Effective cash positioning: Cash management tools and techniques

The role of finance and treasury, in creating and sustaining value, continues to be critical to any organisation. The treasurer’s traditional guardianship and risk management role is extending into one of supporting core needs across the entire organisation. In terms of cash management, this means enabling a continuous and accurate reporting of the cash position, providing responsive forecasting data and handling payment transactions more efficiently, as well as managing and evaluating financial risks with greater precision.

Key practicalities

  • Proactive management of cash-conversion cycles, supporting cash-flow forecasting and enabling better long-term funding and investment decisions;
  • Optimising the use of effective tools to support an efficient cash management structure;
  • Centralisation of payments for significant qualitative and quantitative benefits; and
  • Concentration of cash to generate additional liquidity and optimise interest.

Trends and developments in cash management

Main trends and developments:

  • Companies are increasingly seeking more sophisticated cash management solutions and focused on standardising processes and strengthening internal controls further. This is likely to lead to a greater degree of centralisation of certain cash management activities.
  • As treasury functions become increasingly sophisticated, companies are turning to cash-optimisation strategies, as cash is progressively viewed as a multidimensional asset.
  • Increased efforts by governments to harmonise tax rates and more effectively link taxable activities to economic activity and physical presence may change business structures and trading activities, which in turn may affect existing cash management structures.
  • Governments and regulators are working to open up banking and payments systems across the world (TARGET 2, CHAPS, UPI, etc) to encourage further innovation and provide treasurers with new opportunities for the management of cash. The increase in the number of countries offering faster payments capabilities will enhance the move to global real time, 24/7 payments processing, providing treasurers with new opportunities and challenges for handling liquidity.
  • Increased convergence of cash, liquidity, risk and trade management. Cash management is not only related to ensuring solvency and the handling of payment transactions, but also involves risk management and working capital management alongside the entire financial supply chain.
  • The global pandemic has accelerated investment by banks, companies and regulators in technology solutions, which improve visibility, reduce risks and enhance cash management activities.
  • Increasing adoption of enterprise-wide processes and data standards, which enable organisations to simplify systems and procedures for greater overall efficiency, often leading to the development of an integrated treasury function.

Tools and techniques

There are a number of tools that treasurers can draw on to support an efficient cash management structure. These include:

  • Working capital tools to improve the liquidity available to the organisations using only commercial flows, and not requiring the assistance of any external financial institution.
  • Control over the cycle of payments and receipts to reduce the volatility of intra-month cash balances, and improve application of corporate policies regarding supplier and customer payment terms.
  • Internal processes to accelerate the allocation of receipts to customer accounts, thereby increasing the liquidity available for corporate uses and better customer credit management.
  • An optimised banking structure that uses a limited number of banks and bank accounts.
  • Structures that concentrate available balances in fewer locations and thereby enabling economies of scale, greater risk diversification and a reduction in operational risk.

Working capital

While large, one-off investments may be funded through raising new finance from the debt and equity markets, it is the funds from ongoing operations that typically service debt, pay dividends and pay for labour, goods and services. Simply put, such funds are generated by the receipt of income from the sale of goods and services. More specifically, a supplier (creditor) provides stock, the stock is then sold on credit, creating a debtor. In due course, the debtor pays, thus providing the company with cash resources that are then used to pay the creditor and the surplus cash is retained within the business.

The three key components of working capital are: trade receivables, trade payables and inventories. Controlling the components – which is basically working capital management – is critical to ensuring sufficient liquidity for the company.

The cash conversion cycle (CCC) is a measure of the amount of time cash is tied up in working capital. The CCC quantifies the number of days it takes a company to convert payments for inventory into cash inflows from sales, and therefore the number of days of funding required to pay current obligations and stay in business. The shorter the CCC, the healthier a company generally is, from a working capital perspective.

The operating cycle consists of money tied up in receivables and inventory – offset by trade payables, which are a source of liquidity. While they represent a future use of funds since they will need to be paid, the company still has access to the funds until payment is made.

The CCC can be calculated as:

CCC (days) = days inventory outstanding + days receivable outstanding – days payable outstanding


Days inventory outstanding = (average inventory/cost of goods sold) x 365, ie the average number of days it takes for inventory to be sold. A lower number is generally desirable while still ensuring that sales demand can be met.

