What it means
A group with twenty subsidiaries and forty bank accounts will, on any given day, have some accounts in credit and some overdrawn. Without pooling, the overdrawn accounts pay borrowing rates while the credit accounts earn deposit rates, and the spread between the two is a cost the group pays for keeping its cash in separate boxes.
Pooling puts the cash in one box. Physical pooling works by sweeping.
At the end of each day (or at set times), the bank transfers each participating account's balance to a master account held by the group treasury company, either in full (zero balancing) or down to a target minimum. Accounts in credit send cash up; accounts in deficit receive cash down.
The master account holds the group's net position, which is either invested or used to reduce group borrowing. Each sweep creates or adjusts an intercompany loan between the subsidiary and the treasury company, on which interest is charged at an arm's length rate, so that each subsidiary's accounts reflect what it lent to or borrowed from the pool.
The structure requires intercompany loan agreements, board approvals in each participant, and accounting for the intercompany balances. Notional pooling leaves the balances where they are.
The bank aggregates the balances of the participating accounts for interest calculation, charging or paying interest on the net figure, and the benefit is shared among participants by the group's own allocation. Because no funds move, there are no intercompany loans, but the bank requires cross-guarantees from the participants (since it is effectively lending to the deficit accounts against the credit accounts) and, under bank capital rules, notional pooling is more expensive for banks to provide and is restricted in some jurisdictions.
The benefits are direct. Interest cost falls by the spread between borrowing and deposit rates on the balances that offset: a group with $30 million of subsidiary overdrafts and $25 million of subsidiary deposits can reduce its net position to $5 million and save the spread on $25 million.
Visibility improves: treasury sees the group's cash in one place daily rather than assembling it from subsidiaries' reports. Surpluses are invested as one larger sum at better rates.
Subsidiaries' own facilities and their fees can be reduced or eliminated. The complications are legal, tax and regulatory.
Intercompany loans must carry interest at arm's length rates and be documented, or tax authorities may reclassify them. Withholding tax may apply to intercompany interest across borders.
Thin capitalisation rules may limit the deductibility of interest for subsidiaries borrowing from the pool. Some countries restrict or prohibit cross-border sweeping or notional pooling.
Minority shareholders and creditors of a subsidiary that lends its surplus to the pool may object, and directors of each participant must be satisfied that lending to the pool is in that company's interest. Cross-currency pooling adds exchange risk and is usually done notionally through a bank that offers multi-currency pooling.
Pooling is standard for groups of any size with multiple entities or accounts, and simplified versions (sweeping several accounts at one bank into one) are available to small businesses.
In practice
Real-world examples.
Example
A retail group sweeps 300 store accounts into one master account nightly, so that takings are available to pay suppliers the next morning.
Example
A multinational runs a notional multi-currency pool in which euro, sterling and dollar balances are netted for interest without conversion.
Example
A family group of four companies pools at its single bank, reducing its net overdraft from $800,000 to $150,000.
Think of it
“Cash pooling is like combining all family members' bank accounts to get better rates and avoid overdrafts.
Formula
Calculation
Net Pool Position = Sum of credit balances minus Sum of debit balances across participating accounts
Interest Saving = Offset amount x (Borrowing rate minus Deposit rate)
where Offset amount = the lesser of total credit balances and total debit balances
Intercompany interest (physical pool) = Subsidiary's average balance with the pool x Arm's length rate
Worked example. A group has five subsidiaries with the following average daily balances at the same bank: Sub A plus $4,000,000; Sub B minus $2,500,000 (overdrawn); Sub C plus $1,800,000; Sub D minus $3,200,000; Sub E plus $600,000. The bank pays 2.0% on credit balances and charges 6.5% on overdrafts.
Without pooling:
- Interest earned = ($4,000,000 + $1,800,000 + $600,000) x 2.0% = $6,400,000 x 2.0% = $128,000 a year
- Interest paid = ($2,500,000 + $3,200,000) x 6.5% = $5,700,000 x 6.5% = $370,500 a year
- Net cost = $242,500 a year
With pooling (physical or notional):
- Net position = $6,400,000 minus $5,700,000 = plus $700,000
- Interest earned on the net = $700,000 x 2.0% = $14,000
- Net income = $14,000; improvement = $256,500 a year
- Check: the offset amount is $5,700,000 (the smaller of credits and debits); saving = $5,700,000 x (6.5% minus 2.0%) = $256,500
The group also cancels Sub B's and Sub D's overdraft facilities (fees $15,000 a year) and invests the $700,000 net surplus, plus the treasury company's own $3,000,000, in a money market fund at 3.5% rather than 2.0%, earning $55,500 more. Total annual benefit about $327,000 against bank pooling fees of $18,000 and one-off legal and set-up costs of $40,000.
Intercompany accounting (physical pool): Sub A lends its $4,000,000 to the treasury company and earns interest at the arm's length rate set by the group's policy, say 3.0%: $120,000 a year, more than the 2.0% it earned from the bank. Sub D borrows $3,200,000 from the treasury company at, say, 5.0%: $160,000 a year, less than the 6.5% it paid the bank. Every participant is better off, the treasury company keeps the residual margin, and the intercompany balances appear in each subsidiary's accounts as loans to or from the group.
Cross-border note: if Sub D is in a country with a 10% withholding tax on interest paid abroad, the $160,000 of intercompany interest would attract $16,000 of withholding unless a treaty reduces it, and the group's tax team would evaluate whether Sub D should participate or keep a local facility.Case study
Seen in the real world.
A manufacturing group with twelve subsidiaries in six countries had grown by acquisition and inherited each subsidiary's banking arrangements: 34 accounts at 9 banks, 7 overdraft facilities, and a group treasurer who assembled the cash position monthly from spreadsheets emailed by the subsidiaries. The group's net cash was about $5 million, but gross overdrafts were $22 million and gross deposits $27 million, and the interest spread cost about $900,000 a year, plus $110,000 of facility fees. The treasurer implemented physical pooling within each country at a single bank and a notional multi-currency pool across countries at the group's main bank.
The project took nine months: intercompany loan agreements for every participant, board resolutions, an arm's length interest policy agreed with the tax advisers, exclusion of one subsidiary in a country that prohibited cross-border sweeping, and a treasury system to track the intercompany balances. The annual saving was about $760,000 net of fees; the group's cash position became visible daily; the number of banks fell from nine to three; and the treasurer's monthly spreadsheet exercise disappeared. The finance director's board paper noted that the group had been lending money to its banks at 2% and borrowing it back at 6% for years because nobody had put the accounts together.
Watch out
Common mistakes.
- Pooling without proper intercompany loan agreements and arm's length interest, which invites tax reclassification and leaves subsidiaries' directors exposed.
- Ignoring withholding tax, thin capitalisation and local restrictions on cross-border pooling, which can turn a saving into a cost.
- Sweeping every subsidiary's cash to the centre without considering local minimum balances, minority shareholders or creditors' interests.
Questions
People also ask.
What is the difference between physical and notional pooling?
Physical pooling moves cash into a master account daily, creating intercompany loans. Notional pooling leaves balances in place and nets them for interest only, requiring cross-guarantees. Physical is simpler for banks and tax; notional is simpler for the group's accounting.
Can a small business use cash pooling?
Yes, in simplified form: sweeping several accounts at one bank into one, or setting up an offset arrangement between a deposit account and an overdraft. The principle is the same.
What are the main risks?
Tax (arm's length interest, withholding, deductibility), legal (directors' duties, guarantees, restrictions), and concentration (a single bank holds the group's cash, so its credit standing matters).
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