A cash pool is a financial management system used by companies and financial institutions to optimize the balances of their internal bank accounts. It is a technique employed to manage and optimize the liquidity of a group of companies, usually under a single parent company.
While there isn’t a universally accepted “official” definition, in the context of banking and finance, a cash pool can be defined as a set of bank accounts of different companies (subsidiaries) that are combined into a single account. The goal is to optimize and manage the balance of these accounts by offsetting balances to reduce overdrafts and increase the efficiency of the company’s overall liquidity.
How is it used and its purpose:
- Liquidity Management: Cash pooling allows companies to combine their credit and debit positions in various accounts into one account. This helps in offsetting credit balances against the debit balances, thus reducing or eliminating overdraft charges.
- Centralized Management: It provides a centralized view of the company’s cash position, making it easier for treasurers to manage and allocate funds efficiently.
- Interest Optimization: By consolidating balances, companies can benefit from reduced interest expenses on overdrafts and potentially earn higher interest on combined credit balances.
- Facilitates Internal Lending: Instead of external borrowing, companies can use the surplus funds from one subsidiary to fund the needs of another subsidiary.
- Reduces External Borrowing: With a consolidated view and efficient allocation of funds, companies can reduce their reliance on external borrowing.
- Efficiency in Cross-border Payments: For multinational companies, cash pooling can help in managing multiple currencies and reduce the cost of foreign exchange transactions.
Types of Cash Pooling:
- Zero Balancing (or Zero Balance Account): At the end of each day, all subsidiary account balances are transferred to a master account, bringing their balance to zero.
- Target Balancing: Subsidiary accounts maintain a predetermined target balance, with any excess or deficit funds transferred to or from the master account.
- Notional Pooling: Unlike physical pooling (like zero balancing), the funds are not physically transferred. Instead, the interest is calculated on the net balance of all accounts, but the money remains in individual accounts.
It’s worth noting that while cash pooling offers many advantages, it also comes with challenges, especially in cross-border scenarios where different regulatory and tax implications need to be considered.
This page was last updated on August 9, 2023.