Cash Management Strategies: Best Practices for Financial Stability

Recent events have underscored the importance of adopting best-practice banking account strategies to safeguard your organization's assets and maintain liquidity. Finance leaders are now faced with the critical task of reevaluating their company's banking account structures to ensure financial stability and minimize risk exposure, including implementing smart banking strategies to ensure optimal cash flow, minimize risk, and maximize returns on idle funds. 

Banking strategies for businesses

Companies can achieve financial stability and long-term success by diversifying accounts, separating operations, and investing surplus cash wisely. 

Diversify your accounts

Spreading your cash across two to three accounts, including at least one to two accounts with major national banks or Global Systemically Important Banks (GSIBs), can help protect your funds and ensure easy access when needed. Keeping all your money in smaller regional banks might expose your business to higher risk and limited services. Diversifying your accounts also provides a safety net in the event of bank-specific issues or economic crises.

Have separate operating accounts

Having distinct accounts for different operations, such as accounts receivable, accounts payable, and day-to-day expenses (e.g., payroll and employee reimbursements), can minimize the risk of fraud and protect your cash. By allocating specific accounts for specific purposes, you can more easily track and manage your funds and identify any irregularities or discrepancies.

Invest your surplus cash strategically

There are many options for investing extra cash. One strategy is to tie your operating account to a cash sweep account that automatically invests into an interest-bearing account. This strategy provides a relatively low-risk investment option that generates returns while keeping your funds accessible when needed.

Consider setting up another account that’s used solely for investing and safekeeping purposes. For example, investing portions of your cash in time-bound treasuries, such as $1 million in treasuries maturing in one month and another $1 million in treasuries maturing in two months, etc., locks down yields while maintaining liquidity according to your business's future cash needs. It also allows you to lock down the yield and maintain liquidity for unforeseen circumstances.

Cash Sweep Accounts

A cash sweep account is a financial tool designed to optimize a company's cash flow and maximize interest income. It automates the transfer of surplus cash from a primary checking account to an interest-bearing account (typically a money market or investment account) at the end of each business day.

Benefits:

• Maximizes interest income by transferring idle cash to interest-bearing accounts
• Ensures liquidity by keeping necessary cash in the primary checking account for daily operations
• Reduces administrative burden by automating cash transfers

Risks:

Liquidity risk: If funds are swept into an investment account that doesn't allow for immediate withdrawal or has penalties for early withdrawal, you may face liquidity issues when you need access to cash for urgent business expenses.

Investment risk: Depending on the type of interest-bearing account used for the cash sweep, risks may be associated with the investment. For example, if the funds are swept into a money market mutual fund, there is a potential for loss of principal if the value of the fund's investments declines.

Interest rate risk: Interest rate changes can impact the cash sweep accounts' returns. If interest rates decrease, the yield on the interest-bearing account may also decrease, reducing the returns on your swept funds.

Reliance on automation: While the automation of cash sweep accounts is a significant advantage, it also means that your cash management relies heavily on the bank's systems. Any technical issues, software glitches, or human errors could disrupt the cash sweep process and cause problems for your business.

Cost: There’s an administrative fee for utilizing cash sweep accounts. Some brokerages or banks impose flat fees, while others charge a percentage of the yield. Below a certain funding threshold, the cost can outweigh the incremental returns. 

Concentration Accounts

A concentration account is a centralized cash management system that consolidates funds from subsidiary accounts into a single master account. At the end of each business day, the balance of the subsidiary accounts is transferred to the master account, leaving the subsidiary accounts with a zero balance.

Benefits:

• Streamlines cash management by consolidating funds into a single account
• Reduces the risk of overdrafts and associated fees by maintaining a zero balance in subsidiary accounts
• Enhances visibility and control over cash flow by providing a centralized view of the company's finances
• Facilitates efficient allocation of funds across the organization

Risks:

Fraud risk: Centralizing funds into a single account can make it an attractive target for fraudsters. A single security breach could lead to a significant financial loss, so it's essential to implement robust security measures and regularly monitor account activity for any suspicious transactions.

Operational risk: Concentration accounts rely on the daily transfer of funds between subsidiary accounts and the master account. Any technical issues, human errors, or delays in the transfer process could lead to disruptions in cash management, resulting in insufficient funds for daily operations or unintended overdrafts.

Liquidity risk: Consolidating funds in a concentration account can make it more challenging to maintain adequate liquidity in your subsidiary accounts. If funds aren’t transferred back to the subsidiary accounts as needed, it could lead to temporary cash shortfalls, affecting the ability to cover daily operational expenses.

Regulatory risk: Depending on the jurisdiction and industry, there may be regulatory requirements or restrictions related to the use of concentration accounts. It's crucial to ensure compliance with all relevant regulations and be aware of any changes that could impact the use of a concentration account.

Best practices for account management

Cash sweep and concentration accounts can be used individually or in combination to optimize a company's cash flow, liquidity, and financial control. Here's a brief overview of how these accounts can work together to improve cash management:

The concentration account is used to consolidate funds from multiple subsidiary accounts into a single master account. Once the funds are consolidated in the concentration account, a cash sweep can be set up to transfer excess cash from the concentration account to an interest-bearing account (such as a money market or investment account) at the end of each business day. By using these cash management tools together, a company can consolidate and manage funds efficiently and maximize interest income by putting idle cash to work.

Tips for effective cash management

In today's competitive and rapidly changing economic landscape, businesses must be nimble enough to navigate challenges while implementing strategies to safeguard their assets and maintain financial stability. A few simple practices can help you enhance financial control, reduce risks, and make informed decisions.

Regular review and adjustment: Periodically review your company's cash management practices to ensure they continue to meet your organization's needs. As your business evolves, you may need to adjust your cash management strategies or explore new tools to maintain optimal cash flow and liquidity.

Collaboration with bank partners: Maintain open communication with your bank partners to better understand their services and any new developments in cash management tools. Bank partners can provide valuable insights and recommendations to help you optimize your cash management practices.

Training and education: Ensure your finance team is well-trained and knowledgeable about your organization's cash management practices. Regular training and education can help your team better understand the tools and processes in place, identify potential issues, and optimize cash flow.

Disaster recovery and business continuity planning: Develop a disaster recovery and business continuity plan to address potential disruptions to your cash management processes, such as system outages or security breaches. This plan should outline the steps your organization will take to restore operations and protect its assets in the event of a disruption.

Monitoring and reporting: Implement regular monitoring and reporting procedures to track the performance of your cash management practices. This can help you identify trends, pinpoint areas for improvement, and ensure your organization is maximizing its cash flow and liquidity.

This content herein has been prepared for informational purposes only, and is not intended to provide, and should not be relied on, for financial, legal, or other advice. You should consult your own financial, legal, and other advisors before engaging in any transaction.