What is Cash Concentration?
Cash concentration refers to the process of centralizing and optimizing a company’s cash resources from various accounts or subsidiaries into a single primary account. This financial management practice is typically employed by large organizations with multiple subsidiaries, business units, or bank accounts.
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Organisations and banks have to maintain a lot of accounts for various purposes in several countries with various banks. This kind of arrangement is really very inconvenient while managing treasury because it requires the treasurer to consider and track all individual account balances in the bank.
In such a case, it becomes difficult for the bank to track how much funds it has for centralised payments, debt payments or for the purpose of investments. The solution to this can be found in cash concentration or cash aggregation. In cash concentration, the cash lying in multiple accounts is pooled.
The pooling can be done in two ways: physical pooling (physical sweeping) and notional pooling.
Benefits of Cash Concentration
The various benefits of cash concentration for an organisation or a bank are as follows:
- Elimination of idle cash: The treasurer can redirect the funds that are lying idle in various accounts towards interest-earning investments. In addition, when the treasurer is aware of the total cash of the organisation or bank, then the amount can easily be allocated for short-term and long-term investments, which would improve the return on investment of the organisation or bank.
- Reduced costs: Large banks or organisations often have a provision for automated sweeping of cash lying in various accounts. Such automation helps in reducing the cost of labour.
- Internal funding of debit balances: If an organisation or a bank has multiple accounts and it has to pay its debit amount, it may pool and use the funds lying in various accounts instead of using its overdraft limit (on which it would need to pay a high interest).
Strategies for Implementing Cash Concentration
There are various strategies that can be used for implementing cash concentration. These are described as follows:
- Complete decentralisation: In case an organisation or a bank has various subsidiaries across the world and if the cash balances in the accounts of the subsidiaries are very small, then it may be prudent to let the subsidiaries manage their own cash and accounts.
However, in case the subsidiaries have large balances in some accounts and has overdraft position in some accounts, then it is ideal in that situation to follow a decentralised approach as it can lead to an improvement in the interest income position. Alternatively, the bank/organisation may also implement cash concentration in terms of currency of different countries. - Centralised payments and decentralised liquidity management: Banks may follow the practice of making payments to all the creditors centrally wherein the bank issues payments from a centralised place from the local accounts of different subsidiaries. It means that the cash outflows of the bank remains well-managed but in such an arrangement, the cash balances are not managed.
- Decentralised payments and centralised liquidity management: Here, the bank’s treasury aggregates the cash into a concentration account and is responsible for managing it. However, the payments and disbursements have to be managed by the subsidiaries themselves.
- Complete centralisation: In such an arrangement, the bank’s treasury pools in all the cash into a concentration account. The treasury is responsible for making investments, disbursements and managing the cash in the concentration account.
Cash Pooling
We mentioned that a bank’s or an organisation’s treasury creates a cash concentration account in which all the cash of the entity is pooled together.
Cash concentration can be achieved in two ways: physical sweeping and notional pooling.
Physical Sweeping
In physical sweeping, all cash in all the accounts of all the subsidiaries is pooled together in a single concentration account or master account.
The cash balances in the subsidiary accounts can also be concentrated in the bank’s records without the physical movement of the cash. This concentration of cash balances in the bank records without physical movement of cash is known as notional pooling.
Notional Pooling
In notional pooling, there is no physical movement of funds. Debit balances are offset against the credit balances to derive a net credit or debit amount. The net amount is used to calculate the credit interest received or the debit interest paid.