Days receivable outstanding = (average accounts receivable/sales) x 365, ie the average number of days it takes for a company to collect payment. A lower number is desirable, ensuring that the organisation does not put itself at a competitive disadvantage to other potential suppliers through overly aggressive settlement terms.

Days payable outstanding = (average accounts payable/cost of goods sold) x 365, ie the average number of days it takes a company to pay its creditors. A higher number is desirable, but a balance needs to be maintained between delaying payment and retaining the goodwill of suppliers or taking advantage of any early payment terms.

Good management of the CCC supports cash-flow forecasting and enables better long-term funding and investment decisions, a reduced risk of bad debts, improved liquidity and hence stronger balance sheet ratios (and from this, increased creditworthiness). The management of working capital is essentially a compromise between levels high enough for smooth commercial operation and levels low enough to be financially efficient.

Intercompany and third-party settlements

Centralising payments (internal or external) can result in significant qualitative and quantitative benefits for the company. Size and scale of these benefits will depend on the existing costs, complexities and effort involved in making or receiving payments. The more manual and dispersed, the greater the potential savings.

Many companies engage in a significant level of intercompany trading as they may manufacture in one location, use a number of distribution hubs and use these to sell to local sales companies. There are a number of techniques for managing cross-border liquidity company-wide and for making intercompany transactions more efficient. Aggregating these flows to reduce the volume of transactions is a simple concept, but multilateral netting can be complex to implement. Netting is one of the major tools used by companies with a centralised treasury or an in-house bank.

Types of netting

Netting is the offsetting of payables and receivables from two or more parties trading with each other. When performed within a company, it improves cross-border liquidity management, centralises management of foreign currency risk and reduces banking costs, FX risks and any float. Netting can quickly lead to significant benefits for a company if there is a high volume of intercompany trading. There are two basic types of netting: bilateral and multilateral.

Bilateral netting

Bilateral netting is the offsetting (individual invoice or account level) of receivables due from one entity (A) to another (B) against the payables due from B to A. Only the net position moves between the two entities. Bilateral netting does not need to be centrally managed and can operate internally, within the company, or can also cover payments to and from independent parties.

Multilateral netting

Multilateral netting is an arrangement among three or more parties to net their obligations, and normally requires a multilateral net settlement system. The system consolidates the cross-border payments of the various parties after conversion into agreed common reference currencies. Most companies use multilateral netting in an intercompany context, usually cross-border, involving multiple subsidiaries. With a multilateral netting system in place, intercompany payments result in a single net receipt or payment to each participant in their own currency.

Multilateral netting requires a netting centre (typically operated by the central or regional treasury centre), which can act as the counterparty to all the subsidiaries in the group. The netting centre typically handles all FX exposures as well as FX trading. The netting centre determines the net position of each participant and then instructs participants to make or receive one payment to or from the netting centre on settlement day in their own currency.

Third-party currency payables may also be included (third-party receivables usually are not, as it is more difficult to control the timing of them). In this case, either the netting centre or the local subsidiary pays the third party in their domestic market as paying agent for the group and then settles the amount disbursed through the netting system.

At its simplest, multilateral netting is used to offset trade payables and receivables between companies that trade together within the same group (intercompany trading). Groups with small numbers of participants and low volumes of transactions usually collect transaction data at the invoice level. Groups with large numbers of participants and/or high volumes of transactions typically collect data at account or statement level (ie all trading parties run accounts for each other and submit monthly account statements as input to the netting centre).

Netting drivers

Multinational companies often use netting as a core part of treasury or in-house banking, to significantly reduce transactions that would have traditionally passed through the external banking system. There are four types of trade transactions that can be processed through a netting system:

1. Intercompany transactions: Typically, netting systems are either receivables based (where participants report what they are due to receive) or payables based (where they report what they are paying). In theory, there should be no difference between the two, but many companies opt for a payables-based system to reduce reconciliation problems during the netting cycle and encourage fast resolution of items in dispute. Some companies ask participants to report both receivables and payables so that reconciliation can be achieved and inconsistencies identified during the netting cycle.

