Strategies For Investing Surplus Corporate Cash: A Comprehensive Guide

While it may seem like a dream come true, excess corporate cash can present a challenge for businesses. On the one hand, it can indicate strong financial performance and effective management. On the other hand, it can lead to questions from investors about why the money is not being put to work, and it may be seen as an opportunity cost. Therefore, it is essential for businesses to strategically allocate this excess cash to strengthen their financial position and support long-term growth. This involves evaluating various factors, such as industry, revenue streams, and short-term and long-term goals, to make informed decisions.

Invest in money markets

Money markets are a good option for companies with excess cash that want to make a safe, liquid, short-term investment. Money market funds are a type of mutual fund that invests in low-risk, short-term debt securities, such as certificates of deposit, US Treasury bills, and commercial paper. They are designed to maintain a net asset value of $1 per share, distributing any excess profits as dividends to shareholders. Money market funds are considered safe investments because they are backed by the US government and are regulated by the Securities and Exchange Commission (SEC).

Money market funds are a good option for investors who want to protect their savings while still earning some interest. The interest rate paid by money market funds is typically higher than that of a traditional savings account. Additionally, money market funds offer more flexibility than traditional savings accounts, as they allow investors to write checks and make electronic transfers.

It's important to note that money market funds are different from money market accounts, which are savings accounts offered by banks and are FDIC-insured up to $250,000 per depositor. Money market funds, on the other hand, are not FDIC-insured and carry the risk of losing value. However, historically, this risk has been slight.

When investing in money market funds, it's crucial to consider the expense ratios, as fees can eat up a large percentage of the returns. These funds can be purchased directly from a fund provider, through a bank, or through an online brokerage account.

Overall, money market funds offer a low-risk, short-term investment option for companies with excess cash, providing a small return with more flexibility than traditional savings accounts.

Invest in bonds

Investing excess corporate cash in bonds is often considered one of the safest options, especially over the long term. Bonds are a type of fixed-income investment that acts as an IOU. When a company buys a bond, they essentially lend money to the issuing entity, which promises to repay the face value—the amount loaned—along with interest at regular intervals. Bonds can be purchased on the primary market through a brokerage firm, bank, bond trader, or broker. Some corporate bonds are also traded on the over-the-counter market and offer good liquidity.

Before investing in bonds, it is essential to understand some basics, such as how they are priced, the associated risks, and the interest rates they offer. Bond ratings, calculated by major agencies like Standard & Poor's, Moody's, and Fitch, help investors understand the risk of default by assigning letter grades. Grades ranging from AAA or Aaa to BBB or Baa indicate investment-grade bonds, which are less likely to default. Bonds with a BB or Ba rating or below are called junk bonds, carry higher yields, and have a greater risk of default due to the issuing company's liquidity issues.

When investing in bonds, it is crucial to consider the interest rates and maturity dates. Term bonds typically offer higher interest rates due to their unpredictable performance. Bonds with longer maturity dates tend to pay higher interest to offset the risk of the company's financial stability and profitability changing over time. A callable or redeemable bond can be redeemed by the issuing company before the maturity date, resulting in a loss of interest for the investor.

A well-diversified investment portfolio should include highly-rated corporate bonds with short-, mid-, and long-term maturities. While no corporate bond is entirely risk-free, these bonds can provide a reasonable assurance of a steady income stream over their life. An alternative to individual bonds is investing in a professionally managed bond fund or an index-pegged fund, which is tied to the average price of a basket of bonds.

Invest in the stock market

Investing excess corporate cash in the stock market is one of the most consistent long-term bets available. While there are risks involved, investing in a diversified stock portfolio is likely the safest way to derive a 5% to 10% annual return on investment.

Before investing excess cash, it is important to conduct a self-analysis to confirm the exact amount of extra funds available. This involves performing a rigorous cash flow analysis to identify thriving income streams and their origin. This knowledge can then be used to optimize those channels and make informed investment decisions.

When investing in the stock market, diversification is key. Building a diversified stock portfolio can help to reduce risk and improve the potential for long-term returns. This can involve investing in a range of companies across different sectors and industries, as well as considering factors such as company size, growth potential, and dividend yield.

