Liquidity in multinational companies is essential for their efficient performance and ability to meet their financial obligations. These large economic groups search for the best financial strategies that enable them to manage their liquidity and cash balances more efficiently.
Cash Pooling is a financial tool frequently employed by large economic groups to optimize the management of their cash flows. It consists of consolidating the cash balances of different subsidiaries or affiliates in a centralized account for better management of financial resources and greater efficiency in liquidity management.
When the cash balances are consolidated, the costs associated with negative balances and interest paid on loans can be reduced, as well as the performance on positive balances can be optimized. Thus, if a company within the pool requires capital and seeks financing outside the entity, it will usually encounter high interest rates. Conversely, if another company in the same pool has surpluses and invests them, it may not be able to earn significant returns on those funds. Cash pooling, from a purely financial perspective, provides a solution to this problem.
By pooling all the cash funds of the group, the company with a surplus assists that one requiring funds, thus solving their liquidity needs among themselves, without the intervention of external sources. Thus, business conglomerates employing the financial tool of cash pooling can reduce the need to resort to external financing due to the compensation of deficits in some accounts by surpluses in others within the same business group.
There are 3 forms of implementing a cash pool in an organization:
Physical Cash Pooling:
- It consists of the actual and periodic transfer of cash balances from various accounts to a central one. This approach is presented as a direct and efficient strategy to manage liquidity in a centralized manner.
Notional Cash Pooling:
- Unlike physical cash pooling, this method does not involve actual transfers of funds. Instead, the balances of several accounts are virtually added for the calculation of interest, enabling companies to benefit from the netting of balances without moving cash.
Multi-currency Cash Pooling:
- It enables companies with operations in different countries and currencies to manage their liquidity in several currencies. This approach can contribute to mitigate exchange rate risk and take advantage of interest rate arbitrage opportunities.
Conversely, the implementation of cash pooling faces Transfer Pricing challenges, considering the fundamental principle of the Transfer Pricing analysis addresses each entity as independent, according to the OECD. In the case of cash pooling, this principle faces an opposite scenario, where the entities of an economic group aim to maximize their financial interests by sharing funds, given that a company centralizes all the surplus profits of some companies of the group to transfer them to those with capital deficits and requiring financing, the difficulty arises because the company granting these surpluses receives a rate equivalent to a passive interest rate that banks grant and the companies receiving the surplus should normally pay a lending interest rate.
The Transfer Pricing analyses in financing transactions must always consider the debtor’s risk. Therefore, the borrower’s credit rating is highly important.
Likewise, another important variable evidenced in this type of transaction is the figure of the guarantor, which must also be reviewed and considered (if applicable) for the Transfer Pricing analysis of these transactions. This variable is not considered in the cash pooling figure.
We have listed below a set of difficulties to be considered before a cash-pooling implementation process:
- Difficulty in the Transfer Pricing determination:
- It is crucial to establish appropriate allocation methods to ensure that internal transactions are carried out at market prices, especially when subsidiaries share a centralized account. It may require careful planning and documentation to comply with tax regulations and avoid disputes with tax authorities.
- Risk of affecting the profitability of affiliates:
- If not handled correctly, cash pooling could result in an unequal allocation of financial costs among affiliates. Entities with cash surpluses may benefit from more favorable interest rates, while those with deficits may face higher financing costs. It may affect the profitability of affiliates and generate internal tensions within the group.
- Need for careful documentation:
- Companies must maintain careful documentation to support the allocation of revenues and costs among related entities. It is essential to demonstrate compliance with tax regulations and avoid penalties.
- Risk and benefit assessment:
- Before implementing cash pooling, companies should thoroughly assess the associated risks and benefits. Factors such as differences in interest rates, local tax regulations, and financial market volatility are crucial to consider. A clear understanding of the risks enables the design of strategies that minimize negative Transfer Pricing implications.
