with banks using the centralised account; it also makes administrative tasks easier.

Types of cash-pooling

Various classifications can be established depending on different criteria:

The balance transfers from subsidiaries to the parent company can be as follows:

•Cash-pooling with zero-balance sweep: all the subsidiaries´ accounts transfer their balances to the parent company´s single account at the end of the day. This is the typical cash-pooling centralisation system, since it takes advantage of balance compensation and centralised management of the entire cash account.

•Cash-pooling with return loan: all the subsidiaries´ accounts transfer their balances to the parent company´s single account at the end of the day. So far, this coincides with the zero-balance sweep system, but at the start of the next day, the balances are returned from the parent company to the subsidiaries. This system takes advantage of balance compensation, but there is no centralised management of the cash account. The system gives subsidiaries greater independence.

•Cash-pooling leaving the balance with the subsidiaries: this can be either of the previous two, but when the transfer is made, the subsidiaries´ balances are not left at zero. This system is almost always used more frequently than cash-pooling with zero-balance sweep so that the subsidiaries do not start the next day with zero Euros in their accounts.

There are three ways of making the transfers:

•Cash-pooling with one-to-one transfer of movements: this system makes as many transfers as the number of movements the subsidiary has and therefore generates an excessive number of transactions, which could overwhelm the organisation and accounts department.

•Cash-pooling with global transfer of movements with the same effective date: this is the most commonly used system because it is both simple and efficient and consists of carrying out the subsidiary´s transactions or movements with the same effective date and making as many transfers as the number of transactions or movements.

•Cash-pooling with one single transfer: only one transfer is made of the total movements corresponding to the subsidiary. The same effective date as the transfer transaction date is applied to all the movements. This normally leads to a loss of information, since not all the subsidiary´s transactions or movements will have the same effective date as the date on which the transfer is made.

There are two ways of effectively making the transfer:

•Real cash-pooling: the transfer is effectively made between subsidiaries and the parent company.

•Virtual cash-pooling: the transfer is not actually carried out, but in its interest settlement transactions, the bank treats the total balances as if they were one single account rather than each balance separately.

Whether one or the other of these systems is preferred, what needs to be considered and understood is that the enterprise must use the same system with all the banks with which it wishes to implement the cash-pooling process due to the fact that it would otherwise generate great confusion.

As we have seen, cash-pooling is another tool that brings greater efficiency. Remember that cash account management is of vital importance and has an influence on many aspects of a company, such as the level of investment or business growth. Indeed, nowadays the cash flow status is of fundamental significance in an enterprise. As a result, cash account management is one of the mainstays of large firms and must therefore be optimised, and a good way of doing that is by using cash-pooling.

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