How does physical cash pooling & target balancing work with a TMS?

Cash pooling is a popular solution for balance netting to provide better access and visibility to the group’s liquidity position through a real-time, cross-border, and multi-currency structure. It can be an integral part of a group’s cash management strategy together with target balancing to have the ability to mobilize cash across the entire group.

What Is Cash Pooling?

Cash pooling is a cash management method for optimizing cash balances within a group. There are two different main approaches for pooling: physical cash pooling and notional cash pooling. In this article, we focus on physical pooling.

To put it simply, in physical pooling, the HQ (parent/holding) company works as a hub for collecting the excess cash from entities and distributing the cash to entities that are short on cash. Obviously, there are many different aspects that corporations should take into consideration when pooling cash, like taxes and legal obligations which are left out from this article. In many organizations, the treasury function is in charge of cash pooling processes and agreements.

Many banks provide different pooling options, but we will focus on the process where cash pooling is managed within the group. The benefits of having control of the cash pooling in-house are manyfold. Having a cash pooling functionality in the Treasury Management System (TMS) will create independence from banks, making the system bank-agnostic while covering any currency.

The technical setup for physical cash pooling

In the current economic environment, we have recently witnessed a considerable change in interest rates and currency fluctuations. This is one of the reasons why corporates are constantly searching for solutions to manage cross-currency and multibank cash pooling options. Additionally, corporations are interested in calculating the pooling need with intraday information instead of end-of-day balances.

What is then needed for the technical setup of the cash pool? Obviously, some change management and internal communication are necessary before starting to create the technical setup for a new cash pool. Setting up cash pooling should be easy; you should be able to choose the desired balance per bank account. Furthermore, you should be able to define tolerances for the desired balance as well as payment types for the execution and the HQ’s counter account. Particularly when starting with cash pooling, the corporate treasury should have the option to start cash pooling manually, and then when the process is fully in control, they should be able to automate it. There are always different treasury policies and practices in different corporations. Therefore, executing the actual sweeps or tops should be possible to do with Straight Through Processing or by using as many approvals as needed. Identifying balance transactions in bank statements should an easy task.

Cash pooling and in-house bank (IHB)

Above we discussed cash pooling and the practical setup for it. Many of you might have noticed that the “intercompany loan” between HQ and entities was not discussed in detail. In this chapter, we focus on handling that part efficiently.

Imagine a situation where excess cash is swept from an entity bank account to an HQ bank account. This creates an intercompany loan. There are multiple ways to book the loan, and next, we will focus on utilizing an in-house bank for that purpose.

An in-house bank typically contains one or more accounts, which we call member accounts, per participating entity. Every transaction that hits these accounts will be mirrored to the HQ mirror account. Typically, interest is calculated for the accounts, and in advanced systems withholding tax is included, when applicable. When combining in-house cash pooling and in-house banking, the obvious result would be to allocate the sweep and top transactions to an entity’s in-house bank account. This would mean that any cash pooling transactions could be found on a member account and treasury could automatically calculate interest for the intercompany loan as desired. One might ask: how to allocate the pooling transaction to the entity’s member account? The answer is twofold: firstly, the TMS needs to make sure pooling payments have some individual information that the bank is reporting back and secondly, a sophisticated in-house bank system should have a dynamic way of identifying pooling transactions from potentially thousands of transactions.

Target balancing for centralizing a single company’s cash in a multi-bank environment

There are regions where even the smallest corporates have several bank accounts in several banks operating in just one country. The basic idea here is to have one or two main banks and the others just provide a vehicle for collecting customer payments. In such a case, it might be interesting to sweep the extra cash from the collecting accounts to an optimized bank account owned by the same entity. This method is similar to cash pooling, but in this case, the counter account is not an HQ account, but a different account owned by the same company. The arrangement of course also works for cross-border and cross-currencies, as no intercompany balance is created.

Target balancing with an in-house bank or a hybrid approach

In this blog, we have discussed how in-house cash pooling and even target balancing for a company can be done. Some corporates might even consider combining bank-offered cash pooling and in-house cash pooling in a hybrid structure. In such an arrangement, bank accounts belonging to the same cash pool are balanced by that bank and top accounts are managed from the TMS. Perhaps in the future, we will discuss how target balancing could be used in bilateral in-house bank settlement clearing or how intra-day cash forecasting could be used in physical cash pooling.