In light of the recent dramatic fluctuations in the banking sector, many founders are scrambling to liquidate their investments and shore up their cash reserves. Many investors believe that this hike by the Federal Reserve will lead to more rate hikes in the future, making it difficult for startups and other small businesses to borrow money at traditional rates. While this could lead some founders to panic and increase wasteful spending, others may choose to diversify cash holdings across a wider range of investments in order to mitigate potential future risks.
It can be tempting to spend hours emailing different banks in search of the highest yield payout and agonize over hunting for an extra five to 10 basis points of yield. However, as a founder with limited time, you are better off managing other parts of the business. Cash management automation has reached a point where you and your finance team no longer have to spend hours to achieve yields that reflect the current market rate. This exercise illustrates why you are better off spending your time elsewhere.
Assuming you want to invest the money, here are 5 things you could do with $25 million:
1. You could start your own company and hire 20 employees.
2. You could buy a luxury home in a popular city and live comfortably for
Each dollar of value you create is time and effort that wasn’t spent elsewhere. It can be difficult to quantify these intangible benefits, but having an external provider help manage your finances provides a tangible return on investment. By automating your financial processes and freeing up time for other activities, you’re supporting the growth and success of your business.
It’s now common to see online bank rates in the 2.5%-3.0% range, which is a significant drop from earlier this decade when it was typical to find Treasury yields around 5%. While not all of these new competitive rates are permanent – some may expire or be changed once again in reaction to economic conditions – the takeaway for now is that you’re likely better off devoting your time and effort elsewhere.
When it comes to cash management, the University of Missouri has found that it costs $35 per $100,000 salaried employee in the first half-hour they spend evaluating potential providers. This calculation only covers the initial actions of talking to your current bank or sending an email inquiry to new providers; it does not include the follow-up conversations, internal meetings deciding whom to use and the subsequent steps involved to get things moving. While on one hand this amount may seem excessive, consider that Mizzou’s Finance Team estimates that it spends up to 8 hours a month doing research on cash management options. In total, this means that upholding optimal cash flow can cost over $8,000 per year!
Therefore, it is important to assess the risks and rewards of pursuing any opportunity before investing. Possible opportunities should be carefully considered and weighed against their associated costs and potential downside.
As yield levels approach or exceed competitive rates, managers may consider increasing risk through the addition of higher-yielding assets. For example, a company with an expected return of 5% per year and a growth rate of 10% would generate 104 extra basis points (.104%) in additional yield if it invested in risky assets (i.e., stocks with higher growth potential) instead of safer government bonds yielding 2%. However, by adding this level of risk the company is also exposing its capital to potential depreciation that could reduce its value over time. In this sense, the trade-off between ongoing reward and heightened risk must be carefully weighed for each individual asset class in order to maximize shareholder value
The key to financial stability for a startup is building a strong cash flow foundation. While some digital assets provided exceptional APY last year, ultimately many of these companies collapsed and lost all or part of their operating cash. This negative outcome points to three essential truths about cash management that every startup should acknowledge: 1) Digitally based investments are high risk; 2) liquidity needs cannot be ignored; and 3) retaining operating flexibility is key. By understanding these realities, startups can build a financially stable foundation for future growth.
Three factors that can quash your cash management efforts
Cash stores can be a great way to protect your company’s cash flow and extend its life in a non-zero interest rate environment. However, three factors commonly keep founders from experiencing these benefits: creating interesting products, marketing their company efficiently, and managing expenses effectively. By understanding and optimizing each of these areas, you can increase your chances of success while minimizing potential costs.