2. Third-party trade payables: Increasingly, third-party currency payments are included in netting systems by the more sophisticated netting users. Third-party creditors can be incorporated into the netting system in exactly the same way as an internal participant. Payments to creditors can be made directly from the netting centre to the third parties’ bank accounts. Or, they can be channelled via a group participant (or treasury or in-house bank’s account) located in the same country, which can make the payment on behalf of the paying entity (ie payment-on-behalf-of (POBO), acting as paying agent). This arrangement converts an expensive cross-border payment with an FX commission into a low-cost local-currency transaction. As third-party payables are not always as flexible in terms of when the payment is made, or trade discounts may be missed, the netting cycle is usually run more frequently – once a week or even daily if third-party transactions are included.

3. Third-party trade receivables: Third-party trade receipts are more difficult to include in a multilateral netting system, as they are rarely under the control of the receiving company unless it has the authority to extract the funds via direct debit. One technique that can be used by companies that have an in-house bank is to collect all foreign currency receivables in the appropriate currency account at the in-house bank. The in-house bank becomes the receiving (collections-on-behalf-of (COBO)) agent for all group currency receivables and is set up as a counterparty on the netting system. As payments are received, they are included in the next netting cycle, and payment is made to the receiving party in its local currency. This technique is also used when subsidiaries are not allowed to hold currency accounts in their own names.

Financial flows

In addition to trade transactions, the organisation can also decide to include financial flows; these are often overlooked, but can be of substantial benefit if included. The types of items in this category might include:

  • Foreign currency for sale: UK subsidiary receives USD and sells through treasury or in-house bank for GBP; settlement occurs through the netting;
  • Foreign currency purchases: a subsidiary needs to buy currency and settles in its base currency through the netting;
  • Intercompany loans: a subsidiary borrows from the centre and funds are delivered and repaid as part of the netting process;
  • Intercompany deposits: a subsidiary that is ‘long’ in a currency lends its surplus to the centre; the fund’s movement is linked into and settled via the netting;
  • Payment and collection of intercompany interest on the above;
  • Payment and receipt of management fees, dividends, royalties;
  • Third-party financial receipts: for example, currency interest on a bank deposit or maturing currency deposit where the proceeds are required by a subsidiary in their home currency;
  • Third-party financial payments: for example, currency loan interest or currency loan repayments by a subsidiary that does not have the currency; and
  • Payment of expatriate salaries and expenses.

Increasingly, multinational groups are including as many flows as possible in the netting in order to optimise the benefits. However, once the netting system becomes a core part of treasury, it needs to be run more frequently than the traditional monthly cycle used by most companies for intercompany trading transactions. Some companies run netting weekly, but may only include trade transactions once per month. This allows for efficient settlement of financial flows without creating intercompany loans or burdensome bookkeeping activity.

To optimise efficiency, as many cash activities as possible need to be linked into the netting cycle, including cash forecasting, liquidity management, currency purchases and sales, and third-party payments and collections, as well as traditional intercompany settlements.

Cash concentration

A cash concentration arrangement enables individual bank accounts – belonging to related group entities – to be aggregated for the purpose of generating liquidity and optimising interest paid or received. The resulting cash pools can be established in domestic currency and foreign currencies, and organisations can include group companies domiciled in single or multiple jurisdictions.

Methods of cash pooling

There are essentially two methods of cash pooling: notional pooling and zero balancing (cash concentration). Both methods of pooling achieve the same primary objectives of generating liquidity and optimising interest, with the difference between them being in the mechanics of operation.

The key distinction between the two is that, with a notional pool, a participant’s funds remain in their own bank account, and with a cash-concentration solution, a participant’s net daily cash flow (the end-of-day balance) is physically swept to or from a master account. As a result, each participant’s account end-of-day balance is zero, hence cash concentration is often referred to as zero balancing. The sweep from a subsidiary’s account to a master account creates an intercompany balance.

Many organisations will employ variations and combinations of both notional pooling and cash concentration in their overall liquidity management solutions.

The bank account and financial account entries highlight a key difference between notional pooling and cash concentration:

  • With notional pooling a subsidiary’s credit or debit position is clearly visible on its bank account. The bank simply aggregates the balances across all accounts and treasury is responsible for managing the net position.
  • With zero balancing a participant’s net daily cash flow is swept to or from treasury’s master account at the end of each day. Consequently, the opening and closing balance on a subsidiary’s bank account is always zero.

Newly introduced banking rules, such as Basel III, have increased the cost to the banks of providing notional pooling. At the same time, new accounting standards (such as IAS 32) have increased the risk that notional pooling balances may be treated as debt at a gross level. As a result, zero balancing is now the more popular solution.

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