Keep Watching the Cash

Investment & Policy Considerations

With the heightened volatility in the financial markets and continued uncertainty associated with financial institutions and underlying investment vehicles, cash management should be a top priority for all management teams. In times of uncertainty and market flux, the overarching theme ought to be a bias for liquidity - a means to manage cash needs, to benchmark risks (immediate liquidity will generally entail lower risks), to manage usage and/or availability under credit lines and to take advantage of opportunities to invest in the business that might arise.

While there are many considerations, here are a few basic thoughts for the companies when managing their cash investment holdings:

1. Have a centrally managed investment policy. Have a single point of contact and responsibility for execution with appropriate oversight and control systems in place.

2. Know your investment vehicles and the underlying investments. If you can't explain it in 2-3 sentences, it's too complex. If you don't understand the underlying risks or they're not suited for your risk tolerance, don't invest. Demand complete visibility from your banker, broker, etc. If they can't provide information to your satisfaction, then re-consider the investment.

3. Know what counterparty risk you may be taking. Whether you have existing forward currency contracts or interest rate swaps or are contemplating new alternatives involving future performance by another party, understand the credit worthiness of your counterparty. Counterparty risk might also be defined as the institution that holds your investments (bank, brokerage firm, etc). While certain insurance / investor protections might be applicable (depending upon relevant government- or institutional-sponsored programs), you should be comfortable where your cash investments are deposited.

4. Match your investment durations with your cash flow needs (both cash and currency). Don't place cash in long-term driven investments if you'll need to access cash in the short term. The theme is to invest to have the liquidity, when needed.

5. Avoid chasing short term yield. Not surprisingly, returns are usually matched by the underlying risks. Consider minimizing short term investments in unregulated entities. According to its 2008 survey of investment liquidity by the Association for Financial Professionals, the credit market turmoil has also highlighted negative biases by treasurers and CFOs against auction rate securities, variable rate demand notes and enhanced cash total return vehicles. The more featured alternatives include bank deposits, treasury bills and Eurodollar deposits, with the largest percentage of the maturities being 30 days or less.

6. Safety of principal - conservatively manage your "war chests" or "rainy day" accounts. Particularly once you've raised money from outside investors or have a new credit facility, any loss of principal may create a confidence crisis from your new capital providers. Save your capital for investment in your underlying business - this, presumably, is what companies do best.

Working capital should be treated no differently than cash and should be managed as such. Every company ought to know the monetary value of one day of net working capital (accounts receivable + inventory - accounts payable) and the number of days in its cash conversion cycle.

As a best practice, we recommend that CFOs prepare a Liquidity Report on a monthly basis at minimum, and daily for some businesses, which summarizes cash investments, debt borrowings / availability, and total net working capital.