Centralizing Cash Management- Efficient and Cost Effective Series 0.1

Centralizing cash management is an intuitively straightforward concept. The basic goals of cash management are:

1. To speed up collection of accounts receivable while slowing down the disbursement for accounts payable
2. To shift cash from subsidiaries that have excess liquidities to subsidiaries facing a cash deficit, and
3. To maximize the return on consolidated cash balances. 

The aim is to minimize the amount of time (measured in days) when cash is trapped in inventory and receivables, while extracting the longest possible delay in paying suppliers provided that supplier financing is cheaper than bank financing:

Consider the case of ABC USA—the subsidiary of the Swiss nutrition multinational.

• Its California-based ABC subsidiary projects a cash balance of $260 million for the month of April 2014, earning a paltry 1.75 percent per annum from its bank deposits.
• XYZ, ABC New Jersey–based pasta subsidiary, projects a cash deficit of $160 million and would have to bridge it by drawing on its line of credit at the cost of 6.75 percent.
• By consolidating both cash positions between its ABC and XYZ subsidiaries, ABC-USA has a net cash balance of $100 million and will save itself [(6.75% − 1.75%) × 160 million]/12 = $666,666.

The same logic applies at an international level. For example, ABC–South Korea has a dollar-equivalent deficit of $75 million and faces short-term borrowing interest rates in South Korea of 9 percent per annum. Consolidation of cash balances between the two countries' operations would allow ABC–South Korea to borrow from ABC-USA at the much lower rate of 1.75 percent. This is a classic example of Inter Company Lending, also known as funding the shortfalls internally.

Of course, netting on a cross-border basis raises issues of foreign exchange conversion cost and currency risk. Last but not least, ABC-Argentina is short $10 million for the same period and could draw on ABC-USA at 1.75 percent rather than borrowing in Argentina at the rate of 12 percent. The Argentine peso has been depreciating, and speedy transfer in and out of Argentina may be held up by the country's central bank. This, of course, would make ABC-USA pause before consolidating cash management between its Argentine and U.S. subsidiaries. 

In the next version, I will discuss the advantages of netting and in- house clearing and settlement for global entities.

Thanks

Himanshu Sanguri