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Short Term Investing of Your Working Capital

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With a challenging business climate and rising interest rates, business owners should consider the management of working capital a top priority.

Yet many neglect to focus on analyzing their cash flows, forecasting their cash positions and developing short-term investment guidelines that will help them improve the return on their idle funds. Sound investment guidelines coupled with effective cash management can, for even short time horizons, generate interest income that contributes to a company’s bottom line.

Anthony Carfang, co-founder and partner of Treasury Strategies Inc., suggests that good cashflow forecasting is important if a company wishe to improve interest income. While cash-flow forecasting cannot guarantee future performance or success, it is a sound cash management practice. Online banking services are increasingly helping businesses monitor their cash positions in real time. “Companies would be wise to use online services daily to monitor positions and use sweep investment accounts,” Carfang said.

He added, “First, organize your system so all your money winds up in one place. Second, use a sweep account to keep money invested. Third, practice cash-flow forecasting with an eye on achieving a higher yield consistent with your risk tolerance and investment policies.”

Establish Investment Guidelines A company’s investment guidelines serve as a “road map” for selecting appropriate investment alternatives. This policy should state acceptable investment vehicles, outline acceptable risk parameters (security and interest rate), and provide guidelines for the investment’s maturity (overnight out to 2 to 5 years).

Most business investors have 3 primary objectives:
•Preserve Principal–loss of principal is unacceptable
•Maintain Liquidity–cash must be available when needed
•Achieve Highest Yield–while complying with safety and liquidity requirements

In conjunction with these objectives, a policy should account for risk tolerance.

Analize Cash Flow
Historical sales patterns can provide the trends for future cash flows. Cash-flow forecasting may also come from the field sales staff, especially for manufacturers or wholesalers. These projections, whether weekly, monthly or quarterly, help the company project account balances and develop a short-term cash-flow forecast. This analysis helps ensure that they have funding for daily operations while allowing them to project the balances that may be invested out over a longer term and potentially increase the yield on the portfolio.

Plan Your Investment
As you consider investment options, you should answer four basic questions:
1 How much cash is available for investing and for how long? This is where short-term cash-flow forecasting is essential. Based on this analysis, you will determine the duration of your investment pool:

A Operating Cash–Very short term, up to 30 days
B Short-term Cash–30 days to 1 year
C Intermediate Cash–1 to 7 years

2 What securities may be invested in and what is an acceptable credit rating? Short-term investment guidelines should clarify what instruments you are allowed to invest in and the safety rating of the
investment.

3 How is the business organized? Your business structure along with your current tax rate will help an advisor determine whether tax-exempt investment alternatives are appropriate.

4 What is the company’s tax bracket? Your accountant or tax advisor can provide you with this important information.

Improve Investment Yields
Four basic ways to improve investment yields include:

Improve after-tax returns: Companies in higher federal tax brackets may see better after-tax returns by investing in federally tax-exempt securities. Compare yields on tax-free obligations to those on their fully taxed equivalents to determine which may give a better return. For example, to equal a yield of 4% on a tax-exempt municipal note, a corporation in the 34% tax bracket would need to earn a yield of 6.06% on a fully taxable instrument. For some tax benefits, the company’s business structure may be a determining factor. A C corporation, for example, can use the
Dividends-Received Deduction (DRD) to improve returns. Subject to certain restrictions, federal law allows regular C corporations to deduct from taxable income 70% of the dividends they receive from stock they hold in other U.S. corporations.

Extend maturities of investments: Your investment guidelines should account for your liquidity needs, so you should be able to determine how much cash you can commit for terms of 90 days or more. Consider what amounts would be reasonable for intermediate-term investments that mature in one to three years. If you are building cash reserves for planned expansions, acquisitions or equipment purchases, consider holding these reserves in an investment for a year or two. Diversify credit quality: Your risk tolerance should also be assessed as part of your investment guidelines. As such, you should determine which potentially higher yields might fit that risk. A conservative approach would
limit you to choosing only obligations backed by the U.S. government. While this choice is low risk, its yields are correspondingly low as well. You give up the potentially higher yields of investmentgrade corporate obligations that have a relatively high-degree of safety.

Determine choices based on cash availablefor investment: As your business builds stronger cash reserves, you can choose from a wider array of investment alternatives. You might consider offerings that provide potentially better rates than those with lower-minimum requirements. Treasury bills, for example, with a required minimum
investment of $10,000, are available in multiples of $1,000. But if you have $100,000 or more to invest, you might seek investments with higher minimums and potentially superior yields.

Any information presented herein about tax considerations affecting financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither Merrill Lynch nor its Financial Advisors provide tax, accounting or legal advice.

Professional advisors should be consulted for any planned financial transactions or arrangements that may have tax, accounting or legal implications.

From The Business Whitepapers, “Short-term Investing of Your Working Capital.”