Bank sweep accounts are a great tool for centralizing cash management amongst several accounts. But there are pitfalls. Your financial manager has to know what to record - and what to NOT record from the bank's transaction records. These accounts have been around for quite some time now - since banks' computer systems became powerful enough to go beyond just processing transactions for individual accounts.
For example, a contractor might have the basic construction company. And a C Corp. for tax planning purposes. And another corporation owns the property and leases it to the operating company. And a separate company with appropriate qualifying ownership to allow it to bid on contracts that are awarded preferentially to women and racial minorities.
Each of these separate legal entities is required for legal and income tax purposes to keep proper books and records and file separate returns. But each entity relies on other parts of "the group" to operate: the contracting company rents facilities and equipment; the minority companies hire staff and project managers from the construction company; etc.
Before bank s weep accounts, the financial manager had to transfer funds between the entities. The construction company billed for work completed and received payments in cash. It paid the facilities company to rent equipment, and the operations company to "hire" staff. The facilities management company paid the mortgage and equipment loans. The operating company paid the payroll and related taxes. The financial manager had to plan and juggle and either do telephone transfers or actually write checks to get the dollars into the correct bank accounts to cover the checks for mortgage payments, equipment loans, payroll, employer remittances, etc. etc.
Banks had to have staff to handle the phone calls and process the checks and deposits as money was passed around the group. Each entity might potentially need a line of credit [LOC] that had to be set up and administered by the bank.
Bottom line: lots of time and paperwork and audit costs.
The bank and group set up one master LOC agreement. The bank's computer sets up a Master Account - the Sweep Account or Master Clearing Account. Each night, the bank's computer looks at all of the related accounts. For those that have a cash position from that day's business, it sweeps that cash in to the Master Account. For those that have checks outstanding that need to be covered, it sweeps cash out from the Master Account to exactly cover or fund those checks. At the end of this "sweeping", the individual accounts have exactly zero balances and the Master Account either has cash or is overdrawn.
If there is cash, the bank pays down any LOC balance that is due and invests the remaining cash in the overnight money market and pays interest to the entity, depositing it into the Master Account.
If the Master Account is overdrawn, the bank advances enough from the LOC to cover the overdraft position. If the group is drawing on the LOC, it must pay interest, which the bank periodically withdraws from the Master Account.
Before bank sweep accounts, the financial manager had to record the transfers in or out of each entity's bank account - a check written or a deposit made. And the corresponding deposit or check in to the receiving entity. Lots of accounting and complex inter-company accounts to keep track of what each entity owed to or was due from the other companies in the group. At the end of the day, each entity's net position was a combination of the cash balance or overdraft in its individual bank accounts and its inter company position of money received from or due to the other entities.
The usual accounting practice was to record the checks and deposits between the entities, since they were actual checks and deposits just like those done with customers, suppliers, workers and the government. When financial statements were prepared, the consolidating procedure "undid" the inter-company position and showed each entity with its own position - more work to undo all the previous work!
Once bank sweep accounts are implemented, a group could still follow the practice of recording all the "sweeping" activity in to or out of each account and the related inter-company account. Then "undo" this whenever financial statements are presented so that each entity shows its own net position for each account - cash on hand or LOC overdraft. Note that while the bank only shows 1 Master Account for sweeps - and that has either a positive balance for the whole group's cash on hand or LOC overdraft that the whole group owes to the bank, that "net" bank position is really the sum of the cash or overdraft positions from all the accounts in all the entities.
But, the typical and most efficient way to account for all this sweep activity is to NOT record the sweep activity in the individual entities. At any given time, their accounting records correctly show their net cash or overdraft position. The financial manager can separately use a simple spreadsheet that records the individual entity's positive or negative positions. Add across, it shows the group's net position the bank reports as the Master Account balance or LOC amount due. Each individual entity account must be reconciled promptly each month.
That leaves just one activity not yet accounted for. Each night the bank
Either... invested the surplus cash balance and paid interest in to the Master Account
Or... advanced funds from the LOC and charged interest that was withdrawn from the Master Account.
The bank doesn't try to say which entity earned the interest or paid it - the bank just treats it as a group or Master Account transaction. The group will have to decide how to allocate this interest income or interest expense amongst the individual entities and make the appropriate entries on the books - typically a few minutes once a month to do this.
But beware! If the managers of the different entities are compensated based on profitability of their entity, they will squabble over being credited with some or all of the interest income, but being charged with none of the interest expense!
By all means, investigate centralized cash management with your bank. But be sure that your financial manager understands that only a few of the bank's sweeping transactions should actually be recorded in your books of account.
In Bank Reconciliations we tell the horror story of what can happen when the wrong information is recorded!
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