RSS Feed

Related Articles

Related Categories

Why you need to consider cashflow before making an investment decision

29th March 2018 Print

With a business, there is the desire to invest retained earnings to get a high return. Of course, the main driver of this behaviour is the worry that inflation will eat away at the hard-won profits of the business. That’s a fair concern, of course, but there are other considerations too. 

Here are a few things you should think about relating to cash balances before making investments.

Treasury Decisions

Treasury is the term used with companies that have spare cash that they can put to work overnight. Typically, when a company closes its office before 6pm, they don’t need their bank balance until 8am the next morning. In between those two times, few if any new transactions are expected to go through and these can be accounted for in the balance. These can be tracked using software, such as AccessPay for multi-bank, multi-region,  multi-currency Treasury management, to manage cash investments, as well as liquidity positions, you can learn more about this option over at;

It’s also possible to put a spare balance to work over a longer period of a few days, a week or a month under similar arrangements. The incentive here is a slightly higher interest rate because banks can use global money-market rates or interbank rates to get a return on the money deployed above what they pay for the cash. 

Spare Funds?

The primary concern in the cashflow vs investment argument is the issue of spare funds. When there is spare money in a business with a balance sitting in the business checking account, the question is how much of that balance is really spare money? That’s not immediately easy to answer.

A cashflow forecast must be prepared to provide clarity about what the expected flow of money within the business is likely to be. Some upcoming months might see a slowdown in sales – perhaps during the summer months – but for other businesses, the winter period is the best time of year. Not only is every business different, but the range of customers creates a different amount of order flow based on seasonality or industry type. Due to this, cash balances move up and down surprisingly often making prediction a moving target.

Modelling Outcomes

Sometimes a business must produce several cashflow versions from optimistic to severe. Only this way is it able to get a clear idea about how their cash balance will move up and down, both positively and negatively over time. This can then be reflected back to the current cash balance in the Treasury or in money markets to see how much of that will be needed to cover cashflow negative months before the business turns a profit for the year. 

Lock Up Periods

In terms of investing, the lock up period is a crucial aspect. It is even more important than the investment type or the expected rate of return. The lock up is the period of time that the money is stuck in the investment and cannot be released. Sometimes there is a penalty clause where the funds can be released sooner by either paying a fee or losing some (or all) of the interest accrued, or both. 

For Treasury investments, the lock up period can be a matter of hours or days. Other instruments might be traded day to day, but take up to a week to be sold, paid out and cleared funds received. It depends entirely on the type of investment and the investment agreement as to the length of the lock up period and any penalty structure that’s been put in place.

Putting It All Together

Putting this together, the idea is to use the less optimistic cashflow forecast for future trading and cash levels, combined with the current cash balances, to appreciate the ebb and flow of the cash balance over the coming twelve months. Deciding what money to put into investments over a one year lock up – or even just 6 months – is a critical decision and not to be taken lightly. 

In conclusion, when there is any doubt about funds that are needed quite soon, it is best to keep the cash balance in the bank account or only use overnight Treasury and multi-day lock ups. It’s just not worth trying out a longer-term investment, or a more volatile one, to receive a slightly higher return. The concern over available cash will return and higher return investments will put the original capital at significant risk which defeats the object of cash balance needed back (with nothing lost) in a 3, 6, 9 or 12-month period.