There are off and on balance sheet investment opportunities for companies, much of which hinges on their short-term liquidity needs and their longer-term investment horizon. Many companies, however, have been complacent in the low interest rate environment and aren’t activating their excess cash. Expectations of rate increases should spur some to start.
“As companies look at their liquidity, they should be considering both what they need for immediate purchasing and what their needs are in the coming year,” says Jim Altman, middle Market Pennsylvania Regional Executive at Huntington Bank. “That will determine the liquidity they need, what they can invest and what investment instruments are best, which will enable them to maximize their returns.”
Smart Business spoke with Altman about liquidity and investments in an interest rate environment that’s heating up.
Why are companies not utilizing excess liquidity on their balance sheets?
Since interest rates have been so low for many years, many companies are not looking at how much available cash they have in their checking accounts compared to how much they need to cover operating needs.
It seems to be the case that larger companies, where people in the organization are focused almost solely on managing the balance sheets, are on top of this. They tend not to have as much excess cash because they’re always managing it.
Midmarket companies that have a few million dollars in their checking account have, for the past few years, not been earning anything on it. As rates begin to increase, there is reason to look into what options exist to realize returns on that otherwise stagnant cash.
Any cash remaining after operating expenses is excess liquidity that companies can and should invest or pay down debt. The smaller the company, the bigger the opportunity they have to put to work the excess cash that is otherwise not generating a yield.
Where might companies find excess liquidity off of their balance sheets?
The benefit of off balance sheet investments, especially when there’s a longer time horizon at play, is an enhanced yield to the investor. It’s critical for companies to determine their needs both in the near- and long-term so they can optimize, or in some cases create, yields. As circumstances change, whether anticipated or not, they can make adjustments that create liquidity or optimize yield.
How might interest rates play into a company’s strategy?
A higher rate environment leads companies to notice how their expenses change, but also encourages optimization of assets.
Interest rate adjustments expected to be made by the Federal Reserve will have an impact on what banks will be willing to offer for both short- and long-term loans — borrowers should expect to be paying more in the coming years on borrowed interest.
Conversely, higher interest rates are prompting companies that are holding on to cash to think critically about opportunities to maximize their yields.
How does excess liquidity factor in to the decision-making?
Companies should talk with their bankers about options to utilize excess liquidity, what vehicles allow the company to move easily from short- to longer-term options, and what, if any, instruments are available that pay on every bit of excess cash on a company’s balance sheet. The bank should be looking at a company’s entire financial need and not isolating their solutions just to treasury management or just to investments.
New banking products have been created, which means things aren’t the same as they were when banks were paying interest. For instance, banks can now pay interest on checking account balances and that can help midsize companies with their short-term needs.
It’s well worth the time to talk with a banker about maximizing short- and long-term liquidity needs and putting any excess cash to work.
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