If your company has multiple subsidiaries, you may want to consider revamping your liquidity strategy to consolidate your cash. Here are two options to consider—notional pooling and physical cash concentration.

An extended period of low interest rates, as well as a dynamic regulatory environment, have prompted businesses to re-examine their liquidity structures and investment policies. In particular, businesses with multiple subsidiaries require a liquidity strategy that maximizes available cash while providing three main benefits:

  1. Visibility over cash positions, which allows for the efficient management of funding and investment needs
  2. Access to—and control over—cash flows and balances
  3. Opportunities to leverage tactics that will optimize yields on balances, depending on the amount, currency, duration and location

 

Three-step process for optimizing liquidity: 1. visibility. 2. Control. 3. Optimization.

 

And while your ideal liquidity structure must align with, among other factors, your company culture, industry and goals, most businesses with multiple subsidiaries can optimize global liquidity by adopting a financial structure that consolidates all available funds in a central location.

Why Consolidated Cash Works

Why 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.

For example, consider a company with two subsidiaries: a profitable East Coast subsidiary, which ended the day with a surplus of $1,000, and a fledgling West Coast subsidiary, which ran a deficit of $600. If the subsidiaries’ finances were kept completely separate, the West Coast office would be forced to cover its shortfall through external financing. Meanwhile, the East Coast would invest its entire surplus. Since the interest rate charged on external borrowings is far higher than the rate paid on deposits, the overall company could easily lose money on the day’s interest payments, despite having netted a surplus of $400. If the subsidiaries’ accounts were consolidated, the company could have used its internal balances, eliminating the need for external funding, thereby saving considerably on interest.

And the ability to draw on a larger and even global pool of consolidated balances offers advantages beyond just providing a reserve sufficient enough to cover temporary deficits. 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 a) less cash needs to be kept available for emergencies, and b) more funds will be available for longer-term—and higher-returning—investments.

Structure Matters

A solid liquidity strategy will do 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 a high level of transparency. A successful liquidity strategy will reflect the company’s organizational structure and the relative independenceof its subsidiaries.

When it comes to structure, here are some of the options you might consider.

Physical Pooling

The most straightforward strategy for consolidating cash flow, “physical pooling,” or physical cash concentration, results in a separate consolidated account to hold surplus cash on behalf of the entire structure. 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 itself will ensure that the subsidiary receives the required funds to cover the shortfall.

For a company with centralized operational control, physical cash concentration has many advantages—the system of deposits and intercompany loans is 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.

 

Cash concentration illustration. Header +1000. Acct A USD 0 +USD 2000. Acct B USD 0 -USD 4000. Acct C USD 0 +USD 3000. Interest on Header: Account = 1000 * 2% = +$20. Benefit of Sweeping = +$80. Credit Interest 2%, rates are for illustrative purposes only

 

But physical cash concentration can have its drawbacks. Transferring cash between subsidiaries may be much cheaper than borrowing it from the bank, but it’s not entirely free. Moreover, the flows between participating subsidiaries have to be reconciled as intercompany loans, which could create an additional administrative burden. Foreign currencies cannot be combined in a single account—they must be converted daily or held in separate accounts, and some nations employ strict currency controls that can make the movement of funds difficult. The tax liability on intercompany loans can also vary greatly between jurisdictions.

Physically consolidating accounts may also present difficulties for independently-operated subsidiaries, especially if they are not wholly owned by the parent company. For example, if the East Coast subsidiary were a joint venture, its junior partner might object to a structure that shares balances with a wholly owned West Coast division.

Notional Pooling

Notional pooling is an alternative to physically consolidating operating cash. It’s designed to solve many of the issues facing traditional consolidation. Instead of transferring funds into a single consolidated account, the subsidiaries keep their 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.

 

Notional polling illustration. Acct A, Acct A GBP +USD 2000. Acct B, Acct B USD, -USD 4000. Acct C, Acct C EUR, +USD 3000. Interest applied to the pool: net pool position = $1000. Account = 1000*2% = $20. Benefit of Sweeping = $80. Credit Interest: 2%, Ra

 

That said, notional pooling does come with challenges and restrictions. Despite retaining a great deal of autonomy, subsidiaries must agree to jointly share liability for all incurred debts, which could be a sticking point for highly independent or jointly-owned organizations, and some countries simply don’t allow it. The system of separate accounts improves local access to funds but makes central, automated control over spending and investment more difficult. Notional pooling is also not available in all jurisdictions—notably in the US.

Choosing the Right Liquidity Strategy

The advantages of pooling operating cash are straightforward, but designing a cash pooling structure that optimizes global liquidity requires innumerable decisions about organizational autonomy and impact. The necessity of tight control over spending must be balanced with the need for rapid access to funds. And ultimately, multinational firms must weigh a variety of tax and regulatory considerations when managing their liquidity and reconciling outlays in foreign currencies.


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