Investing Surplus Cash. Surplus cash that is not required in the short run should be invested in liquid assets, Le.. marketable securities, or other securities that can be instantly converted into cash when required. Cash itself is an unproductive asset, and keeping it in the same form will not benefit the firm. Rather, it has its own opportunity cost, and to avail the same, it should be invested elsewhere. The area for investment should be selected with utmost diligence. The following factors may be considered when selecting the right security for investment:
The security selected should be completely marketable, i.e., it should be liquid and possible to realize in cash in an hour of need.
The security should have a minimum maturity period. If the maturity period is long and the funds are required before the maturity date, the same has to be premature but prematurity charges will be attracted.
3) Risk of Default:
Risk and return are directly related to each other. Investments are made for the purpose of gaining a return. But if that brings the risk of default along with it, then the same should be avoided. This might reduce the value of the investment of the firm.
Liquidity and return are inversely related to each other. The more liquid investment will bring lesser returns and vice versa. So, while investing, the timing of the requirements of the company is considered. If the funds are not required for a longer time, the same is invested in less liquid assets to gain a better return.
The company should maintain sufficient funds to meet its obligations. But, if the same is not retained and the company finds itself in deficit, then it has to borrow the funds at a higher rate of return. So, the cost of borrowing will exceed the number of returns
The last but not least factor influencing the decision is the yield. Much weight is not given to this factor as the decision is largely directed by the above factors.
Apart from considering the above factors, investments should be made in the securities that give the maximum yield.
For example, a firm may break its surplus cash available into the following three major groups:
1) Surplus funds, i.e., the basic reserve kept making the unpredicted payments. In this situation, marketable security is more beneficial than the one giving the maximum yield. As in the case of need, the same can be immediately realized in cash.
2) Surplus cash is at the disposal on certain pre-decided dates for the disbursements like tax, dividend, capital expenditure, etc. In such a situation, investment is made in securities having a definite maturity period and that too relates to the date of the disbursement.
3) Surplus cash, i.e., other reserves that are not required for any particular purpose. In this case, investment is preferred in securities having longer maturity periods and giving maximum yield.
As a finance manager, certain decisions like how much to invest, where to invest, and when to invest hold the key. If the same can be taken correctly, the firm can minimize the cost and the maximum can be reaped out of the surplus cash.
Controlling Cash Outflows- Click here