Keeping your operating funds working for your company is crucial to maintaining healthy cash flow and maximizing your financial return. Investing idle funds wisely may help you to generate income from your working capital, increasing your yields while maintaining liquidity.
There are a wide variety of investment instruments available to companies seeking a return on excess cash. How do you know which investments to choose? Many businesses emphasize only convenience and accept whatever return is offered. However, there are ways you may be able to improve yields on your idle working capital.
Concentrate on maximizing after-tax returns
If your company is in a lower tax bracket, focus on higher yields rather than tax advantages; however, if your federal tax bracket is high, you may be able to obtain a better after-tax return by investing in federally tax-exempt securities. It's important to compare the yields on tax-free obligations to their fully taxed equivalents to find those that provide a higher after-tax return. The tax benefits of some investments may depend on your business structure.1
Extend the maturities of investments when practical
Investing funds for longer terms typically means higher yields. If your business keeps its cash highly liquid, perhaps in a money market fund, when only a portion is needed for daily operating expenses, you may well be sacrificing some yield.
Determine how much you can commit for a longer period. By investing that amount for as little as 90 days, you may be able to earn extra return. Also consider intermediate-term investments with maturities from one to three years. If your business is building cash reserves for an expansion, an acquisition or new machinery, you may be able to invest those funds for a year or two.
Diversify credit quality to help increase yield potential
The potential for additional yield might warrant assuming some moderate investment risk. Newly issued obligations guaranteed by the U.S. government (such as Treasury bills) yield less than securities lacking that guarantee. You may be able to obtain a higher yield with high-quality investment-grade corporate obligations.
A number of rating services, such as Fitch Investors Service, Moody's Investors Service and Standard & Poor's Corporation (S&P), provide comparative analyses of the risk levels of various instruments. If you choose bonds with short maturities, you may want to consider an A-rated bond by S&P. This type of bond is likely to yield a higher return than an AAA-rated bond (S&P’s highest investment rating) of equal maturity. You should, however, be comfortable with the incremental risk associated with lesser quality credits.
Choose investments based on the amount of cash available to you
Many working capital investment vehicles must be purchased in minimum amounts and in multiples of the same or smaller amounts. Treasury bills, for example, can be bought in multiples of $1,000, with a minimum investment of $10,000.
As a business grows and builds a stronger cash flow, the variety of investment opportunities increases. If you have a large amount of investable assets (perhaps $100,000 or more), this gives you an advantage in finding higher rates. Many institutional investment vehicles require high minimum investments but, in return, offer higher yields.
1 Neither Merrill Lynch nor its Financial Advisors offer tax or legal advice. For information on how this may affect your particular situation, please consult professional tax and/or legal counsel.