If your company has multiple subsidiaries, you may want to consider revamping your liquidity strategy to consolidate your cash.
Smart Business spoke with Chase Commercial Banking’s Dave Schaich about two options you could consider — physical pooling and notional pooling.
Why would a business consolidate cash?
The primary advantage is that it allows a company’s subsidiaries to borrow from one another to cover temporary deficits, which eliminates interest payments on short-term debt. And beyond providing a sufficient reserve, consolidated cash means that the company’s combined revenue stream will come from diverse sources, making it less volatile than the earnings of any single subsidiary. Predictability provides greater flexibility when investing the company’s surplus cash. A larger pool means:
- Less cash needs to be kept available for emergencies.
- More funds will be available for longer-term and higher-returning investments.
How much does structure matter?
It matters a lot. A solid liquidity strategy does more than simply distribute cash to cover shortfalls and earn higher returns on excess balances. A consolidated account should be managed in a way that provides subsidiaries with ready access, while maintaining tight control over the flow of funds and ensuring transparency.
A successful liquidity strategy reflects the company’s organizational structure and the relative independence of its subsidiaries. You might consider two structural options, physical pooling and notional pooling.
How does physical pooling work?
Physical pooling, or physical cash concentration, is the most straightforward strategy for consolidating cash flow. The result is a separate consolidated account to hold surplus cash on behalf of the entire company.
At the end of each day, the participating subsidiaries sweep their excess cash into the consolidated account, where it is invested collectively. If a subsidiary runs a deficit, the consolidated account ensures that the subsidiary receives the required funds.
For a company with centralized operational control, physical cash concentration has many advantages, such as the system of deposits and intercompany loans are highly transparent and relatively easy to control. Plus, automated controls can be put into place, further improving transparency and efficiency. The structure also maximizes the company’s flexibility when investing the surplus revenue that accumulates in the consolidated account.
How does notional pooling compare?
Notional pooling is an alternative to physically consolidating operating cash. It’s designed to solve many of the issues facing traditional cash consolidation. Instead of transferring funds into a single consolidated account, the subsidiaries keep operating cash in their own accounts. For purposes of calculating interest, however, the bank refers to a ‘notional’ position that combines the separate accounts of each subsidiary.
The single greatest advantage of notional pooling is the ability to operate in multiple currencies — an overseas subsidiary will not have to regularly exchange its currency to participate. Additionally, notional pooling allows subsidiaries to maintain greater autonomy over their balances. Each participant keeps its own account and will not see the daily inflows or outflows from a central account.
What might companies want to take into account when choosing the right structure?
Designing a cash pooling structure that optimizes global liquidity requires a number of decisions about organizational autonomy and impact. For example, it’s important to balance control over spending with the need for access to funds.
Multinational firms must also weigh a variety of tax and regulatory considerations when managing their liquidity and reconciling outlays in foreign currencies. And ultimately, your ideal liquidity structure must align with your own company goals and industry regulations.
It may sound complicated, but your bank’s international treasury experts can work with your accountants and legal team to structure the best solution for your company — and help you achieve the level of liquidity you need to drive global success.
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