MD: Genesis Corporate Solutions
Cash flow is the best indicator of the health of a business. It shows how far the company is from financial distress and whether reinforcements need to be called for.
Keeping an eye on cash flow and developing an optimised cash management system is often challenging when company leadership cannot see the wood for the trees. This challenge is also being complicated by the external noise exacerbated by technology.
Taking a step back and looking at things from a position of calm and relaxation may provide you with a different perspective. I recently read an article on cowrywise.com which points out a few scenarios companies should be looking to take advantage of.
Idle cash balances
The Cowrywise article points out that Idle funds—cash sitting unused in bank accounts—represent an opportunity cost. Studies indicate that, even in short periods, idle cash loses value due to inflation. For businesses expecting idle funds for weeks or months, investing them in short-term, low-risk assets can generate returns that enhance profitability. Treasury management tools offer accessible platforms for businesses to manage temporary surplus funds while retaining liquidity.
According to Markowitz’s Portfolio Theory (1952), diversifying investment in short-term, liquid assets reduces risk while optimising return. This approach aligns with the need for businesses to deploy idle funds effectively, reducing opportunity costs while maintaining the flexibility to withdraw when needed.
Capital expenditure planning
Capital expenditures (CapEx) often require accumulating cash reserves over time. Businesses that hold cash while saving for large purchases, such as real estate or machinery, can invest these funds for incremental returns. Utilizing financial products that align with CapEx timelines helps businesses avoid cash erosion due to inflation.
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Cost of capital theory suggests that businesses should maximise returns on all funds, including those designated for future expenditures. By earning interest on funds saved for CapEx, companies offset capital costs, a practice particularly effective in high-inflation environments.
Managing periodic operational expenses
The Cowrywise article adds that, for businesses with monthly, quarterly, or annual operating expenses, keeping cash in interest-bearing accounts until due dates provides a means to optimise liquidity. Operational expenses tied to specific timelines, such as payroll or lease payments, allow businesses to capture additional income by investing in short-term instruments that mature just before the expense date.
According to Cash Conversion Cycle Theory (CCC), shorter cycles increase liquidity and profitability. Applying CCC principles, investing cash earmarked for operational expenses can reduce liquidity constraints, especially for businesses facing cyclical cash flow demands.
Project milestones and deferred revenue
Companies engaged in long-term projects, such as real estate or infrastructure development, often collect partial payments in advance. By investing these interim funds, businesses can generate additional revenue without impacting liquidity for project phases. This approach proves effective for companies facing cyclical cash flows or extended project timelines.
Project-based finance theories emphasise the importance of maximising interim cash. Using investment vehicles to generate returns while awaiting full project funding aligns with sound capital management practices, reducing financial strain and enhancing project return on investment (ROI).
Inventory management in manufacturing
Manufacturers, especially those managing seasonal production cycles, experience cash surpluses after sales but before restocking. Instead of allowing these funds to remain idle, short-term investment strategies can generate returns that improve purchasing power for future inventory requirements.
Inventory cycle theories highlight the value of reinvesting idle cash between production cycles. By optimising cash flow during inventory turnover, companies can stabilise cash reserves, ensuring consistent operational funding.
Undeployed investor funds
The Cowrywise article points out that, post-fundraising, startups often need time to allocate resources. During this planning phase, startups can optimise investor funds through temporary, safe investments. This approach not only maximises capital but also demonstrates fiscal responsibility to investors.
Capital efficiency theories support the practice of interim fund deployment. Efficient use of undeployed funds aligns with shareholder value maximisation, a central principle in capital market theory that underscores the importance of optimising investor contributions.
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Working capital cycles in trade businesses
Businesses in trade or retail often face short cycles of rolling income, where revenues from sales accumulate until they can reorder stock. Investing these interim funds provides businesses with greater purchasing power for restocking, enhancing liquidity without compromising order timelines.
According to Working Capital Management Theory, efficient capital allocation between sales cycles maximises profitability and ensures sufficient liquidity for growth. This cycle of reinvestment provides a framework for efficient cash flow optimization in high-turnover industries.
Liabilities and income optimisation in lending businesses
Lending businesses often accumulate cash from deposits or liabilities that are temporarily inactive. By investing these surplus funds, lending institutions can generate returns to improve net interest income (NII), enhancing profitability without increasing risk exposure.
Financial intermediation theories emphasise the importance of efficient fund deployment. Maximising NII from idle liabilities aligns with bank-based finance models that prioritise cash flow efficiency to maintain liquidity and profitability.
Foreign exchange delays in import businesses
The Cowrywise article points out that short-term investments counter the adverse effects of exchange rate fluctuations for import-dependent companies awaiting currency exchange. Investing funds while waiting for foreign currency access preserves purchasing power, a practice beneficial in volatile currency markets.
International finance theories advocate for strategies that protect cash flow from currency devaluation. By investing idle funds, import businesses can hedge against exchange rate losses, a practice endorsed by risk management models in finance.
Milestone-based payments for contractors
Contractors receiving advance payments face milestone-based cash flow demands. Investing these funds between project phases ensures that cash remains productive, generating additional income to support operational needs.
Project finance models endorse reinvesting advance payments to maximise liquidity. Utilising short-term investment strategies allows contractors to fulfil milestone requirements without incurring additional debt.
The Cowrywise article points out that, for startups and high-growth companies, strategic cash flow management supports scalability, investor confidence, and operational resilience, ensuring sustainable growth and long-term success. By understanding and leveraging cash flow cycles, businesses are able to be resilient, especially in high-growth and resource-intensive industries.
Seeking advice
What are the key highlights from the Cowrywise article?
- The opportunity cost of idle funds: Cash that sits in bank accounts without being used represents an opportunity cost for businesses. Even short-term idle cash can lose value due to inflation, making it vital for companies to actively manage these funds by investing them in low-risk, short-term assets to generate potential returns and enhance profitability;
- Utilisation of treasury management tools: Companies can use treasury management platforms designed to help manage temporary surplus funds effectively. These tools allow businesses to invest idle cash while retaining liquidity, supporting better capital allocation and financial efficiency;
- Investment strategies for capital expenditures: Businesses planning for large capital expenditures (CapEx) can invest the cash reserves they accumulate for future purchases. This strategy helps counteract inflation’s impact on cash value and maximises returns on funds set aside for investment, ensuring that the capital is actively working for the business;
- Managing operational expenses: For businesses with predictable operational expenses, keeping cash in interest-bearing accounts until necessary allows for optimised liquidity. Investing cash earmarked for periodic expenses, such as payroll or rent, in short-term instruments helps generate additional income and reduce potential liquidity constraints; and
- Reinvestment during production cycles: Manufacturers can take advantage of cash surpluses that occur post-sales but before resupplying inventory. Implementing short-term investment strategies during these surplus periods can yield returns, enhance purchasing power for future inventory needs and stabilise cash flow during production cycles.
By focusing on these strategies, businesses can ensure that their idle cash works effectively toward their financial goals. Businesses should also seek professional help to enhance their cash flow optimisation options. Business rescue and turnaround professionals are close at hand and can tailor strategies to address your specific needs.
