Basel II aims to produce greater consistency in the way banks and their regulars approach cross-border risk management. One of its main goals is to align regulatory capital with risk management, which was deemed one of the failings of the original Accord.

Basel II is based upon three “pillars”

• Pillar I:Minimum Capital Requirements. Improvement and standardization of the calculation of three major risks which banks face:credit risk, operational risk and market risk
• Pillar II:Supervisiory Review Process. Provision of a framework for regulators when dealing with all other forms of risk, which the Accord refers to as “residual risk”
• Pillar III:Market Discipline. Increase in disclosure requirements for banks to allow better market visibility and more informed pricing from counterparties.

This articles look at what’s are cash pooling- its advantages and it basic mechanism.

Cash pooling is simply a banking structure where balances on a number of separate bank accounts are treated COLLECTIVELY for interest purposes. By pooling these accounts together or this concentration of bank balances, it optimizes the amount of interest companies both pay and receive as the bank who ask you to pool will consider the total “pooled” balance when computing the interest.

So, the main benefit of cash pooling is to improve liqudity management as total cash balances can then be managed centrally rather than locally.

Next, there are two ways of handling/conducting cash pooling:

- by the “physical” basis whereby funds are actually transferred from participant accounts into a master(or header) account at the end of each day or each week or each month.

-by the “notional” basis  where no physical movement of funds takes place. Here, the bank offsets the debit and credit balances of participating accounts to compute the pool’s net interest position. Certain countries like China do not permit the notional pooling basis .

• it should encourage divisional managers to actin the best interests of the organization as a whole eg maximise the wealth of the shareholders and achieve goal congruence
• facilitate the assessment of management performance by ensuring that one division is not subsidizing another division
• support divisional autonomy eg managers should be abl to purchase from the cheapest supplier
• the transfer pricing should be deemed to be fair
• the system should be clear and understood by all concerned
• if appropriate, the system should aim to minimize the tax liability of the company.

Yield

o         the rate of return on an investment.

Wasting assets

o         assets of a fixed nature but as they are being used by the business are physically diminishing in size eg a mine

Working capital

o         the total of current assets less the current liabilities

Work in progress

o         semi-finished goods

Variable overheads

o         indirect expenses that vary directly with output eg power

Variances

o         the difference between a budgeted performance and the actual performance achieved.

Understandability

o         Information provided in financial statements has the quality of understandability when is comprehensible to users who have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence.

Tangible asset

o a physical asset

Times interest earned

o the number of times that loan interest is covered by profits, ie earnings(profits) before tax and interest divided by the interest charge. It indicates how safe creditors interest charges are.

Thin capitalization

• a thinly capitalized company is one where its capital structure consists of very high debt/gearing level.
• many countries have thin capitalization rules restricting the level of debt financing by foreign shareholders to encourage an appropriate level of capital and restrict financing of subsidiaries by inter-companies loans,w hich otherwise enables interest to be deducted as an expense for tax purpose.

Trading on the equity

o whereby a company takes advantage of high gearing, paying a modest fixed interest charge for funds that are employed to earn a higher return for the ordinary shareholders.

Turnover( assets)

o the number of times that total assets are turned over to generate sales revenue ie the ratio of sales to assets

Turnover (sales)

o the total value of sales

Sale and leaseback transaction

The sale of an asset and the leasing back of the same asset. The lease payment and the sale price are usually interdependent because they are negotiated as a package.

Sarbanes-Oxley

• The Sarbanes Oxley(SOX) Act of 2002 is a piece of US legislation
• It was introduced in response to high profile financial scandals like the Enron and WorldCom
• It aims to protect shareholders and the general public from accounting errors and fraudulent practises
• it is administered by the Securities and Exchange Commission(SEC)
• The Act defines what company records must be stored and for how long. It set rules for the certification of financial reports by CEOs and CFOs, who are then personally responsible for the statements made, in addition to a number of other provisions. 

Solvency

The availability of cash over the longer term to meet financial commitments as they fall due.

Subsidiary

An entity, including an unincorporated entity such as a partnership, that is controlled by another entity (known as the parent).

Substance over form

The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form.

Share capital

o         the amount raised from the shareholders of the business

Shareholders’ funds

o         the total of ordinary and preference issued capital plus the total of revenue and capital reserves

Share premium

o         a capital reserve owned by the shareholders arising when a company issues shares at a price in excess of the nominal value.

Sources and uses of funds

o         see funds statement

Standard cost

o         a predetermined cost, ie what it ought to cost to produce something.

Standard hour

o         a hypothetical hour that measures the amount of work that ought to be carried out in the hour.

Stock turnover

o         ratio of cost of sales to stocks. This measures the number of times stocks are turned over in the course of a year.

Realisable value

o         The amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal.

Recognition

o         The process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the following criteria for recognition:

a.       it is probable that any future economic benefit associated with the item will flow to or from the entity; and

b.       the item has a cost or value that can be measured with reliability.

Relevance

o         Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

Reliability

o         Information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.

Revenue

o         The gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

Reserves

o         these represent the build-up of undistributed profits and consist either of revenue or of capital reserves

Retained profits

o         see ploughed-back profits

Revenue reserves

o         these trading profits are distributable as dividend to the shareholders in a restricted manner, ie basically by the issue of fully-paid bonus shares.

Risk Premium

•  The difference between the rate of return on a risk-free asset and on an asset with risk attached. The rate of return is higher if more risk is taken on.

Rights issue

o         an issue of shares for cash to existing holders of share capital in the company. Normally the issue is at a price lower than the current market price acting as an inducement to existing holders to take up the shares.