Cash Management Tools for Small Business

Recently I was discussing business plans with a young business owner. She has just over a year under her belt and money is starting to come in. I mentioned that excess cash should be placed in a money market account so working capital generates some income, too.

She stopped me there and asked, “What is a money market account?”

This surprised me since I consider cash management accounts basic financial knowledge. Worse, it was my daughter asking the questions! So we discussed money market accounts and other ways to manage working capital in a business and how to use cash management accounts in personal finance.

Cash Management

All businesses need a solid foundation. The basics are that foundation. The same applies in personal finance. And nothing is more basic than cash management.

There is no reason for embarrassment if you don’t understand cash management tools. Until you are exposed to the information you can’t know. This post will help you understand the variety of cash management tools and when best to use them. By the end of this post you will have solid information that will put extra money in your pocket, some of it tax-free income.

Let’s define what a cash management tool is. A cash management account is a place to hold short-term money, money that is needed in less than a year (sometimes longer: see sinking funds below) and needs to be easily accessible and safe. These are the two priorities of any cash management tool.

Your checking account is a perfect example of a cash management tool. Unfortunately, the ease of accessibility is coupled with a very low return on the capital in the account. Many times checking accounts pay no interest.

The checking account isn’t the only cash management tool available. Money market accounts are very common. You can also integrate savings accounts, certificates of deposit (CDs), Treasury bills (a full discussion below), and other alternative forms of short-term savings accounts.

One thing to note, cash management accounts are not investments in the traditional sense. Yes, you have easy access to a mutual fund invested in equities (stocks), but the risk of a decline over the short-term works against mutual funds as a cash management tool. Mutual funds are a long-term investment, whereas cash management accounts are designed for stability so all the money placed there, including interest, is accessible at all times.

Another thing to know is that you are not wed to a single account for cash management. It is common for a business to have a checking account and money market account at the same time. Each tool is for a specific purpose. You can maximize the efficiency of your cash by matching the cash management tool with the appropriate amount of liquid capital.

Now let’s turn to a short description of each cash management account.

Checking Account

The checking account may be the most understood account on this list. However, many young people are moving away from checking accounts or using a checking account with a debit card only for spending, never actually writing checks.

Generally, checking accounts are guaranteed if held at a bank or credit union. Checking accounts are super liquid. You can drop money in anytime you want with deposits available within a few days for withdrawal.

Even if you use other cash management tools, it is likely most of your capital will flow into and out of the checking account when business is transacted.

Money Market Accounts

Money market accounts are available at banks, credit unions and investment houses like Vanguard and Fidelity. The interest rate paid can change daily and follows short-term interest rates set by the Federal Reserve (the Fed).

Money market accounts at banks are FDIC-insured. Credit union money market accounts are similarly insured.

Money market accounts are NOT insured at brokerage firms (Vanguard, Fidelity…) unless so stated. However, money market accounts are considered the lowest risk of all investments. It is reasonable to expect money market accounts at brokerage firms to maintain their value while paying short-term market interest rates.

Money market accounts usually earn a higher interest rate at brokerage firms than banks and credit unions.

Certificates of Deposit

CDs sometimes offer a higher interest rate than money market accounts, but lock your money up for a short period of time, from a few weeks to 5 years.

CDs are usually insured, meaning they are a very safe way to store money.

Whereas money market accounts can see their interest rate fluctuate daily, the CD locks in the interest rate paid for the term of the CD. (Some CDs vary the interest rate in some instances. This is clearly shown when you are buying a CD. Almost all CDs lock the interest rate for the term of the CD.)

CDs are a powerful tool for earning a bit more interest for covering expenses at a known future date.

Treasury Bills

The two main ways to purchase Treasury debt is through a brokerage account or Treasury Direct.

Before we talk about buying Treasury bills, we need to assure you understand the terminology. Treasury bills have a term of 1 year or less. Treasury notes have a term of 2-10 years. Treasury bonds have a term of over 10 years.

Treasury bills also have a unique feature; they sell at a discount. Example: If you buy a $1,000 1-year T-bill paying 5%, you pay around $950 for the T-bill and get paid the face value when it matures; $1,000 in this example. Notes and bonds pay interest semi-annually.

For over 10 years interest rates were very low. Treasury bills paid almost nothing and for a short time went negative (you paid to save). As a result, Treasury bills were not a viable cash management tool for households or businesses. That has changed.

