When it comes to running a small business, cash management is an essential aspect that often gets overlooked. Unfortunately, many business owners don’t consider the opportunity cost of suboptimal cash management practices. This is particularly true when it comes to managing your business’s idle cash.
What exactly is idle cash? In this context, idle cash refers to the excess cash reserves that a business has on hand, which is not currently being utilized for operations, investments, or other immediate expenses. Idle cash can be invested (safely) so that it earns a return during the time it is not being used. Done well, idle cash management protects your funds, maintains access to liquidity, and maximizes yield return.
Holding your idle cash in an insured checking account seems like a sensible move in comparison to, say, keeping physical cash in a safe at your principal business location. But it’s often better to invest it in a diversified basket of short-term, low-risk securities or to use it to pay off high-interest debt. Each — or both, more likely — can save your business money, preserve capital, and generate supplemental income.
As your business grows, the benefit of optimal cash management practices grows along with it. So does the opportunity cost of anything less.
You have three options to address the threat: do your own cash management, have your bank do it, or entrust it to a specialized cash management provider.
Option #1: Handle It Yourself
Your first option is to handle your cash management needs internally. Depending on the size of your business and your cash flow needs, this may involve doing it yourself or assigning a trusted employee.
What It Looks Like
You can internally manage your business’ idle cash in several different ways. What unites each of these approaches is that you don’t rely on an external service provider, like a bank or specialized cash management solution.
To decide on the best approach for your business, you need to figure out what you can afford (both in terms of time and money) and how much direct control you want over the process:
- Do it yourself. If you value control over your finances — as most business owners do — this is an appealing option when your business is small and its cash management needs are straightforward. But even then, managing and investing idle cash is going to be a time commitment, and doing it well requires expertise that you may not have. You might not be the best person for the job.
- Have your bookkeeper or accountant do it. They already manage other aspects of your finances, so why not your idle cash? Increasing your part-time bookkeeper’s hours spares you the expense of hiring a new employee.
- Hire in-house expertise. As your business grows, its cash management needs become more complex. Eventually, the time needed (and potentially the expertise required) is just too much for you or an existing employee to handle. But a new hire with the requisite knowledge and skills is not cheap.
Pros of In-house Cash Management
You know your business better than a bank or third-party treasury management provider, so it makes sense that you’d want to deploy its idle cash yourself. And there are some advantages to that approach.
- Deeper knowledge of the business and alignment with ownership’s preferences. As the owner, you know your risk tolerance, liquidity needs, growth plans, and so on without having to explain them to an external stakeholder. Even if you’re not directly responsible for cash management, you can train the responsible employee on these preferences with an easier learning curve.
- More flexibility and control. When you handle your cash management yourself, you can adjust tactics and strategy on the fly. You can correct mistakes faster. You can make “inadvisable” decisions (like liquidating long-dated, low-yield CDs and paying the interest penalty) in service of a larger goal.
- Potential for cost savings. Allocating cash management responsibilities among existing employees is an excellent way to trim expenses without letting anyone go. The cost benefits become murkier as you grow, however.
Cons of In-house Cash Management
Doing your cash management seems like a good idea until it doesn’t any longer. These are the biggest pitfalls.
- Major time commitment. Keeping your business financials straight is already a big time commitment for you or your internal finance team. Proper idle cash management is an added time cost that could have been spent focusing on operating your business. You might not be able to absorb the additional workload as easily as you think, even if you’re willing to add to your headcount.
- Lack of required expertise. Small business owners or employees may not have the necessary financial expertise to manage idle cash optimally, which could lead to missed opportunities (reduced performance) or increased risk exposure. And if you do decide to hire an expert, expect to face a tight labor market and pay top dollar for a seasoned treasurer.
- Limited access. Small in-house cash management teams will likely not have access to the same tools, investments, and technologies as professional cash management options like banks or Registered Investment Advisors. This can limit the effectiveness and performance of a business’s cash management strategies and potentially increase risk.
Option #2: Have the Bank Handle It
Another option for small businesses is to have your bank manage your idle cash. Many banks offer some sort of cash management service, and it can be convenient to work with an institution that you are already familiar with. However, handing over your idle cash to your bank comes with some risks that may not be apparent at first.
What It Looks Like
If your bank offers treasury management services, it can manage your idle cash, with no problem. If your bank doesn’t offer treasury management services, it’s probably a sign that your bank’s focus is most likely not aligned with your needs, so it may be time to switch banks (even if you’re not sold on bank-led cash management).
Bank-led cash management is convenient and hands-off by default, giving you back precious time and resources. Banks also traditionally have access to a wide variety of investments, including lower-risk options like government-backed securities. Bank cash management services often use advanced algorithms to quickly identify and allocate excess cash, streamlining the process compared to manual management. Banks will often provide useful insights and reporting, enabling business owners to have a more granular view of their idle cash performance.
Pros of Having a Bank Handle Your Cash Management Needs
You already have a business bank, so you could entrust your cash management needs to it. Here’s why that could make sense.
- You already work with them (convenience). Inertia has its charms. If you’re generally satisfied with your business bank, it makes logical sense to have them manage your cash.
- Easy access to low-risk, insured financial products. Banks have access to a variety of low-risk financial products with FDIC deposit insurance. If your risk tolerance is low, you don’t need anything exotic anyway.
- In-house expertise. Cash management is a core business banking service. Even smaller regional banks have in-house experts who’ve been doing it for years.
