All companies must have sufficient cash to meet the company’s payment needs (suppliers, salaries, taxes, among many others). In this daily task carried out by the treasurer, they may temporarily face situations where available cash exceeds the company’s needs. Good cash management anticipates these moments and takes the opportunity to invest those funds, always within the framework defined by the company’s investment policy, to generate additional returns for the organization. When this temporary excess cash becomes more permanent, the first reaction of the organization is to seek higher-risk instruments to maximize returns. However, we have seen that companies can benefit more by improving the company’s cash flow projection so that surpluses are invested in instruments with longer duration, aligning future needs with the maturities of the instruments.

Companies generally tend to think there will be opportunities to improve returns by choosing equity instruments or low -quality-credit bonds—financial instruments and institutions that are typically explicitly prohibited or limited in companies’ investment policies. On the other hand, few companies focus on the most relevant aspect: creating and maintaining a projection of operating, financial, and investment cash flow that allows them to maximize the duration of investments. In our experience, to achieve better returns, among all actionable parameters, the duration or term of financial instruments is the most effective.

The ability to keep funds invested for longer is the most relevant factor in maximizing the return on cash surplus investments. The longer a company can keep its funds invested, the higher the return it will obtain. This is because, over time, interest and dividends accumulate and are reinvested, increasing the total return on investment.

In a recent project, we discovered that there is “an additional level” of return/risk for companies, only available to those with high/long cash predictability—corporate bonds. In general, very few companies consider this alternative because cash, as defined by senior management, is not intended for speculation or taking on risks not inherent to the business. This type of investment requires a particular condition so that the management and presentation in the financial statements do not generate volatility—by declaring the investment as “held to maturity,” there is no recognition of a higher or lower value during the period the instrument is held, and the gain or loss is realized only at the time of liquidating the bond.

A good example of a corporation that makes these types of investments is Apple’s subsidiary that manages over $200 billion in cash and cash equivalents, Braeburn Capital. Since Apple structurally generates excess cash chronically (its cash and cash equivalents reached over $200 billion in February 2022), and due to the 30% tax on repatriating profits to the U.S. generated internationally, it creates a situation where there is a lot of cash held outside the U.S. For this reason, Braeburn has invested 44% of this cash excess in corporate bonds with durations of 1 to 5 years, which on a consolidated basis has represented between 5% and 10% of Apple’s bottom line between 2013 and 2020.

It’s important to note that maintaining a short- and long-term cash flow is not trivial. For most companies, this requires a lot of coordination between different areas of the company, which often do not have the proper communication channels. Sales projections, collections, purchasing inputs and services, operating expenses, commodity prices, exchange rates, and many other items need to be projected over time horizons typically ranging from 12 weeks to 3 years to achieve the goal. Even so, we have seen companies in Chile that have excellent cash management and achieve outstanding results in their investments by using this disciplined cash projection

In a study where we analyzed the cash management of six large Chilean companies across four industries, we observed that all maintained an investment policy approved by the Board of Directors, explicitly stating the treasury objectives (capital preservation and maintaining sufficient liquidity) and defining approved investment instruments (term deposits and money market funds). Along with the policy, all companies conducted short- and long-term cash flow projections. In the more sophisticated ones, available cash was separated into “buckets” (short-long or buffer-surplus) to manage safety cash independently from investment cash, thus matching the duration of investment instruments with future cash needs.

So, if you don’t have an investment policy, build one—in all of them, you will see that the important thing is to limit risk by limiting the type of instruments (low or very low risk) and counterparty risk (operating with solid institutions to ensure the integrity of reserves). If you don’t have short- and long-term cash flow projections, start by building them together with the areas that know the outflows and inflows best.

In your journey to improve cash management, don’t focus on seeking higher-return (and higher-risk) instruments; instead, your focus should be on how to (1) ensure an investment policy (if you don’t have one) that limits investment risk and (2) improve cash flow predictability with adequate models that then allow you to improve the duration of instruments to invest. Only then will you achieve a better average return on your cash in a safe and appropriate manner.

At Montblanc, we have helped large companies understand cash uses and sources, cash flow variability, define a safety cash reserve, maintain a schedule of relevant flows, and model cash flow projections to maximize investment returns by optimizing durations, achieving excellent results.

We can help you prepare and implement your cash management strategy.