It is also important to consider the time frame, desired returns, and risk tolerance when investing in the stock market. Investing in the stock market typically involves a longer time horizon, as it allows for compounding returns and can smooth out short-term market volatility. Additionally, it is crucial to understand the risks associated with stock market investments, which can be mitigated to some extent through diversification and proper asset allocation.

By investing excess corporate cash in the stock market, businesses can aim to achieve consistent returns while also retaining liquidity and flexibility. This strategy can help drive optimizations, build systems within the business, and prepare for potential market shocks or downturns.

Pay off company debts

Paying off company debts is a great way to invest excess corporate cash. While it may not be the most glamorous option, it is a prudent financial decision that can help your business in the long run. Here are a few reasons why paying off company debts is a good idea:

Improve Cash Flow

Paying off debts can help improve your cash flow by reducing the amount of money going out of your business. This can be especially beneficial if you have high-interest debt, as the longer you take to pay it off, the more interest you will owe. By settling your debts, you can free up more cash for other purposes, such as reinvesting in your business or exploring new growth opportunities.

Reduce Risk

Debt can be a burden and a potential risk to your business. By paying off debts, you reduce the risk of your business becoming overwhelmed by debt, especially if sales projections are not met. High debt can destroy your business, so it is essential to keep it under control. Paying off debts can also lower your company's debt-to-equity ratio, improving your financial health and making your business more attractive to investors.

Improve Business Relationships

Paying off debts can help maintain and improve your relationships with vendors, suppliers, and other business partners. Failing to pay off debts that affect business relationships can damage these relationships and may result in losing the ability to make future purchases from them. Settling these debts promptly shows your commitment to maintaining a good relationship and can lead to better negotiation terms in the future.

Tax Benefits

In some cases, paying off debts can provide tax benefits. For example, if you have equipment leases, you may be able to lower your financial obligation by returning the equipment to the lessor. Similarly, secured debts may be reduced by surrendering security deposits or collateral. By settling these debts, you can also avoid penalties and interest charges, which can add up quickly.

Improve Creditworthiness

Paying off debts can improve your business's creditworthiness. This can be beneficial if you plan to take out loans or seek investment in the future. Lenders and investors will look favorably upon a business that manages its debts effectively. Additionally, maintaining a healthy credit portfolio can give you more financial flexibility and improve your negotiating power with creditors.

Prioritize Debts

When paying off company debts, it is essential to prioritize. Focus on debts with high-interest rates and penalties to minimize the negative impact on your business. Also, consider any business collateral you might lose if you default on specific loans. For example, failing to pay off a loan could result in losing a company vehicle or other essential equipment.

Reinvest in your business

Reinvesting in your business is a great way to allocate excess corporate cash. This can take many forms, depending on your business model and industry. Here are some ways to reinvest:

• Research and Development: If you have excess cash, consider allocating additional funds towards research and development. This can help you stay ahead of the competition by innovating new products or services, or improving your existing offerings.
• Marketing: Reinvesting in your business can also mean allocating more funds towards marketing and advertising campaigns. This can help you reach a wider audience, promote your brand, and ultimately increase sales and revenue.
• Hiring and Training: If your current team is struggling to keep up with the workload, use your excess cash to hire additional staff or third-party specialists. Investing in employee training and development programs can also improve the skills and productivity of your existing staff, ensuring they can meet the demands of your growing business.
• Property and Equipment: For bigger businesses, investing in property, such as office spaces or retail stores, can be a great way to utilize excess cash. Additionally, consider upgrading or purchasing new equipment to improve efficiency and productivity.
• Inventory: If you're in an industry where it makes sense, consider purchasing inventory in bulk to take advantage of discounts. This is especially beneficial if you're in an industry with fluctuating prices and you can secure a good deal.

Remember, before making any decisions on how to reinvest your excess cash, it's important to conduct a thorough analysis of your cash flow and revenue streams. This will help you identify the best ways to allocate your surplus funds and ensure that your decisions align with your short-term and long-term business goals.

Frequently asked questions