Play Money

Some companies are earning high returns on their idle cash -- and living to regret it.
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Richard C. Russell was in trouble, and he knew it. A vice-president and treasurer of Danis Industries Corp., in Dayton, Ohio, he had invested a hefty chunk of his company's idle money in Mead Money Management Inc.'s Corporate Cash Management Fund, a mutual fund with $225 million in assets used by businesses with intermediate-term cash to invest. Before long, the mutual fund's share price took a nosedive. Fortunately, Russell knew what he had to do next. Before investing in the mutual fund, he had established target levels based on returns that would determine when he would sell Danis's shares. That is what he did, and, in the end, the family-owned construction company escaped with all but around $20,000 of its original investment.

Russell is, of course, not the only person to drop a few dollars in a mutual fund. But, unlike a lot of people, he had had the good sense to learn from his experience. Now when he invests Danis Industry's idle cash, he looks at security and liquidity first and high aftertax yields second.

That is a wise practice, but it is not always an easy one to follow (See INC., June 1983, page 48). Ever since interest rates started to rise in the early 1970s, corporate finance departments have been under tremendous pressure to boost earnings on "idle corporate cash" -- dollars that companies don't need for 90 days or more. And although interest rates have started to decline, the pressure hasn't let up. With venture capital harder to come by and the market for initial public offerings in a slump, many small, private corporations have started to look at their idle cash -- properly invested -- as a way to stretch their existing resources.

Exactly where small and medium-size companies should invest this money depends in large measure on the size of the company and how well it is capitalized. A big public corporation with, say, $10 million in idle cash can try a variety of investment vehicles, whereas a small private company with $100,000 doesn't have as many options.

Another consideration is the length of time for which the cash is to be invested. Money market mutual funds make sense only for intermediate and long-term cash. Six-month certificates of deposit (CDs) don't pay if you cash them in prior to their date of maturity. Also important is the amount of time executives can spare on tending the company's investments. "Your job," advises Edwin P. Morrow, chairman of Confidential Planning Services Inc., in Middletown, Ohio, "is not to be a financial wizard. It's to make widgets or whatever else it is you are in business to do." Another consideration in investing idle corporate cash is the tax situation of the company. Corporations in the 46% tax bracket need to weigh the tax implications of their investments. Companies that aren't making a profit and therefore aren't paying any taxes don't need to bother.

As a rule, all companies investing their idle cash must make security a prime consideration. And the safest place to deposit money is in CDs from banks and savings and loan associations. The money is insured by the Federal Deposit Insurance Corp. (FDIC) or the Federal Savings and Loan Insurance Corp., it earns fair market interest rates, and there is an added bonus -- depositing money in a bank helps a company build its relationship with its banker. "If you need money," says Beverley McKinney, a vice-president at First Huntington National Bank in Huntington, W. Va., "it's nice to know that money will be available. You can't get a loan from Merrill Lynch." That's a hard point to ignore, or so Kent Johnson, president and chief operating officer of Microrim Inc., a software manufacturer in Bellevue, Wash., decided. He considered depositing his company's cash elsewhere to capture a higher yield, then nixed the idea. "Our bank," he says, "stood by us during the tough times. It isn't worth messing up a good relationship to take our money elsewhere."

Major brokerage houses do not make loans, but they do offer higher yields. Consequently, many companies have begun investing their idle corporate dollars in the new money-market central asset accounts, such as the one offered by Fidelity Investments. The money-market funds invest in Treasury bills, government securities, and other money-market instruments. Central asset accounts usually yield about a half a point more than bank CDs. What's more, they allow customers to write checks on the money deposited. Many of these accounts also provide discount brokerage services, gold credit cards, traveler's checks, plus a small line of credit ($5,000). The initial investment for these accounts generally runs from $2,500 to $40,000. The fees for maintaining the accounts vary, starting at around $3 a month.

Despite, or perhaps because of, the growing number of investment opportunities these days, companies should beware of overemphasizing the concept of cash management. Some businesses, for example, have turned their corporate finance departments into bona fide profit centers, and have begun evaluating their chief financial officers in the same way as they evaluate other corporate managers -- by how much they contribute to the business's bottom line. As Richard D. Lehmbeck, a partner in the Roseland, N.J., office of Main Hurdman KMG, the accounting firm, puts it, "Cash has become a commodity. [As such] it is being expected to perform like any other corporate asset." That is a relatively new attitude.

The burgeoning financial services industry has, of course, contributed to businesses' awareness of the cash management possibilities. Everyone, it seems, has gotten into the act: banks, brokerage houses, mutual fund organizations, and so on. Even accounting firms are trying to out-razzle-dazzle each other with cash management strategies. One CPA firm, Alexander Grant & Co., has gone so far as to advertise its promise to transform your company's comptroller into a profit center -- if you will just shell out several thousand dollars for the firm's computer software package. Needless to say, the ad makes no mention of any problems or risks that might be associated with such a transformation.

One clear example of dangerous risk-taking is the practice of some cash managers who deliberately deposit corporate dollars in unstable banks. The reason these people go to such institutions, the FDIC says, is that troubled banks are willing to pay higher-than-market interest rates just to hike up their deposits. The beauty of the scheme, these cash managers believe, it that there is little risk to the corporation or its cash, as long as it doesn't deposit more than $100,000 -- the amount insured by the FDIC -- in a single institution. But what these cash managers may not realize is that they can get burned badly if the bank goes under. Their company's cash can be tied up for a while as the FDIC investigates the bank's failure and processes the necessary forms. It is tough luck if the corporation needs the money before that process is completed.

Such scheming aside, it is possible for even the most responsible financial officer to trip up, given the growing number of investment vehicles and the volatility of the financial markets. Danis Industries's Russell, for example, could not have predicted the sharp drop in the share price of the Mead Fund. That is because the culprits weren't the managers of the fund, but the condition of the banking industry as a whole. Skittishness over loans to Latin American countries, combined with the failure of Continental Illinois National Bank & Trust Co., sent the entire market for adjustable-rate preferred stocks into a tailspin. Virtually all of the funds' share prices took a plunge.

Some companies have also been drawn to mutual funds by tax laws that allow U.S. corporations that own stock in other companies or in mutual funds to exempt 85% of the dividends they receive from their taxable income. The appeal of this tax break to financial officers like Russell is easy to understand. Suppose, for the sake of illustration, that a company that pays the maximum corporate income tax rate owns stock in a mutual fund. Suppose further that in the first quarter the business is paid dividends of $10,000. Eighty-five percent of that amount, or $8,500 is not taxable. The remaining $1,500 is subject to taxation at the company's normal tax rate -- in this example, 46%. That makes the effective tax rate a meager 6.9%.

Good as that yield may sound, however, mutual funds may still be an unwise investment vehicle for many small and medium-size companies. Some are quite risky, and the money is tied up for six months or more.

"In an investment like this one," notes Russell, "you could wake up in two or three weeks with 10% of your principal gone. You've got to be prepared to leave the money in for a while."

Gregory Nenni, president of URS Printers Inc., a small, privately held printing company in Middletown Ohio, has a different perspective on the whole concept of cash management. He has a money-market account with the Midwest Group of Funds in Cincinnati. But he doesn't keep his company's money in the fund for very long. The best place to invest his idle corporate dollars, he has discovered, is in his own business. "We can get 10% a year on our money in the money market, but if we invest in a new piece of equipment, we could draw 20% or 25%. The dividends are much higher."

Last updated: Dec 1, 1984




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