Poor cash flow management is the number one reason businesses fail – outpacing competition, staffing issues, and even a lack of demand for their products. In many cases, these businesses fail because they do not have enough cash available at a pivotal moment. This moment could be an expansion opportunity, an emergency that requires an immediate expenditure, or a slowdown in sales.
It can be challenging for businesses to forecast income and expenses, and to manage the timing of both so that cash is available when required. However, by focusing on liquidity management, firms can ensure their cash is accessible when needs arise.
What is liquidity management?
Liquidity management is the process of positioning a company’s cash reserves to meet its goals while maximizing interest income. In many cases, the goals of having cash available at a given time and maximizing returns are contradictory, which can make liquidity management a difficult balancing act.
Why is liquidity management important?
Liquidity management is vital to the health of a business because it ensures that the company can meet its obligations. A company with sufficient liquidity can pay vendors, staff, and debtors on-time without disrupting their long-term investments. On the other hand, poor liquidity management can lead to defaulting on loans, troubled relationships with vendors, a lower credit rating, and bankruptcy. These negative outcomes were particularly evident in the recent failure of Silicon Valley Bank [SVB].
SVB experienced a liquidity crunch due in part to heavy investment in long-term Treasury securities. These bonds are backed by the full faith and credit of the U.S. government, so the quality of the investments was not an issue. Instead, the problem arose because the investments did not offer the necessary liquidity. When interest rates rose, the value of the bank’s bonds fell. Then, an influx of withdrawal requests from struggling tech companies forced the bank to sell bond holdings at a $1.8 billion loss. As the media began covering the struggles of the bank, frightened depositors rushed to withdraw their funds. This bank run led to insolvency for SVB. In hindsight, many of the problems that faced Silicon Valley Bank could have been prevented with a successful liquidity management plan.
Creating an Effective Liquidity Management Plan
To create a successful liquidity management plan, companies must balance their accessibility needs with their return requirements. This often involves separating cash reserves by the timeframe in which they are needed.
Operating Cash
Cash that is needed to meet current obligations – also known as operating cash – is often kept in an easily accessible account. This cash could be used for a variety of purposes such as paying mortgages, rent, utilities payments, employee salaries, and loan payments.
There are several options to invest operating cash but one of the most common is a deposit account such as a checking account. These accounts are highly liquid, and their value does not fluctuate with changes in investment markets.
Deposit accounts are insured up to the $250k FDIC / NCUA limit at each institution. This government insurance protects the principal and accrued interest from bank failure up to the applicable limit. Due to the nature of these types of accounts, they typically pay a lower amount of interest than long-term alternatives. However, with advances in financial technology – a.k.a. fintech – companies can achieve extended government insurance and nationally competitive returns on these accounts.
Medium and Long-term Cash
In addition to operating cash, companies often have cash reserves that are not needed immediately. This type of cash could include funds earmarked for future projects or cash intended to help the company take advantage of opportunities as they arise. Medium and long-term cash can be invested to optimize returns.
Certificates of Deposit [CDs] are common investment vehicles for medium and long-term cash reserves. These investments typically provide a higher rate of return than deposit accounts without sacrificing safety. Like deposit accounts, both the principal and interest invested in CDs are covered by government insurance up to the $250k per financial institution limit. With fintech, companies can access extended government protection above the standard limit.
Banks typically pay significantly higher rates for CDs than deposit accounts because the business agrees to leave the funds in the investment for a specified length of time. CD rates are fixed, so businesses can lock in high rates when interest rates are elevated and maintain those returns even when market interest rates decline. And with fintech, businesses can access competitive CD rates from across the country.
In some instances, businesses need to access cash on a set schedule to complete a project or take advantage of changing interest rates. In this case, a CD ladder can help optimize returns while ensuring investments mature when needed.
Crafting a liquidity management plan often involves collaboration between finance and risk management departments. Additionally, an experienced deposit management firm that harnesses the latest fintech can help businesses optimize investments to meet their liquidity needs.
Earn More, Risk Less® with Deposit Management by ADM
At the American Deposit Management Co. [ADM], our experienced cash consultants help businesses invest cash to match their liquidity needs. Our American Money Market Account™ [AMMA™] offers next-day liquidity, access to extended government insurance, and nationally competitive returns.
In addition to highly liquid accounts, we also offer CDs and CD ladders for funds that are not currently needed. We have access to a vast network of financial institutions that compete for deposits, so our customers receive nationally competitive returns whether they invest in CDs or more liquid alternatives.
To learn more, contact us today.
*American Deposit Management Co. is not an FDIC/NCUA-insured institution. FDIC/NCUA deposit coverage only protects against the failure of an FDIC/NCUA-insured depository institution.