In business, they say cash is king. It doesn’t matter how many contracts you have on, or what your accounts receivable looks like, if you haven’t got cash coming in the door to cover your expenses and you don’t have access to additional credit, then you are in serious trouble. For this reason, businesses put an intense focus on their cash flow in order to make sure that they have enough on hand for continuing operations.
However, there can come a time your cash flow is under control, and your business is starting to build up a reserve in the bank. At this point, the question becomes exactly what you should do with that extra money. On the one hand, the temptation is to hold onto it as a contingency for any unexpected bad times ahead, and, on the other hand, you may wonder if cash in the bank represents a missed investment opportunity.
First, before you make any decision, you need to really understand how much cash you have. There may be a large balance in the bank, but you have to offset that against the money you will need for short-term and medium-term operations. For example, you may have salespeople who need to be paid additional commissions if sales increase, but payments on the contracts you win may not appear for many months. It is this sort of thing that needs to be taken into consideration, so you need to have at least a 12-month cash flow projection – and an overall three-year business plan, including your anticipated balance sheet, can make all the difference.
Once you really know how much cash you do have, perhaps the first thing to do is to consider paying off debt, particularly if it is at a fairly high interest rate. You need to ask yourself could you get a better rate of return on that money by investing it into your business, or by reducing the amount of interest you pay out on debt each month. Also, focus on paying down those debts where you can still tap into the credit – for example, even if you pay off a line of credit, you should be able to access the money again if you need it. Above all, make sure that you have a buffer if you do start to reduce your debts – significantly lowering your ongoing financing costs, only to find out that there is a major unanticipated expense that you cannot cover, is a recipe for disaster.
Next, assuming that you still have cash left over once you have cleared all the debts that you want to clear, you need to make sure the cash is working for you. If you don’t need the money in the short term, you could consider investing it in a certificate of deposit (CD). For example, if you deposit 100k in any of these 2 year CDs, you’ll make significantly more money than if the money is sitting in your current account. However, you do need to be careful about when the CD matures, since you will not be able to access your capital prior to that time without significant penalties. Another option to consider if you want more flexibility is to invest the money in a brokered CD, which, as its name says, is sold by a broker rather than a bank, and can be resold on the market before it actually matures.
Of course, you may have significant new opportunities for your business and want to invest in them. This could be anything from additional marketing effort to boost sales, through to investing in additional inventory or manufacturing facilities, or even launching a completely new product or service that complements your existing portfolio. This can be a good use of money, provided that you do your due diligence upfront. You need to put together a business case that takes into account all of the potential revenues and needed investment, including what the return on investment will look like if things are delayed or go wrong. A business case doesn’t need to be pessimistic, but it does need to take a realistic view of both the downside and upside. Also keep in mind that while an investment may look good, you need to think about the net present value (NPV). This looks at the effect of spending expensive dollars now to earn cheaper dollars later on – taking into account things like inflation and what you could earn if you just kept the cash in the bank.