Laila Keith
Large corporations such as Apple, Google, and Microsoft have been known to hold massive amounts of cash. These corporations have various options for investing their cash, including short-term and long-term investments, with the goal of maximising returns while maintaining liquidity. Companies often keep their cash in commercial bank accounts, money market funds, or low-risk investments like Treasury bills. They may also utilise high-yield savings accounts, corporate bonds, or foreign currency deposits. Additionally, corporations invest in securities such as stocks, bonds, and certificates of deposit to protect their finances and improve their balance sheets.
| Characteristics | Values |
|---|---|
| Where | Commercial bank accounts, money market funds, high-yield savings accounts, Treasury bills, corporate bonds, foreign currency deposits, etc. |
| Why | To protect the company, improve balance sheets, and achieve better returns than a regular bank account. |
What You'll Learn
Investing in securities
Securities are financial instruments such as stocks, bonds, certificates of deposit, and other paper-based assets. They can also include government securities like Treasury bills, commercial paper, corporate bonds, or foreign currency deposits.
There are several reasons why corporations invest in securities:
Better Returns
Securities can provide a better return on investment than simply keeping money in a low-interest operating account. The greater the risk of the investment, the greater the potential return.
Diversification
By investing in securities, corporations can spread their assets around to avoid losing all their capital if it is tied up in one place. For example, during the first year of the COVID-19 pandemic, many small businesses that invested their excess cash in securities were able to offset their operating losses.
Tax Advantages
Some investments can help reduce a company's tax burden, depending on how capital gains are handled. Money earned from sales is considered income, whereas money earned from non-sales sources, such as investments, is classified as receipts, which are taxed differently.
Strategic Positioning and Influence
Corporations may buy the securities of other companies to gain operating leverage or influence over the target company. This could include buying common stock to have a vote on important matters, investing in corporate debt instruments to pressure the company to make certain decisions, or acquiring a majority stake to make the target company a subsidiary.
Other Factors to Consider
Before investing in securities, corporations should consider how much excess cash they have, how much they need to keep on hand for operations and emergencies, and the potential returns on that cash. They should also take into account their access to credit and the interest rates associated with it.
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Diversifying assets
Securities
Securities are financial instruments such as stocks, bonds, and certificates of deposit. They offer corporations a way to spread their investments across different options to reduce risk. During the COVID-19 pandemic, for example, businesses that had invested their excess cash in securities were able to offset their operating losses with their investment gains. Additionally, securities can provide better returns than simply keeping funds in a low-interest operating account. The level of risk and potential return is directly correlated, so corporations must carefully assess their risk tolerance when investing in securities.
Money Market Funds
Money market funds are a common option for corporations seeking higher returns than traditional bank accounts. These funds are highly liquid and typically have slightly higher interest rates than standard bank accounts. However, there may be restrictions on the number of transactions or minimum deposit requirements. Money market funds are a good option for corporations looking for a balance between liquidity and returns.
Treasury Securities
Treasury securities, particularly Treasury bills, offer corporations a highly liquid option for investing their cash. Treasury bills are short-term government debt issues that can be resold in the public market at any time, providing flexibility for corporations. Other options within treasury securities include Treasury notes, with maturities of less than 10 years, and Treasury bonds, which typically mature between 20 and 30 years. These longer-term options may be suitable for corporations with a long-term cash holding strategy.
Foreign Currency Deposits
Multinational corporations often deal with multiple currencies due to their international operations. Holding foreign currency deposits can help stabilize costs and revenues in the face of currency fluctuations. It also enables efficient transactions in local currencies, reducing the need for frequent currency conversions. However, holding foreign currencies for speculative investment purposes carries a higher risk of loss.
By employing these strategies and carefully assessing their financial goals and risk tolerance, corporations can effectively diversify their assets to protect and enhance their financial position.
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Improving balance sheets
Corporations can invest their cash in a variety of ways to improve their balance sheets. Here are some strategies to achieve that:
Boost Your Debt-to-Equity Ratio:
It is common sense that a business is generally better off with less debt and more cash on the balance sheet. A low debt-to-equity ratio can also help you raise capital. To improve this ratio, focus on bringing in more sales to pay down debt, and consider unloading assets such as office equipment or real estate. This will not only strengthen your balance sheet but also improve cash flow and put you in a position to pursue growth opportunities.
Reduce Costs:
A cash-flow deficit will quickly lead to the demise of a small business, so reducing costs is crucial to improving your balance sheet and bottom line. Map out different scenarios for cash outflow, including worst-case, best-case, and likely scenarios. If your likely scenario resembles the worst-case scenario, find ways to drastically cut business expenses.
