Cash Concentration

Larger companies with many subsidiaries, especially those with operations in multiple countries, maintain a significant
number of bank accounts. This is an inefficient arrangement from the perspective of cash management, since the
treasury staff must track all of the individual account balances. With such highly fragmented cash balances, it is
extremely difficult to repurpose the funds for either centralized payments, debt paydown, or investments. An excellent
solution is cash concentration, where the cash in multiple accounts is pooled. Pooling can be achieved either through
physical sweeping (where cash is actually moved into a concentration account or master account) or notional pooling
(where funds are not actually transferred, but balance information is reported as though physical sweeping had occurred).
This chapter describes the various cash concentration strategies, the mechanics of pooling, and supporting policies,
procedures, and controls.
Benefits of Cash Concentration

Elimination of idle cash Improved investment returns

The treasurer's best argument will be that cash If the company's cash can be aggregated, then it is
idling in a multitude of accounts can be aggregated easier to allocate the cash into short-term, low-
into interest-earning investments. yield investments and higher-yield, longer-term
investments. The overall results should be an
improved return on investment.

More cost-effective oversight of accounts Internal funding of debit balances

When an automated sweeping arrangement is used Where a company is grappling with ongoing debit
to concentrate cash, there is no need to manually balance problems in multiple accounts, the
review subsidiary account balances. This can yield a avoidance of high-cost bank overdraft charges
significant reduction in labor costs. alone may be a sufficient incentive to use cash
concentration.
Interest Income Improvement Example

Scenario without
Cash
Concentration

Subsidiary 1 8% 3% $100,000 $3,000

Subsidiary 2 8% 3% ($50,000) ($4,000)

Subsidiary 3 8% 3% ($35,000) ($2,800)

Subsidiary 4 8% 3% $75,000 $2,250

Totals $90,000 $(1,550)

In the exhibit, interest income improves by $4,250, which makes cash concentration cost-effective as long as the
sweeping fee charged by the bank is less than that amount.

$4,000.00

$2,000.00

$0.00

-$2,000.00
Without Concentration With Concentration
Cash Concentration Strategies

Complete decentralization
Every subsidiary or branch office with its own bank account manages its own cash position

Centralized payments, decentralized liquidity management

Centralized payment factory handles all payables but issues payments from local
accounts

Centralized liquidity management, decentralized

payments
3
Treasury staff centralizes cash but local managers handle
disbursements

All functions centralized

Treasury staff pools all cash, invests it, and manages
disbursements

The final (and most centralized) of these strategies is the most efficient approach for cash concentration, but it may not
be the most cost-effective. If a company has relatively few subsidiaries with low account balances, then creating a central
treasury staff to manage the cash may add more overhead than will be offset by increased interest income or reduced
interest expense.
Pooling Concepts

Cash Pool Cross-Border Cash Pool Multicurrency Center

Comprises a cluster of subsidiary If a pooling arrangement includes If a company pools all of its
bank accounts and a accounts located in more than foreign currency accounts in a
concentration account. Funds one country, this is known as a single location, this is a
physically flow from the cross-border cash pool. A multicurrency center
subsidiary accounts into the company may elect to pool cash arrangement. Multicurrency
concentration account under a within the home country of each centers are generally easier to
physical sweeping method. currency (e.g., U.S. dollars are manage, but transactions are
Alternatively, cash balances in pooled in the United States), more expensive than under the
the subsidiary accounts can be which is known as the single- single-currency-center model.
concentrated in the master currency-center model.
account only within the bank's
records, with the cash remaining
in the subsidiary accounts. This
later method is called notional
pooling.
Physical Sweeping
Zero-Balance Account Setup Credit Balance Sweep
Bank automatically moves cash Cash in accounts with credit
from subsidiary accounts into a balances are swept into the
concentration account concentration account

Debit Balance Coverage

Zero Balance Result
Funds are transferred from
At the end of the sweep, there are
concentration account to offset
no credit or debit balances in the
debit balances in subsidiary
zero-balance accounts
accounts

It is also possible to use constant balancing to maintain a predetermined minimum balance in a subsidiary account, which
involves sweeping only those cash levels above the minimum balance, and reverse sweeping cash into the subsidiary
account if the balance drops below the minimum balance.

