Cash management is a crucial aspect of running a small company that's often overlooked. Many business owners do not consider the opportunity costs of poor cash management. This is especially true when managing your business's idle money.
What is idle cash exactly? Idle cash is the surplus cash that an organization has, but which it does not use for immediate expenses, investments or operations. Idle money can be invested safely so it will earn a return while it is not in use. Idle cash management, when done correctly, protects your money, keeps you in a position of liquidity and maximizes the yield.
It may seem more sensible to keep your cash in an insured account than, for example, in a secure at your main business location. It's better to put it into a basket of low-risk, short-term securities or use it to pay down high-interest debt. Both -- or more likely both -- will save you money, preserve your capital and provide supplementary income.
Cash management is a vital part of your business growth. The opportunity cost of doing less is also increasing.
Three options are available to you to deal with this threat: either do your own cash handling, let your bank handle it or hire a cash management specialist.
Option #1: Do It Yourself
You can first manage your cash flow internally. This may require you to do it yourself, or that a trusted employee is assigned.
What it looks like
There are several ways to manage the idle cash of your business internally. Each of these methods is based on the fact that you do not rely on external services, such as a bank or cash management software.
You need to decide what you can afford in terms of both time and money, and how much control you want.
Do it yourself This is a good option if you want to be in control of your finances, as many business owners do. Even then, managing and reinvesting idle cash will take time, and you may lack the expertise to do it properly. Your accountant or bookkeeper can do it. Why not let them manage your idle cash as well? Employed expertise. Cash management becomes more complex as your business grows. The time required (and possibly the expertise needed) will eventually be too much for either you or your existing employee. A new hire who has the required knowledge and skills will cost you a lot of money.
The benefits of in-house cash management
It makes sense to use your own idle cash, since you know your company better than a third-party provider or bank. There are some benefits to this approach.
Knowledge of the business in depth and alignment with owner preferences. You, as the owner, know what your risk tolerance is, your liquidity needs, your growth plans, etc. without needing to explain it to a stakeholder. Flexibility and control. You can change tactics and strategies on the fly when you manage your own cash. You can fix mistakes quicker. Cost savings potential. It is possible to reduce expenses by dividing cash management duties among employees. As you grow, the cost benefits are less clear.
Cons of in-house cash management
Cash management is a great idea, until it's not. Here are the most common pitfalls.
Major time commitment. You or your finance team will need to spend a lot of time keeping your financial records straight. The time you would have spent on idle cash management could have been better spent operating your business. Lack of expertise. Lack of expertise. Small business owners and employees may lack the financial knowledge to effectively manage idle cash, leading to missed opportunities or increased risk. Access is limited. The small in-house cash managers will not likely have the same access to tools, investments and technologies that professional cash management services like Registered Investment Advisors or banks do. This can reduce the performance and effectiveness of a company's cash-management strategies, and increase its risk.
Option 2: Let the bank handle it
You can also have your bank handle your idle cash. It is convenient to use a bank that you already know for cash management services. Giving your bank your idle cash comes with risks that you may not realize at first.
What it looks like
Your bank can easily manage your idle cash if it offers treasury services. If your bank does not offer treasury services, this is a sign that the bank's priorities are not in line with yours. It may be time to change banks, even if you don't like bank-led cash handling.
Cash management by the bank is convenient, hands-off and automatic. This gives you valuable time and resources back. The banks have always had access to many different investments, such as government-backed securities that are lower risk. Cash management services from banks often use advanced algorithms that identify and quickly allocate excess cash. This streamlines the process when compared with manual management. Many banks will provide valuable insights and reports, allowing business owners to get a better understanding of their idle cash performance.
The Benefits of Hiring a Bank to Handle Your Cash-Management Needs
If you already have a bank for your business, then it would be logical to entrust the management of your cash flow to that institution. This is why it could be a good idea.
Convenience: You already work together. Inertia can be a good thing. Access to low-risk financial products that are insured. FDIC deposit protection allows banks to offer a wide range of low-risk products. Cash management is an essential service for business banking. Even regional banks with smaller branches have experts on staff who have been in the business for many years.