Cons of Having a Bank Handle Your Cash Management Needs
Banks are convenient and seemingly safe, but they have some hidden and not-so-hidden downsides.
- Potential conflicts of interest. Banks may have conflicts of interest due to financial incentives like kickbacks or commissions for promoting specific investment products. This misalignment of interests can lead to banks prioritizing investments that benefit themselves, rather than focusing on the best investment options for your business.
- Bank fund risk. Banks typically hold clients’ funds in their own bank accounts or invest it under the bank’s management system. If the bank experiences financial distress or insolvency, as we’ve seen recently, the clients’ funds could be at risk. This is unlike options that hold funds with custodial accounts, where a separate financial institution acts as a custodian to safeguard the assets.
- Limits on deposit insurance. Many banks offer no way around the FDIC’s deposit insurance limits. As we saw when Silicon Valley Bank failed, this can be an existential threat to well-capitalized business clients. Because of this, many savvy U.S. SMB owners have turned to new risk-management strategies, such as partnering with 831(b) plan admins like SRA.
- Limited customization. With many banks, customization and white glove services are only provided to their largest clients, leaving many small businesses with the standard offering. While this may work for some, many businesses have their own unique growth goals, risk tolerance, and liquidity needs that would be better served by a customized portfolio for their idle cash.
Option #3: Use a Third-Party Cash Management Provider
Your third — and for many businesses, the best — option is to use an expert third-party cash management service that isn’t directly associated with a bank and doesn’t require you to create a new cash management role internally.
What It Looks Like
A third-party cash management service is more customized and flexible than a typical banking cash management program. Third-party cash managers are typically Registered Investment Advisors, regulated by the SEC, and have a fiduciary duty that requires them to prioritize the client’s interest over their own.
Cash management services also typically offer investment options and products that are a good fit for small businesses. For example, the cash management platform Treasure offers a reserve account that’s a customizable mix of diversified, risk-appropriate financial products: FDIC-insured cash accounts, money market funds, dynamically managed government-backed securities, and actively managed fixed-income mutual funds. Many business banks offer only cash accounts, sometimes just a handful, and don’t allow clients to customize between different offerings.
Pros of Using a Third-Party Cash Management Provider
A third-party cash management provider won’t replace your bank or accountant, but they’re very good at what they do: managing your idle cash.
- Specialized expertise. Like banks, third-party cash management providers know their stuff. They’re arguably even better suited to it because it’s all they do; top-tier cash management providers regularly outperform bank and fund benchmarks.
- Customized strategies. Cash management services will often develop tailored portfolios for their clients based on things like growth goals, risk appetite, and upcoming cash needs. Top cash management services will also actively manage those portfolios so they can adjust strategies based on changes in the client’s needs or fluctuations in the market.
- Fiduciary responsibility. Many third-party cash management services operate as registered investment advisors (RIAs) and have a fiduciary responsibility to act in their client’s best interests. RIAs are strictly regulated by the SEC, and their role as fiduciaries means there is no potential for conflict of interest in their investment recommendations. This can provide additional peace of mind and protection for small businesses.
Additional Pros to Consider
- Potential for a wider range of investment and deposit account options. Leading cash management providers offer more risk-appropriate deployment options from a variety of banks and investment service firms. This means a bigger menu of higher-yield products and more investment options likely to do well in challenging market environments.
- Potential for higher ROI on deployed cash. More investment options greatly increase the likelihood of higher blended ROI on deployed cash. That means more income for your business.
- Potential for higher deposit insurance limits. Spreading your cash among multiple banks allows for greater deposit insurance coverage, reducing your exposure to black swan events like bank failures.
- Dynamic management (more flexibility). Third-party cash management providers use sophisticated algorithms to optimize deployed cash for yield, risk, and diversification. Your bank may do this as well but with a narrower menu of deployment options.
- Frees up internal resources for cash flow management. Third-party cash management providers can help your business optimize its idle cash, but it’s not their job to help you earn more of it through business activity (not directly, at least) or to hold your hand through the cost-cutting process. Nonetheless, they do many hours of legwork on your behalf each month, freeing up your in-house treasurer or controller, or accountant to focus on high-ROI growth and cost-reduction opportunities.
Cons of Using a Third-Party Cash Management Provider
Before moving forward with a third-party cash management solution, see how it compares to your current banking relationship or an internal employee or team.
- Not a one-stop shop. By definition, specialized cash management providers do not offer the full suite of products found at a full-spectrum bank. You’ll need to rely on other financial providers for things like managing payroll and securing loans.
- It’s important to choose the right provider. When selecting a third-party cash manager, it is important to carefully vet your partner. You will want to choose a partner that is a Registered Investment Advisor, meaning they are closely regulated by the SEC and have a fiduciary duty. You also will want to make sure they hold funds in custodial accounts (most partners do) and check with them about their fee structure. In general, you should not be paying more than 50 basis points on your assets under management.
In conclusion, cash management is an essential aspect of running any business, and its importance grows as the business expands. Business owners have three options to manage their idle cash: do it in-house, have their bank do it, or entrust it to a specialized cash management provider.
Each option has its pros and cons, and business owners need to evaluate their needs and preferences before deciding. Regardless of the option chosen, suboptimal cash management practices can lead to opportunity costs, and businesses can benefit from investing idle cash in low-risk securities or paying off high-interest debt. In the end, the goal of cash management is to save the business money, preserve capital, and generate supplemental income, making it a crucial aspect of financial success.