Cash Management for Corporate Treasurers

Introduction to Cash Management

As companies increase in size, the number of entities and bank accounts will increase over time.

With multiple currencies in different bank accounts, it can be a challenge for the Group to maintain oversight and control over the cash flows in and out of the different bank accounts.

Today, more companies are looking into treasury centralization strategies - centralization of cash management, bank relationship management, standardization of processes and risk management controls across entities. With the centralization of cash management and processes, companies hope to achieve greater efficiency and reduce cost for the Group.

In this article, we will focus on cash management, the difference between decentralized or centralized cash management and introduce the 2 main types of cash pooling structures - notional and physical cash pooling.


Decentralized Cash Management is Generally More Inefficient

In a decentralized cash management strategy, cash is managed separately in different bank accounts by individual entities.

This may lead to accumulation of idle cash in separate bank accounts, which could have been better utilized for other uses.

This approach can also be inefficient, if some accounts are having large balances, while others are having debit balances, and incurring overdraft changes.


Centralized Cash Management Enables More Efficient Utilization of Funds in Group

Many companies adopt a centralization cash management strategy to aggregate cash from multiple bank accounts into a single cash pool.

A centralized cash management strategy will not only enable the Group to maintain oversight of total cash in the Group, but also allow the Group to eliminate idle cash and enable better utilization of funds within the Group.

Cash pooling reaps the most benefits when there are some accounts with debit balances incurring overdraft charges, and other accounts with large positive cash balances to offset the negative balances.

To illustrate this, let’s look at the following example below:

Case #1: 4 Individual Bank Accounts, No Cash Concentration

  Overdraft rate Interest Rate on Cash Balances Cash Balance in Account Annual Interest
Account 1 5% 2% 10,000 200
Account 2 5% 2% (2,000) (100)
Account 3 5% 2% (3,000) (150)
Account 4 5% 2% 15,000 300
    Total 20,000 250



Case #2: Cash from 4 Bank Accounts Concentrated Into Single Cash Pool

  Overdraft rate Interest Rate on Cash Balances Cash Balance in Account Annual Interest
Account 1 5% 2% 10,000  
Account 2 5% 2% (2,000)  
Account 3 5% 2% (3,000)  
Account 4 5% 2% 15,000  
    Total 20,000 300


In the above example, the company will benefit by pooling its cash from the 4 individual bank accounts as total interest income increases by 50 in case #2, i.e. cash centralization.

However, treasurers need to be aware that cash pooling may not always be possible due to limits or controls on cross-border inter-company lending and borrowing activities in various jurisdictions.

Generally, there are 2 common ways to aggregate cash from multiple bank accounts – notional pooling and physical pooling.


Cash Pooling Structure #1: Notional Pooling

In notional pooling, there is no physical movement of cash between the different bank accounts, i.e. no intercompany borrowing between entities.

Cash balances in the different accounts are notionally offset to determine the final cash balance, which is then used to calculate the interest.

The interest earned on the total amount will usually be allocated back to the individual accounts in the cash pool, with a small admin fee charged for administration of the cash pool.

While notional pooling is very simple and easy to operate, notional pooling may be difficult in some countries like the US and Germany, as the local tax authorities may regard notional pooling as co-mingling of funds.

Another point to highlight is that from the perspective of the bank, deficit balances from the pooling participants appear as assets on the bank’s balance sheet. However, with a cash pooling arrangement, there is no interest earned on these assets due to the ability to use surplus funds to offset the deficit balances, and therefore they will appear as a ‘non-performing loan’ for the bank. In order for the bank to show that these deficit balances are not ‘non-‘performing loans’, the bank may require cross guarantees among pooling participants.

Notional pooling can also be more complex if multiple currencies are involved. It is necessary to convert the currencies into a single base currency before pooling can take place.

This can be done via a short-dated swap, giving the company greater control of the FX and interest rates.

Alternatively, the company may convert the currencies to the base currency using a notional rate, with the risk adjusted in the interest rates of each currency.

Either approach can be cumbersome and too costly for the company, in which case companies would prefer to turn to physical cash pooling.



Cash Pooling Structure #2: Physical Cash Pooling

Physical cash pooling is often also known as ‘zero-balancing’.

In this set-up, the bank automatically sweeps cash from different bank accounts into a header account, so that the cash balances in the different bank accounts will be zero after the cash sweep.

If the bank account has a debit balance, cash will be swept from the header account to the bank account to offset the debit balance.

The physical cash sweeps between bank accounts should be monitored, as interest earned in the header account should be allocated back to the zero-balance accounts (ZBAs) that have contributed cash to the header account.

These cash sweeps will also be considered as intercompany loans between companies, and some tax jurisdictions will require interest expense on these intercompany loans to be calculated at market rates for purpose of transfer pricing.


Considerations for Notional Pooling and Physical Pooling

In summary, between notional pooling and physical pooling, notional pooling does not involve cash physically leaving the bank accounts of each subsidiary, i.e. no intercompany loans.

Sometimes, entities may have joint ventures or minority shareholders, who might view physical pooling as a ‘loss of control’ over their cash balances.

Negotiation and careful explanation of the concept of pooling to these shareholders will be required before companies with joint-venture setups can perform physical cash pooling.

From the company’s point of view, notional pooling is normally more straightforward, as entities retain full control of the cash over their bank accounts.

However, notional pooling is not legal in certain countries, and it can get complex if multiple currencies are involved.

It is possible that companies employ a hybrid of notional and physical pooling for their bank accounts in multiple currencies and countries.

In any case, it is always advisable to check with your bankers on different relevant local regulations, before deciding on the best approach to concentrate cash from your different entities.

Read this blog post if you would like to understand more about cash pooling and various considerations.


Liquidity Management

If the companies have surplus funds, the treasurer can consider various investments to maximize yield of these funds.

While investing excess funds, the treasurer needs to consider both market risk of the investment and liquidity risk of the company.

High-yielding investments may not always be suitable for the company, if the investment is not marketable, i.e. it cannot be converted into cash easily.

Typically, companies that have high cash needs and require liquidity of funds should not enter into investments with high maturity.

Some common investment options that have low risks and high liquidity employed by corporates are:

  • US Treasuries refer to debt issued by the US Government, and is considered to be risk-free.
  • Low-maturity corporate bonds are bonds issued by corporates that are close to maturity, and thus have a smaller risk to fluctuations in interest rates.
  • Certificates of deposit are bank deposits that pay a fixed interest rate on maturity.
  • Commercial paper is short-term notes issued by large corporates which carry higher yield compared to US Treasuries
  • Money market fund is a fund consisting of T-bills, notes and bonds, managed by a fund manager.
  • Repurchase agreement refers to securities that investor can buy from a financial institution, and will sell it back to the financial institution at a specified date.

The investment strategy taken by the treasurer will depend on the investment policy of the company, which should state the types of investment options allowed for excess funds.

The treasurer will also need to understand the future cash needs of the company from the cash flow forecast, and decide the amount of funds that can be invested for higher yield while ensuring that there is always sufficient cash buffer, in case cash is needed sooner.

We hope this short summary gives you a good understanding of cash management for corporate treasury - cash centralization and decentralization, notional and physical cash pooling structures, liquidity management…

Next, we will cover the topic of funding. What do CFOs or treasurers do when the company needs funding? What are the main sources of funding and what is the cost of funding? Read on to learn more about this interesting topic!