Cons of having a bank handle your cash management needs
Although banks are convenient and seem to be safe, they can have hidden and not so hidden downsides.
Conflicts of interest. Due to financial incentives such as kickbacks and commissions, banks may be in a conflict of interest when promoting certain investment products. Bank fund risk Bank fund risk. As we have seen in recent times, clients' money could be put at risk if the bank is experiencing financial distress or bankruptcy. Limits to deposit insurance. The FDIC deposit insurance limit is not a problem for many banks. This can pose an existential risk to clients with a high level of capital, as we saw in the case of Silicon Valley Bank. Limitation of customization. Many banks only offer white glove service and customization to their biggest clients. Small businesses are left with standard offerings. This may be a good solution for some businesses, but many have unique growth goals, liquidity requirements, and risk tolerances that are better met by a custom portfolio.
Option #3: Use an external cash management provider
The third option, and the one that many businesses find to be best, is to hire a third-party expert cash management service. This service is not directly affiliated with a financial institution and does not require you to create an entirely new role within your business.
What it looks like
Third-party cash managers are more flexible and customized than the typical banking cash management programs. Third-party Cash Managers are usually Registered Investment Advisors regulated by SEC and have a Fiduciary Duty that requires them prioritizing the client's interests over their own.
Cash management services offer a variety of investment products and options that are suitable for small businesses. Treasure, a cash management platform, offers a reserve fund that is a mix of risk-appropriate, diversified financial products. These include FDIC-insured money market funds and fixed-income mutual funds. Most business banks only offer cash accounts. They may even have a few. Clients are not allowed to choose between the different products.
Third-party cash managers are not a replacement for your bank or your accountant, but they excel at managing your idle money.
Expertise in a particular field. Third-party cash managers are experts in their field, just like banks. Customized strategies. Cash management services often create tailored portfolios based on factors like their client's growth goals, risk tolerance, and future cash needs. Fiduciary duty. Third-party cash management companies are registered investment advisors and have the fiduciary duty to act in the best interest of their clients. RIAs are regulated strictly by the SEC and, as fiduciaries, they have no conflict of interest when making investment recommendations. Small businesses can benefit from additional protection and peace of mind.
Other Pros to Consider
There is the potential for a wider variety of options in terms of deposit and investment accounts. Leading cash management companies offer a wider range of risk-appropriate investment options. Higher ROI potential on cash deployed. The likelihood of a higher blended ROI is greatly increased by having more investment options. Dynamic management (more flexible) Third-party providers of cash management use sophisticated algorithms to optimize cash deployment for yield, risk and diversification. Cash flow management is made easier by releasing internal resources. Third-party cash managers can optimize your idle cash. However, it is not their responsibility to earn more money through your business (at least directly) or guide you through the process of cost-cutting. They do a lot of work for you each month. This allows your treasurer, controller or accountant to concentrate on cost reduction and high ROI growth.
Cons of using a third-party cash management provider
Compare the third-party solution to your existing banking relationship, or an employee or team within your company.
Not one-stop shopping. Specialized cash management providers, by definition, do not provide the same range of products as a full spectrum bank. The right provider is important. It is crucial to thoroughly vet your partner when selecting a third party cash manager. Choose a Registered Investment Advisor. This means that they are closely regulated and have a Fiduciary Duty. Also, you will want to ensure that they have funds in custody accounts (most partners hold them) and ask about their fee structure. You should generally not pay more than 50 basis point on assets managed.
Cash management is a vital part of any business and becomes more important as it grows. Businesses have three choices for managing their idle cash. They can manage it themselves, let their bank handle it, or hire a cash management company.
Before making a decision, business owners should evaluate their preferences and needs. Each option comes with its own pros and cons. Cash management can be suboptimal, leading to high opportunity costs. Businesses can save money by investing their idle cash into low-risk investments or by paying off debts with high interest rates. Cash management's ultimate goal is to generate additional income for the business, save money and preserve capital.