“If you watch the pennies, the dollars will take care of themselves.” OK, so it was William Lowndes, Secretary of the British Treasury, not Ben Franklin that came up with this cash flow management observation. Your client may find themselves with money on hand that the business doesn’t need for a while. As their accountant, helping them with this problem is another way you show your value.
Most businesses have a line of credit with a local bank. Obviously, banks charge borrowers a higher interest rate than what they pay to depositors. Business owners with cash on hand usually want to find something to spend it on, as if the money is burning a hole in their pocket. As their accountant, you can suggest the best, immediate use is paying down the loan balance.
Your business owner wants to derive maximum revenue wherever possible. Cash sitting in their business checking account likely earns zero, so they need alternatives. Cash equivalents are often defined as very safe securities maturing within three months. Your client may (or may not) have a longer timeframe.
What are their options? Here’s a few:
- Interest-bearing account at the bank: We used to call them savings accounts, but this is a fantastic option, since the national average is 0.10 percent.
- Variable interest rate account at the bank: These are the bank’s version of money market funds. You or your business owner can shop online for better rates or an introductory one, but you want this type of account to carry the same guarantee as your bank offers. The national average is 0.21 percent.
- Outside money market funds: They have traditionally been considered safe, but they don’t offer FDIC insurance. Expect slightly more than bank money fund rates.
- Bank certificates of deposit: You have lots of choice in terms of length, so shop around your local banks. You can also look online, but confirm the product is an actual CD with FDIC insurance. Expect to pay a penalty to remove money before maturity. The national rate on a 1 year CD is 0.88 percent.
- Treasury bills: You know all about them. For investors, they have the advantage of state and local tax exemptions. Bills run under a year, typically 3, 6 and 12 months. Treasury Bonds run longer. The face value and interest are backed by the full faith and credit of the US government. The current rate for a one-year Treasury bill is about 2.44 percent.
- Very short-term corporate bonds: Fixed-income securities are priced on yield to maturity, but it’s possible to buy a 10-year corporate bond in the final 6 months before maturity. The safety rating is obviously important. You can also buy new issue bonds, assuming you are comfortable holding them to maturity.
- Commercial paper: This is very short-term debt issued by businesses on the other side of the equation. They need to borrow money for a short term, then pay it back again. According to Investopedia, they rarely run longer than 270 days. Again, safety ratings are important, and a 90-day AA-rated commercial paper annualizes at about 2.46 percent.
- US agency bonds: Federal agencies like the Small Business Administration and the Federal Housing Administration also issue bonds, but they generally don’t carry the same government guarantee as US Treasury bonds.
- Taxable municipal bonds: Most munis are free of federal taxes. In some cases, when a project isn’t directly for the public good, but may bring in jobs and business tax revenue, local governments can issue taxable bonds connected to that project.
Anything where the principal value can fluctuate should be avoided by businesses seeking a short-term home for cash. Businesses owners don’t have the time to patiently ride through cycles. A company needing the cash in a year shouldn’t buy a 10-year bond.
As their accountant, there are other risks you can warn them about. These include:
- Transaction costs: If there’s a fee to buy or sell, that must be included in the rate of return calculations.
- Foreign currency risk: Yes, you can get higher returns overseas. However, you are making the purchase at one exchange rate and cashing out at another. Currency swings can do serious damage.
- Offshore accounts: You hear about banks based on exotic islands, but be careful. They might offer CDs at attractive rates, but they don’t come with FDIC insurance. There might not even be a bank there at all.
- Short-term funds with principal changes: You might hear about funds that only buy short-term debt. Your rate changes, and the share price fluctuates. It’s like a bathtub. The interest earned is the faucet. The share price variation is the plug. It doesn’t matter how fast the water comes in if the drain is working faster.
- Fixed-income funds with leverage: They offer higher rates and talk about reasonable price stability and use options strategies or borrowed money to enhance returns. Maybe they have two share classes. When something goes wrong, the principal takes the hit.
Higher returns generally involve higher risk, and there are tradeoffs. Remember: Your client will need this money later. As their accountant, you can open their eyes to the range of possible cash flow management solutions available. They aren’t limited to the rate of return the bank is offering on deposits.