Using Cash Pooling to Optimize Resources

by FEI Daily Staff

Cash pooling can often help to streamline the financial operations of a business, making it easier to keep up with cash flow.

As a means of dealing with volatility in the global and United States currency markets, cash pooling is a highly effective strategy. This financial management strategy allows companies to maximize both current credit and debit positions, so that they receive the most benefit from those currency exchange positions.

In addition, cash pooling can help the company to avoid a number of costly bank fees, as well as help to reduce the chances of the corporation suffering reputational damage because of negative balances on a bank account. In effect, cash pooling helps make the most of the resources that are available.

There are a few different approaches to cash pooling that will aid in cash management for both small and large companies. Cash pooling can often help to streamline the financial operations of a business, making it easier to keep up with cash flow. By employing cash pooling to avoid expenses that are not essential to the operation of the business — and by possibly even creating a small additional revenue stream through accrued interest in the process — an organization can build sufficient cash assets.

These assets can be drawn upon when a downturn in the economy impacts sales, thus allowing the company a chance to weather the depressed market. Once the market begins to swing upward and the demand for the company’s products returns, the process of cash pooling can be used to replenish resources depleted during the downturn.

Creating an Intra-group Bank Strategy

In today’s market, monetary currency volatility is a dramatic item that has led to the establishment of the intra-group bank/cash-pooling strategy. This is not a real bank in the classic sense; rather, it is a special purpose vehicle. Essentially, the intra-group bank establishes denominated accounts in selected foreign currencies as a pool for its global working capital needs.

All the money the company earns in other countries goes into this global bank, where managers can track it in real time on the Internet and translate it immediately at the current rate, while leaving it as the asset of a particular country. This prevents problems stemming from fluctuating exchange rates, repatriation and regulatory controls.

It also means that companies do not have to keep their money in multiple currencies. Intra-group banks can lower a company’s overall effective tax rate across the board.

To determine the best path to pursue, the following structural overview presents a step-by-step process for creating an intra-group network. First, a corporation in the United States establishes a foreign subsidiary — known as a bank entity — in the appropriate jurisdiction or jurisdictions to act as the “bank” for the entire group, or for certain entities, depending on geographic considerations.

The bank entity then establishes a repurchase (“repo”} agreement with a sophisticated international bank and agreements with the American company’s foreign subsidiaries, whereby excess cash or working capital at the operating companies is swept into the bank entity.

It is then backed by a repurchase agreement with the external bank to repay the funds in the selected currency mix at the spot rate of the various currencies as of the next business day, or other timetable established by the company.

The foreign affiliates can demand return of their funds for operations at any time and will realize any exchange gain or loss when funds are returned.

The benefits of such a structure are many: ■ Helps manage risk of currency fluctuation relative to the U.S. dollar or British pound. It does so by spreading excess cash among a number of different currencies as determined by the company’s treasury function, as opposed to holding it in the subsidiary’s functional currency. ■ Companies feel that their subsidiaries are “naturally hedged,” by virtue of both revenue and expenses being denominated in their local currencies. However, there is usually substantial unmanaged currency risk in most foreign jurisdictions in which the company’s functional currency is local. ■ Assists in mitigating hedge currency risk and volatility, currently and ultimately upon repatriation to the U.S. company. It also has exposure in the U.S. by virtue of its American operations and exposure to fluctuation in value of the U.S. dollar. ■ Provides increased internal control over and ability to track and manage excess funds remotely as a company’s treasury function.

This article first appeared in Financial Executives magazine.