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Cash Pool Model


This simple model illustrates the benefits of implementing a cash pooling solution. Cash pooling is optimal for corporations that have affiliates conducting business in different countries and with multiple currencies. It is the basis for setting up a corporate in-house bank with whom affiliates can execute cash transactions like they normally would with a commercial bank. The difference is cost -- services through an in-house bank are “free” within the organization. The cash pool model will show how this works and how it can drastically reduce borrowing and transaction costs, minimize exchange rate risk, and improve overall liquidity forecasting.

To understand the major concepts of cash pooling, two common Treasury scenarios are presented with and without the cash pool: Foreign Exchange and Affiliate Netting. Typical Cash Pool Account Structures are also discussed.


One of the major responsibilities of an effective cash manager is determining short-term liquidity needs for the corporation. For example, if more cash is needed to satisfy today’s payments, cash is borrowed. And if incoming cash is forecasted tomorrow, it can be invested or used to pay back the borrowed money. Cash planning becomes more complex when the corporation starts dealing with foreign currencies. If the corporation does not have enough British Pounds to make payments to a number of foreign vendors but has excess US dollars, a foreign exchange (FX) deal is made with the appropriate financial institution to exchange US dollars for British Pounds. Once the FX deal is executed, a currency exchange rate risk is created and should be hedged with a futures contract.

The above situation is manageable with reasonable cost if the corporation is doing business in a single country with a majority of its transactions conducted in local currency. However, real cash management inefficiencies occur when a corporation starts to expand globally. Because each country has its own tax and legal requirements and the corporation may have specialized business strategies tailored for each country, cash is naturally managed separately on a country-by-country basis. As a consequence, each is executing its own borrowing, investing, FX, and hedging deals. From a global, corporate-wide perspective; the net result is redundant and overlapping execution of Treasury transactions. Cash pooling and the concept of an in-house bank dissolves this redundancy as the scenarios below illustrate.

Scenario #1a - Foreign Exchange without Cash Pool

The diagram below is an example of four affiliates or companies within the same organization, two in the U.S. (US1 and US2) and the other two in Germany (DE1 and DE2) who manage their cash at the country level. In this simple scenario, the US companies concentrate their US dollar (USD) collection accounts into Company US1’s disbursement account [1]. Likewise, the German affiliates concentrate their collection accounts into the appropriate US dollar and Euro (EUR) disbursement accounts [2]. Company US1 finds it has excess US dollars available during the next few days and decides to make use of it by selling commercial paper [3]. In Germany however, Company DE1 is in dire need of USD to payoff its foreign vendors and elects to execute a foreign exchange (FX) deal with the bank to buy USD for EUR [4] and to borrow any additional US dollars for the remaining balance needed for payments [5]. To offset any currency exchange risk, Company DE1 hedges between USD and EUR with a futures contract [6].

Note the Company DE1 could have saved the trouble and expense of borrowing, exchanging, and hedging with the commercial bank by borrowing the USD from its affiliate Company US1 or from any one of the organization’s other affiliates who have excess USD. Scenario #1b illustrates how this can be done with a cash pool.

Scenario #1b - Foreign Exchange with Cash Pool

The diagram below illustrates the same foreign exchange scenario above except the cash pool is involved. Company CASH1 owns the cash pool and acts as the in-house bank for the organization by pooling together excess cash from all companies. The cash can be used for optimal global investing and for funding company accounts with negative balances. In this scenario, Company US1 informs Company CASH1 it wants to invest its excess USD because it will be unused during the next few days [1]. Company DE1 tells Company CASH1 it needs USD to pay off its foreign vendors and wants to exchange EUR for USD [2] and borrow the remaining USD forecasted [3]. So Company CASH1 uses USD from Company US1 to lend to Company DE1 and keeps the EUR Company DE1 has offered in the FX for overnight investing or funding to another affiliate’s EUR account.

The net effect is zero transaction costs and no exchange rate risk because all the cash is moved and exchanged internally through the in-house bank cash pool. Any cash needs that cannot be satisfied by the cash pool are borrowed from an external commercial bank [4]. Likewise, any excess cash the organization has as a whole is invested [5]. Cash pooling makes hedging easier to manage and reduces exchange rate risk because all cash is centralized. This enables the organization to move closer to a perfect hedge while eliminating redundant FX transactions.