Interest rates have normalized recently (Treasury bills pay a reasonable amount of interest) making T-bills a powerful cash management tool. In most times, Treasury bills will pay a bit more interest than other options from a bank or credit union with the exception of promotional CDs at specific institutions.

Even though it is possible to sell T-bills any time you want, for practical purposes, you should act like a T-bill purchase is a CD without the option for an early withdrawal.

Because T-bills come in 4-, 8-, 13-, 17-, 26-, and 52-week maturities, it is easy to ladder your cash management plan. Need $XXXX for property taxes in six months? Buy a 26-week T-bill.

Another nice feature of T-bills is that you can reinvest on Treasury Direct. If you discover you don’t need the money at maturity you can reinvest in the same maturity. The Treasury deposits the discount on the new T-bill into your bank account on file.

Treasury interest is also exempt from state and local income taxes.

Alternative Cash Management Tools

For more than a decade interest rates scraped 0%. Keeping money in a checking or savings account did no harm since nothing paid any kind of return. Now that interest rates are higher, alternative cash management tools are less desirable due to their elevated level of risk.

These alternative cash management tools still exist. I am not a fan since most offer no guarantees and provide only a modestly higher interest rate than current traditional cash management tools.

For review only, in my opinion, you can see how many alternative cash management tools worked. Worthy paid 5% when rates at banks were 0%. Worthy pays a bit more now, but the spread between Worthy’s rates and traditional cash management tools is narrower.

And here is a bank offering a positive return during the 0% era. There were (and are) many more alternatives to choose from. However, this article is focused on very safe short-term cash management tools so we will pass on alternative options.

Maximizing Cash Management Tools

The variety of cash management tools provides ample opportunity to maximize interest income on short-term capital.

The checking account, as we stated, is the tool where most money enters and exits the household or business. Since the checking account almost always pays the least amount of interest, it is best to move monies not currently needed into regular investments or another cash management tool for intermediary capital needs.

Bank and credit union savings accounts also are a poor choice as they are a small step above the checking account when it comes to earning interest on monies waiting for deployment.

Money market accounts at financial institutions tend to pay less than money market accounts at brokerage firms (Vanguard, Fidelity…) and Treasury Direct. VMFXX is the money market account at Vanguard I currently use for business and personal cash management needs. Transfers between the brokerage account and my business or personal checking account is fast. Requests for money today are in my checking account the next day. If you need faster access to your funds you will need to stay with local financial institutions for your money market account.

CDs and T-bills are incredible tools for laddering financial needs. I don’t use CDs personally, but they are still a powerful tool for laddering maturities with expected near future financial needs.

I started using Treasury Direct again once interest rates started to climb. I use a variety of maturities, matching future business needs with maturity dates. I keep a reasonable amount of money in the shortest maturity (4-week) so I always have extra cash available in a week or so at all times. Most of the time I keep reinvesting. Still, when I need money, it is available. I use longer maturities for late calendar year business expenses (property taxes, calendars for clients and mailing costs…). Build a T-bill ladder best suited to your needs.

Sinking Fund

If you are not familiar with the sinking fund you will love the concept.

A sinking fund is where you drop short-term money for future expenses. With the sinking fund the expenses can be more than a year out. You can have a sinking fund for a vehicle. By the time your are ready to update your wheels you have the money to pay cash.

Landlords often use a sinking fund for deferred maintenance. Roofing is a big item for landlords; same for all home owners. Having liquid funds for a furnace or AC replacement, flooring, or other building expenses takes the stress out of these big tickets expenses. Money saved in a cash management account for these needs is called a sinking fund.

Your needs will vary from your neighbors or your friendly accountant. Structure your cash management tools to serve your needs. These tools are designed to make your life easier and you get paid while you wait for the expense to arrive.

Known longer-term expenses brings Treasury notes and CDs into play. A 5-year CD fits the need for a planned roof replacement in 5 years. Treasury notes available on Treasury Direct also give you a longer term to save cash needed in the near future. (Reminder: Treasury notes pay interest semi-annually rather than at a discount.)

Cash management tools are simple to use and the traditional tools are very safe and often guaranteed. There is no reason for keeping large amounts of cash in your checking or other low interest bearing accounts. Use the variety of cash management tools to increase your income effortlessly while near term expenses are still in the offing.

I hope this basic outline of cash management tools will help you manage your finance better. From this foundation you can take money that will not be needed for a very long time and move it into investments or retirement accounts.

Let me know in the comments how you are using or plan on using the cash management tools discussed in this article. By sharing ideas we all benefit.