“Is there a way to maintain our company’s capital preservation and earn more than the paltry amount of interest we currently receive?”
This common question about maximizing the return on temporary cash balances was recently the topic of conversation with a friend of mine. His CEO was frustrated that the company carried an average balance of several million dollars from month to month, but had no real opportunity to earn any significant interest income.
As I told my friend, there is no “silver bullet.” However, contractors do have a few options to make better use of their excess cash.
The Contractor’s Dilemma
Compared to other industries, contractors generate a large proportion of cash relative to their equity base. This is primarily due to the large draws that are submitted upstream to GCs or owners for their scope of work on projects. The majority of the cash (outside of the gross margin) passes downstream to subcontractors and suppliers. However, there is usually a significant amount of time between when the accounts receivable are collected and the accounts payable are paid.
If you have attended CFMA’s Cash Management and/or Treasury Management courses, then you are keenly aware that a basic tenant of managing liquidity is to invoice (and hopefully collect) draws as quickly as possible while delaying payments to third parties without damaging relationships with downstream partners. This results in relatively large (albeit temporary) positive cash flows.
Despite the recovering economy since the 2009 recession, short-term interest rates have remained close to zero for several years. Regardless of whether or not lower rates have had a positive impact, the U.S. Federal Reserve has been reluctant to increase interest rates given the lack of significant economic growth coupled with low inflation. While there has been some recent indication that the Federal Reserve will increase the rate, it will likely occur over several quarters (if not years).
Since it’s not practical to make any long-term commitments given the rapid movement of funds into and out of a business, what should a contractor do with this “cash in transit”?
While some avenues are available to contractors relative to size, scale, and complexity, three specific options should be considered.
Pay Down Short-Term Debt
Most contractors have some method of short-term financing for their businesses – typically a line of credit with a bank or other credit provider.
The CFO of a small architectural and engineering firm for which I previously worked made it a point to have cash in the bank “just in case.” At the same time, the firm’s short-term lines of credit were significantly drawn upon (often times fully drawn).