Although conceptually simple; managing the accounting, reporting, liquidity planning and forecasting for cash pooling can become complex with hundreds of companies and bank accounts. SAP is ideal for cash pooling because it is an integrated system by design. This is a huge advantage over third-party Treasury systems because a significant amount of configuration such as company and general ledger account setup is already in place. In contrast, a third-party Treasury system interfaced to SAP requires the same bank account, general ledger, and company information in SAP; thus duplicating the effort.

Scenario #2a - Affiliate Accounting without Cash Pool Netting

A common practice within large organizations is to conduct business among its own affiliates or companies. There are many strategic and cost-saving reasons for doing this. However, additional costs are accrued when real money is transacted during affiliate trading. The following scenario shows how these additional costs are accumulated.

Three European Union affiliates EU1, EU2, and EU3 conduct business with each other during the course of a month as indicated in the diagram below. For simplicity, assume the transaction currency is the same. Because real cash is exchanged, payments and receipts are processed through the bank; thus accruing substantial banking charges as transaction volume increases. At month-end, Company EU1 has an affiliate balance of +200, Company EU2 has +800, and Company EU3 has -1000. The net balance for all three companies is zero. From a shareholder perspective, paying bank fees to move cash from one account to another within the same organization may not make sense. It’s like paying to transfer a dollar bill from one pants pocket to the other. Scenario #2b below offers a solution to avoid such fees.

There is another drawback with using cash for affiliate transactions. From a cash management standpoint, affiliate transactions can significantly distort the liquidity forecast and cause unnecessary borrowing. For example, the Treasury department runs a liquidity forecast and sees it needs to make $200M in payments but only $50M is available in the disbursement account. So the $150M is borrowed with a 6% overnight lending rate. However, unknown to Treasury, $100M out of the $150M consists of affiliate payments. This isn’t discovered until the bank statement is received the following morning showing the $100M total coming back into the organization as receipts. Now Treasury has an excess of $100M and the cash must be invested at a lower 5% overnight rate. The cost of moving cash from one pocket to another is $1M. More importantly, the unnecessary cash movement distorts the true cash needs of the organization and as a consequence, can be detrimental to business planning and to its strategic execution. True situations like this exist with major corporations today.

Scenario #2b - Affiliate Accounting with Cash Pool Netting

The diagram below illustrates how the cash pool can save money by cash-settling affiliate transactions only once per accounting period (e.g. at month-end). The dashed lines show the transactions that occurred among the affiliates during the course of a month. The accounting for payments and receipts are maintained exactly as in Scenario #2a except the only difference is cash is not moved until month-end. Goods and services are still exchanged during the month as usual. At month-end, the net balance of each company is calculated. If a company has a negative balance, it must physically pay the cash pool the balance. If a company has a positive balance, it will receive the amount from the cash pool. This is reflected with solid lines in the diagram below. All in all, the total affiliate balance for the organization becomes net zero. More importantly, monthly transaction costs are minimized to a single payment per company and prevents unnecessary borrowing costs as demonstrated in Scenario #2a.

Affiliate netting services are offered by some banking institutions but they are expensive and require each company to furnish the transaction data. This extra effort and cost does not make sense when netting can easily be implemented in SAP. In addition, interest for cash that should have been paid during the month can also be distributed accordingly to each affiliate. Interest needs to be calculated to compensate for companies that do not receive cash until month-end. This opportunity cost can impact the performance of an individual company so the appropriate accounting should be done. Although affiliate netting and proper interest distribution is currently not a feature in SAP’s Treasury module, the customization is minimal and costing only a fraction of a year’s worth of affiliate netting services.

Cash Pool Account Structures

The above cash pool model is adaptable to match different organizational structures. A typical the cash pool structure is to organize the bank accounts by country and region. In this structure, cash is initially concentrated separately in each country. The primary reason is the inherent dominance of that country’s local currency and its legal requirements. Cash can then be pooled globally or regionally depending on the business needs and time zone factors. Cash pools can also be organized per business unit rather than by country. Each corporation must evaluate the best design but typically the cash pool structure maps very closely to the existing organizational structure