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What Should a Company Do With Excess Cash? | Payference

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If you’re fortunate enough to be wondering what to do with excess cash in a business, then congrats are in order. You are in a coveted position, especially when you consider that only 45.4% to 51% of small businesses are still around five years after their founding. And only about a third make it to celebrate 10 years in business.

You’ve survived. And, of course, you’d like to find yourself in the same positive place again and again. So the decisions you make about "what should a company do with excess cash" should not only be smart for the short-term but should further secure your future as well. 

There are any number of ways to accomplish both immediate and long-term goals. In this blog, we’ll briefly go over some of the areas where you can put excess cash to good use. But just as importantly, we’ll explain how you can use AI-enabled software to know exactly how much excess cash you have. Having an accurate read on your cash flow and idle cash is critical. Spending decisions based on incorrect financial information can have disastrous effects.

Once you’re confident in the number you’re working with, there’s another point to consider before you decide what to do with excess cash in a business. Ask yourself why you have that surplus. Was there a market shock or a seasonal factor that resulted in a windfall? If so, you may want to proceed slowly. If not, you could allocate your excess funds to one or more of these categories.

1) Use Excess Cash for an Emergency Fund

First of all, it’s wise to establish an amount of money to keep as cash reserves. Some of your profits should be set aside as a cash buffer. That way you can keep unforeseen events from derailing your business. If your revenues drop or there are shifts in the market, you’ll still be able to meet payroll and other bills. 

To determine how much cash should be held back, start with this scenario: For whatever reason revenues are down by 25% and costs have increased by 50%. How much would you need to survive such a bleak financial picture for a few months? That’s the amount you should strive to keep in your cash reserves.

That probably sounds like a large amount of cash to have on hand. But keep in mind that one unexpected setback–an overlooked tax bill, for example–is all it takes to risk everything you’ve spent years and sweat building.

2) Pay Off Debts with Your Excess Cash

An accumulation of debts is as bad for a business as it is for the average person. The longer it takes your business to pay off those loans, the more interest you end up paying. Paying down your debts is a smart move because it can lower your business’s debt-to-equity ratio. 

This isn’t to say you should pay off everything. A certain level of debt can be beneficial. According to the the experts at Harvard, companies may want to use debt as a financing resource for two reasons:

Tax Deductions–The US corporate tax rate is one of the highest in the world at 35%. But the government does allow businesses to deduct the interest on debt from their corporate income taxes. 

Costs Less Than Equity–As a form of financing, debt is cheaper than equity. First, because a company usually isn’t legally obligated to pay dividends, shareholders want more in the way of a certain return rate. On the other hand, companies have a legal obligation to pay their debts, so it’s less risky for investors and therefore is typically at a lower rate.

Your business model and overall financial strategy will determine what kind of debt you take on, but one way to use an excess of cash is to eliminate the debts that don't provide any benefits to you.

3) Spend Extra Cash on…?

Your own expenses fluctuate much like your revenue does. Whether it’s due to a demand issue, market disruption, seasonality or problems with the supply chain, your costs can suddenly increase at any time, shrinking your profit margins.

You may want to use some of your excess cash to buy more inventory to avoid the above situation. This can be a smart move, especially if the price of what you need is low and you can buy in bulk–as long as you have adequate storage space or another solution.

In the same vein, you may want to take advantage of the opportunity to increase your capital expenditures. The purchase of property, buildings or equipment can bring a two-fold benefit. First, it sets you up for growing your business down the road. Second, you’ll have more in the way of tax deductions.

4) Invest Excess Cash Wisely

Even if your excess cash is in a business bank account that accrues a little interest, you can most likely do better. If it’s sitting in a non-interest bearing account, then you’re actually losing money because of inflation.

You can make long-term investments or invest in short-term offerings that provide some liquidity. The most common categories to invest in are these:

Money markets–Both money market mutual funds and money market accounts are short-term debt investments that provide low risk and high liquidity.

Bonds–Many financial advisors consider bonds the safest of investments, especially for the long term. City and state bonds are usually safer than corporate bonds.

Stock market–This is one of the most common forms of investment for small businesses. Although this type carries various levels of risk, it is often possible to enjoy an annual return of 5%-10% by investing in a diversified stock portfolio.

Managed funds–Through a single transaction, small businesses can invest in a large number of investments that are professionally managed. The main types of funds are investment funds, indexed funds and exchange-traded funds (ETF). 

Banking products–Another common way for small businesses to invest is through simple banking products. These would include certificates of deposit (COD)s and high-performance savings accounts.

The above list is certainly not exhaustive. Some businesses may also want to look at investing in annuities, options or retirement plans. Should you decide to invest your excess cash, it’s always a good idea to consult a financial advisor before taking action.

5) Reward Your Employees with Extra Cash

If you’re sitting on a pile of profits that your employees are largely responsible for by hitting their performance metrics, then you may want to show them some appreciation. You can reward them with cash bonuses or with 401 (k) contributions. 

Don’t worry if the pay out doesn’t seem big enough. Even small bonuses are good for morale and incentivizing future goals–both of which can help with increased job satisfaction and reduced employee turnover.

So How Much Excess Cash Do You Really Have?

Before you decide how you want to allocate your excess cash, it’s critical to know exactly how much you have. If you’re relying on manual processes to identify the amount, you should know there’s a good chance that amount will not be accurate. For one thing, the data used to calculate that total is not real-time data. The true total could be higher–and it could be lower. 

Another factor that comes into play is the other cash available to you–the idle and hidden cash you have but simply don’t know about. Whereas excess cash is usually thought of as extra cash that’s not being used for current operational costs, idle cash also includes funds in a checking account or investments that aren’t earning income. Then there’s hidden cash which is locked into your receivables and payables. 

How to Use AI-enabled Technology to Unlock All Excess Cash

Cash management platforms that are driven by machine learning (ML) and artificial intelligence (AI) can help identify all your excess cash, so you can make as much as possible work for you. 

Not only do these software solutions provide real-time visibility into your cash positions, they can help increase cash flow (which can mean even more excess cash) by:

  • Automating the invoicing process
  • Managing vendor payments
  • Accelerating customer payments
  • Streamlining AP and AR processes
  • Predicting payments
  • Identifying high-risk accounts
  • Improving cash forecasting
  • Improving cash management

Because AI-driven cash management software, such as Payference, learns from your historical data, it can more accurately predict how much cash will be coming in to meet your current operational costs.The technology also determines the best time and terms for your payables, optimizing working capital to unlock hidden cash. 

All these functions work together to give you insight into all the excess cash available to you. If you’d like to learn more about how an all-in-one cash management tool like Payference can impact your overall finance operations, schedule a demo today.