Cash pooling and how to use it
Cash pooling is a modern tool for efficient management of funds. It can be described as a banking product that can optimize the corporate accounts of many businesses that have a single owner. Its main benefit is an easier access to cash and optimization of costs associated with financing the business.
Why cash pooling and who it is for
Cash pooling is used by businesses for four main reasons:
- saving financial costs
- centralisation of liquidity management + overview of cash balances
- settlement of credit and debit accounts between the participating entities
- more favourable interest rates for those involved
However, this banking product is not for everyone. The target clients tend to be large companies, for which the banks offer several options depending on the management method. Implementing the entire system can be time and money consuming and that is why its effectiveness needs to be carefully considered.
Types of cash pooling
The basic criterion for the classification of cash pooling is according to the way in which funds are transferred between the participants.
- Physical – this is the actual daily transfer of funds between the accounts involved and the so-called master account set up by the bank. In other words, it is a group loan where the cash pooling balance will not be reported as ‘cash in accounts’ or ‘due to credit institutions’ but as ‘receivable or payable in group’.
- The advantage is the minimisation of interest costs and fees compared to other financing methods, but there are higher administrative requirements for preparing documentation and setting up rules, especially internationally.
- Notional – there is no physical transfer of cash account balances between the parties involved. Transfers are notionally made to a shadow account where the bank balances debit and credit account balances on a daily basis.
- Advantages include preferential interest rates for participating groups, minimal administration (no internal clearing items) and low banking costs (no physical balance transfers).
How to proceed
When planning cash pooling, you need to consider the amount of interest to be paid. According to the Income Tax Act, Section 23(7) of Act No. 586/1992 Coll. (Zákon o daních z příjmů § 23 odst. 7 zákona č. 586/1992 Sb.), the tax administrator shall adjust the tax base by the difference between the price negotiated between related parties and the prices that would have been negotiated between unrelated parties in normal business relations under the same or similar conditions. This is the so-called normal interest test („test obvyklé výše úroků“).
Further, when introducing cash pooling, it is appropriate to apply the low capitalisation test under Section 25(1)(w) of the ZD (§ 25 odst. 1 písm. w ZD). This is a test that only includes interest-bearing loans to related parties. The amount of loans to individual “members” should not exceed four times the amount of the equity of the enterprise to which the bank is lending. If the equity is negative, all finance costs are excluded from tax-effective costs.
What’s next?
The use of cash pooling in your company will be a task for your bank advisor. However, our AICCON team will be happy to help you with its accounting and reporting.