Corporate cash: handle with care

Written by Joe Prendergast and Catriona Coady

23 September 2020

Negative interest rates have arrived – options for corporate deposits

Most cash-rich organisations follow a highly conservative investment strategy aimed at protecting the value of cash in order to ensure maximum liquidity.  This most often simply means leaving money on deposit at a bank or financial institution.  Traditionally, some interest would be received and compounded, such that the value of cumulated profits could grow and at least keep pace with inflation, while still being liquid. Today, negative rates mean that the value of cumulated hard work and enterprise is eroded every day it is left in the bank.  With negative rates here to stay for several years, the choice faced by corporate Treasurers appears stark: accept negative interest rates and erosion of value – or accept less security and liquidity.

The conservative solution

There is no one single solution to resolve this dilemma. Instead, treasurers should consider a combination of careful liquidity planning and conservative credit strategy to maintain security without negative interest rates. By doing so, it is possible to both sustain ample liquidity and sustain the real the value of retained cash earnings.  

The single most important task is to determine what liquidity is needed and when will it be required? Cashflow forecasting can determine the minimum amounts required to sustain in highly liquid and secure form over time. For this purpose, both cash in the bank and investment in the highest-quality, short-term government bonds should be considered. While the latter are more secure in terms of credit risk, the yield is similarly negative on both. 

Secondly, for cash in excess of foreseeable needs, some additional credit risk can be taken while still maintaining liquidity for unforeseen circumstances. For example, Goodbody has a positive income portfolio (PIP) strategy which combines a diversified range of short-dated, high quality, liquid credit instruments which together generate a modestly positive yield in euro, after all hedging and management fees are allowed for.

Thirdly, for cash holdings well in excess of foreseeable needs and precautionary balances, more risk and less liquidity could be considered, in exchange for higher expected returns. This can still be a conservative fixed income strategy, with longer-term credit instruments, or it can of course extend even further into public equity markets or illiquid private markets, insofar as the corporate investment policy allows.

What’s at stake? 

Consider a company with €10 million cash on bank deposit, now suffering a -0.65% negative interest rate. If maximum required liquidity for the next year is estimated at €2 million, then there is €8 million on deposit that could transfer a positive yielding, high quality ‘PIP’ strategy earning say a net +0.4% yield. Combined, the negative interest on the required cash deposits and the positive yield on the conservatively invested excess cash are positive at just 0.20% - but that is 0.85% better than the full amount being on deposit at -0.65% - meaning €85,000 in gross difference, or more than €250,000 when compounded over three years.  With some excess cash in longer-term (or riskier) instruments, the expected difference would be yet greater. 

Other important things to consider

While it may be desirable in principle to invest surplus cash, there may be some concern that investing will impact on valuations and tax reliefs – particularly for corporates and SMEs who are focused on preparedness for a sale, third party investment or inter-generational transfer. The way cash is invested can be important in determining how a business is valued and on how it is viewed in the context of some important tax reliefs.  

However, typically where the investment is in assets which are readily convertible into cash this should not create any difficulties from a valuation perspective. On the tax reliefs that are commonly considered by family businesses such as CGT retirement relief and entrepreneur relief and business relief for gift and inheritance tax purposes not all value on a balance sheet may qualify for the reliefs such as value attributable to investment assets and surplus cash. However, much depends on the circumstances, the corporate structure and whether the many other conditions applicable to these reliefs can be satisfied. Therefore a decision to invest may not need to be postponed but it is recommended that it is considered in conjunction with the future plans of the corporate. 

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