Daily sweeping may not be necessary outside of a company's designated core currencies. This is especially likely when
noncore currency account balances are relatively low. If so, it may be more cost-effective to sweep them less frequently,
or to implement trigger balances. A trigger balance is an account balance level above which excess funds are swept out of
the account.
Notional Pooling

Interest Calculation
Mechanism for calculating interest on the combined credit and debit balances of accounts without actually
transferring any funds

Subsidiary Control
Each subsidiary company takes advantage of a centralized liquidity position while still retaining daily cash
management privileges

No Intercompany Loans
No need to create or monitor intercompany loans, nor are there any bank fees related to cash transfers

Global Capabilities
Where global notional pooling is offered, the pool offsets credit and debit balances on a multicurrency
basis without foreign exchange transactions

Interest Allocation
Interest income is usually allocated back to each of the accounts making up the pool

The main downside of notional pooling is that it is not allowed in some countries, especially in portions of Africa, Asia, and
Latin America (though it is very common in Europe). In these excluded areas, physical cash sweeping is the most common
alternative.
Bank Overlay Structure

Higher Layer
1 Networked regional banks or single global bank

Daily Sweeps
Zero-balancing between layers

Lower Layer
In-country banks for local transactions

Companies operating on an international scale frequently have trouble reconciling the need for efficient cash
concentration operations with the use of local banking partners with whom they may have long-standing relationships
and valuable business contacts. The solution is the bank overlay structure.

A bank overlay structure consists of two layers. The lower layer is comprised of all in-country banks that are used for local
cash transaction requirements. The higher layer is a group of networked regional banks, or even a single global bank, that
maintains a separate bank account for each country or legal entity of the corporate structure. Cash balances in the lower
layer of banks are zero-balanced into the corresponding accounts in the higher layer of banks on a daily basis (where
possible, subject to cash flow restrictions).

These sweeps are accomplished either with manual transfers, SWIFT messages from the networked banks to the local
banks, or with standing authorizations to the local banks. This approach allows funds to be consolidated on either a
regional or global basis for centralized cash management.
Cash Concentration Controls and Policies
Key Controls Essential Policies

Review target balances There is one key policy required for cash concentration,
Review excluded accounts which is one that places responsibility for cash
concentration on a specific group within the company:
Compare intercompany loan rates to market rates
Verify the allocation of interest income to subsidiaries All cash concentration activities shall be managed by
Verify the calculation of intercompany loan balances the corporate treasury department.

This can be a surprisingly important policy in a larger firm

where divisional managers may attempt to retain control
over their bank accounts. The policy clearly places
responsibility for cash concentration in the hands of the
corporate treasury department.

It is also possible, though not necessary, to state the company's cash concentration strategy with a policy statement.
Doing so certainly clarifies the company's direction in this area, but also requires a subsequent policy change if the
treasurer wants to turn in a different direction.
Cash Concentration Procedures and Summary

System Setup
Once a cash concentration system is set up, the
system should be fully automated, with cash
balances either shifting to a concentration Tracking Procedures
account with physical sweeping or appearing in a Procedures are needed to track intercompany
notional account with a notional pooling loans and related interest expense allocations (if
arrangement. physical sweeping is used), as well as to allocate
interest income back to the subsidiaries.

Cost-Benefit Analysis
A company must determine if it makes sense to
engage in cash concentration activities. For it to
be cost-effective, the company should have
Banking Partner Selection
large, ongoing balances in multiple accounts that 4
are not being efficiently invested. The level of automation associated with these
services mandates the use of a large bank with a
broad range of automated services; a small local
bank simply cannot assist a multilocation
company with a cash concentration strategy.

The incremental reduction in overdraft fees and increase in interest income should outweigh the incremental increase in
pooling fees and administrative costs. There is also the intangible factor of whether the managers of local subsidiaries
will accept corporate-level interference in their bank accounts. If this analysis is favorable, then a company should engage
in cash concentration activities. While notional pooling is theoretically to be preferred over physical sweeping, either
method is significantly better than having no pooling at all. Also, manual sweeping is not recommended; it involves a large
volume of manually initiated transactions to transfer funds between accounts.