Get the Most Bang from Your Excess Cash

Companies with consistently strong sales and profits that manage their cash flow successfully may end up with a good “problem”: excess cash in the business checking account. Their challenge is to manage this cash to receive the highest possible return while maintaining the liquidity needed to meet the day-to-day working capital needs of the business.

A number of different options are available to help you put excess cash to work. Before considering them, however, reexamine your cash flow cycle, determine an acceptable level of liquidity for working capital funds, and decide on the appropriate time frame for excess cash and the level of risk you’re willing to assume:

• Cash flow cycle: This is important because what appears to be excess cash might not necessarily be so. For example, if you’ve collected payment for a large job upfront but still have to pay for materials and other cost of goods sold, the excess cash position in your checking account is only temporary and will vanish once you have paid all your expenses.
• Liquidity: The level of liquidity needed to meet daily operating expenses will vary from one company to the next. One way to determine yours is to total all expenses over the past year and divide this by 12 to get a rolling monthly average; then consider this amount your minimum checking account balance.
• Time frame and risk: Your liquidity needs will help you determine the appropriate time frame and risk for investing excess cash. While you want to maximize potential return, it’s usually more important to ensure adequate liquidity and (relative) safety of these funds.

The next step is to talk to your bank about the various investment options. These may include business money market deposit accounts and mutual funds, sweep accounts, and certificates of deposit. One of the biggest benefits of these bank vehicles is that they typically offer FDIC insurance on deposits up to $250,000 per depositor, along with market interest rates and liquidity.

Sweep accounts are an especially attractive option for small businesses because they help make sure excess funds are working for the business without the owner having to micromanage the funds. At the end of each business day, excess balances above a predetermined minimum balance are automatically swept from the business checking account into short-term (sometimes overnight) investment vehicles.

Moving a little farther out on the time horizon, CDs may be a good option for excess funds with a three-to-six-month or one-year time frame. The interest rate will likely be a little higher than money market funds and sweep accounts, but the trade-off is that you give up some liquidity by agreeing to leave your money in the CD for a specific period of time. The more money you invest, and the longer you invest it, the higher interest rate you will receive.

For excess funds with a two-to-three-year time frame, you might consider short-term treasury bonds and bond funds. However, keep in mind the inverse relationship between bond prices and interest rates: As rates rise, bond prices will fall. If you have to liquidate the bond early, this could result in a loss.

As for stocks, these may potentially offer the highest return, but they do so at the highest level of risk. Experts generally recommend that you not invest money in the stock market that you may need in the next five years (or even 10) because it can take that long to recover steep losses.

Don Sadler is a freelance writer and editor specializing in business and finance.