Build a Cash Reserve:
Monitoring your business savings account is vital. You need a pot of money for emergencies or unexpected opportunities. Without cash in reserve, you may be forced to secure financing quickly, which can be challenging. A good rule of thumb is to divide your cash into three parts: one-third goes back into operations, one-third is invested in growth, and one-third is kept as a protective balance.
Manage Accounts Receivable:
Getting paid is a significant challenge for small business owners, and overdue bills can strain cash flow. Put someone in charge of collecting overdue payments using persistence, patience, and politeness. This person should not be a salesperson, as they need to stay in a "good-guy" role. Effective management of accounts receivable will reflect positively on your balance sheet and improve cash flow.
Simplify Accounting:
Consider using small business accounting software to fine-tune your finances. These programs can automatically generate balance sheets and cash flow statements, reducing manual labour and human error. Choose software that is easy to use and can integrate with your bank and other business apps. This will simplify your finances and put you on the path to building a solid balance sheet.
Track Equity Trends:
Equity reveals how well you are managing your company's value over time. Plot it on a graph, with time on the x-axis and equity on the y-axis, each time you receive a balance sheet. This will show whether your company is growing or losing value.
Consider Changes in Assets and Liabilities:
After calculating equity, consider assets and liabilities individually. These numbers will show you where your company's cash is going. If you have a profitable period but still face cash flow issues, your liabilities are likely growing faster than your assets. Compare these numbers from balance sheet to balance sheet, and if assets increase more than liabilities, your company is growing.
Determine Liquidity:
Calculate your current ratio (current assets divided by current liabilities) to determine your company's liquidity or ability to repay debts. A current ratio greater than one generally indicates a healthy financial state, meaning the company should have no problem repaying debts or covering expenses.
By implementing these strategies, corporations can improve their balance sheets, optimise cash flow, and make their businesses more attractive to investors.
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Investing in commercial paper
Commercial paper is a short-term debt instrument issued by corporations to finance short-term liabilities such as payroll, accounts payable, and inventories. It is typically issued at a discount from its face value and matures at face value within a short time frame, usually between one and 270 days, with an average maturity of 30 days. Commercial paper is an unsecured form of promissory note that pays a fixed rate of interest. It is usually issued by large, financially stable companies with good credit ratings.
Commercial paper is a convenient financing method for corporations as it allows them to avoid the hurdles and expenses associated with securing continuous business loans. The Securities and Exchange Commission (SEC) does not require securities that trade in the money market to be registered, making commercial paper a cost-effective and simple means of financing. It is also easier to obtain than a business loan, and it offers lower interest rates.
The minimum denomination of commercial paper is $100,000, and it is usually sold to institutional investors such as money market funds, corporate treasurers, pension funds, insurance companies, and banks. These investors are attracted to commercial paper due to its short maturity and relatively low risk.
Commercial paper is a good investment option for corporations looking for short-term, low-risk, and liquid investments. It provides a source of working capital and is considered relatively safe for investment-grade issuers. Companies can invest in commercial paper to earn interest income while preserving liquidity.
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Holding foreign currency
When a company operates across multiple countries, it may receive revenue in different currencies. Holding foreign currency allows the company to pay local expenses, such as salaries, rent, and utilities, without incurring additional exchange rate fees and risks. It also enables timely payments to suppliers, reducing the need for frequent currency conversions.
Additionally, holding foreign currencies can act as a hedge against adverse exchange rate movements, helping to stabilise costs and revenues in the face of currency fluctuations. While some companies may hold foreign currencies for speculative reasons as an investment, there is a risk of loss associated with this type of investment. Companies with a known need for cash flow for operations may be better suited to hold less risky cash reserves.
Overall, holding foreign currency allows corporations to efficiently manage their finances in an international context, facilitating trade and reducing the impact of exchange rate volatility on their operations.
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Frequently asked questions
Corporations store their cash in a variety of places, including bank accounts, money market funds, and foreign currency deposits. They may also invest in securities, such as stocks and bonds, or in other companies.
Corporations typically use commercial bank accounts or low-risk money market funds. They may also use high-yield savings accounts, business sweep accounts, or multi-currency business accounts, depending on their specific needs and financial strategies.
Corporations invest in securities to protect their company, improve their balance sheets, and seek better returns. Securities also offer diversification, allowing companies to spread their assets and reduce risk. Additionally, some securities provide tax advantages, helping to reduce the tax burden.
Analysts generally recommend that corporations hold between three to six months' worth of liquid cash and cash equivalents to ensure continuous operations. Holding excess cash may provide more safety but can also be less efficient. Corporations should consider their operating expenses, emergency funds, and the potential opportunity cost of keeping cash idle when deciding how much cash to hold.
