CDs for Business: Everything You Need to Know

Business cash managers often seek balance between three objectives – safety, liquidity, and returns. Fortunately, Certificates of Deposit [CDs] offer a unique approach to all three that can benefit cash management plans in certain scenarios.

Unlike savings or money market accounts, CDs are term investments – meaning they are issued for a specific length of time. This structure presents opportunities for cash managers to increase returns while maintaining the ultimate safety and managed liquidity.

What Are Certificates of Deposit?

CDs are available at most banks and credit unions, and they require depositors to leave cash invested for a specific length of time – called the term in exchange for a set rate of return. These ‘time-deposit’ investments are typically issued with terms between 1 month and 5 years.

Throughout the term, the cash earns a fixed rate of interest which is compounded according to the criteria set by the financial institution issuing the investment. Compound interest increases the total yield that the depositor receives by allowing them to earn interest on previously accumulated earnings.

At the end of the term, the CD matures, meaning that the agreed upon investment timeframe has ended and the depositor is free to withdraw their funds. In some cases, the CD proceeds are automatically reinvested in another CD with the same term at maturity if the depositor does not request a withdrawal.

Considerations When Investing in Certificates of Deposit

Why would a business agree to lock up their cash for a specified period of time? In most cases, the answer is that they can earn a higher return for their cash in a CD compared to a more liquid account. Additionally, CDs provide access to government protection for cash reserves along with managed liquidity.

While CDs provide many benefits to cash managers, they also have drawbacks that should be carefully considered. Among these are early withdrawal penalties, limited government protection, and the potential to forgo access to higher interest rates during periods of monetary policy tightening.

Safety

CDs issued by FDIC member banks or NCUA member credit unions are protected by government insurance from these agencies. Government backing provides the ultimate protection for cash since the agencies guarantee that deposits up to a certain limit will be returned to depositors if the financial institution holding them fails.

However, government insurance is limited to $250,000 per account ownership category at each insured financial institution. Businesses with cash reserves that exceed this limit can invest with multiple financial institutions to access extended coverage, but this process is time consuming to manage. Fortunately, modern cash solutions provide a simple way to access full government protection without the hassle.

Yields

Many factors can influence the rates that financial institutions pay for deposits, including the needs of the financial institution issuing the investment and prevailing interest rates. However, unlike savings and money market accounts, CD yields also vary based on the term.

When a bank issues a CD, they receive an agreement from the depositor that the funds will remain in the account for the length of the term. This guarantee gives the bank more flexibility in how to use the funds. In turn, the bank is typically willing to pay a higher rate of return for funds in a CD than deposits in a more liquid account type.

Further, CD interest rates are generally fixed – meaning they are set at the time a depositor purchases the CD, and they do not change throughout the term. Therefore, if the prevailing interest rates fall during the term of the CD or the bank lowers rates for new deposits, the CD owner still receives the agreed upon interest rate. Due to this dynamic, fixed-rate CDs can be particularly beneficial during periods of easing monetary policy.

On the other hand, businesses lose the opportunity to capture higher rates of return when interest rates are rising. Fortunately, there are ways to dampen interest rate risk. One of the most popular involves using a CD ladder – in other words, buying CDs with staggered maturities and reinvesting them as they mature.

When interest rates are rising rapidly, another option is to withdraw the funds invested in an existing low-yield CD. The business will owe an early withdrawal penalty, but they will also gain the opportunity to reinvest in a new CD at a higher rate. Depending on the interest rate of the current CD and the yields of new CDs, reinvesting could overcome early withdrawal penalties to provide a significant increase in interest income.

Liquidity

The term of the CD provides a blueprint for when the depositor can access their funds. This dynamic provides the opportunity for a depositor to match their liquidity to their needs. Those who need to access their cash on a predictable schedule can also consider the alternative use of a CD ladder – ensuring funds are available at set times.

If the CD owner needs to access their funds prior to the maturity date, they owe an early withdrawal penalty. The amount a depositor must pay in this case is typically measured in days or months of interest and varies based on the term of the CD and the agreement with the financial institution.

Use Cases for Certificates of Deposit

CDs are a versatile investment option for businesses to supplement their cash management plans. They are not generally advisable for cash that is needed to cover daily operations, but there are several scenarios where they add significant value.

Investing Cash That Is Not Allocated to A Specific Project

Sometimes businesses find themselves with an abundance of cash and no concrete plans for how to use it in the short term. In this case, the company can purchase a CD to increase their rate of return over a specific period while maintaining safety.

Maximizing Returns for Cash Earmarked for A Future Project

When a company has cash set aside for a specific project in the future, they can use CDs to maximize their returns until the start date of the project. CDs are a wise choice in this scenario because they keep the necessary funds safe and generally offer a higher rate of return than alternatives – which can provide additional income or funding for the project.

Funding a Project with A Specified Timeline

Projects that require funding on a specific schedule – like construction – are also an advantageous time to use CDs. CD ladders are often used in these scenarios because they make cash available at particular times while optimizing overall returns.

In all these cases, a business should consider the importance of choosing the right financial institution from which to purchase CDs. This could mean comparing rates of return from several banks and credit unions before investing or partnering with a deposit management company. The right deposit management partner will provide access to extended safety and nationally competitive returns with a single account.

Optimize CD Investments With ADM

At American Deposit Management, we offer a unique approach to CDs for business. Our solutions spread corporate cash across a network of banks and credit unions to access full coverage from the FDIC or NCUA. This allows businesses to achieve government protection for all their cash – even funds above the traditional limit – with a single account and consolidated monthly statement.

In addition to extended protection, the banks and credit unions in our network compete for deposits – allowing businesses to achieve nationally competitive returns. We also offer support to help businesses get the most from their investments. Our cash consultants can even help craft an effective CD ladder or reinvest existing CDs at higher rates.

To learn more about how we help businesses optimize their CD investments, contact a member of our team today.

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