How Small Businesses Can Balance Liquidity and Earning Interest on Cash Reserves

Small businesses must maintain access to their cash reserves. But does maintaining access limit the business’s ability to earn interest?

A cash reserve is a rainy-day fund. Small businesses need reserves to grow as much as possible by earning interest. But, as organizations like the U.S. Chamber of Commerce recommend, small business rainy-day funds should contain at least three to six months’ worth of expenses and be accessible within less than 90 days.

Business owners and managers should look for ways to earn interest while remaining as liquid as their business needs.

Key Differences Between Banking Products

Money market accounts and certificates of deposit (CDs) are a common choice for investing business cash reserves. Their rates and ease of access differ.

CDs can have higher fixed interest rates than money market accounts. The interest rate, as well as the funds placed in a CD, are locked in for the term, which can be for years, or just a month or two. If funds must be withdrawn early, the business will typically pay a penalty amounting to several months to a year’s worth of interest.

On the other hand, money market accounts offer access to funds similar to savings accounts with no early withdrawal penalty. But rates are not locked in; they can change over time. Not to be confused with money market funds, which are not usually offered by banks and not FDIC insured, money market accounts are FDIC insured and can offer checks.

Why do these differences matter for small business cash reserves?

Once owners and managers understand their exact liquidity needs, the structures of money markets and CDs can be used in complementary ways that protect funds while providing returns.

Where to Start

Cash reserves cover at least three to six months’ expenses and must be accessible within 90 days. However, not all of it needs to be accessible immediately, which allows businesses to place cash in various accounts.

But how do businesses decide between CDs and money markets?

As we covered in the example shared in our “How Much Should a Business Save?” blog post, if you have $50,000 in sales and $30,000 in expenses, the business runs at a net burn rate of $20,000 per month. This suggests cash reserves will be $30,000 (your monthly expenses) times the number of months you want to be able to run with $0 in sales. In the case of this example, a cash reserve with at least three months of expenses amounts to $90,000.

However, even with fairly substantial disruption, a business may still not need all its reserves in the first month. This is where owners or managers must make a business decision based on risk factors unique to that business. Here are some questions that help define that decision:

• How likely is your business to experience a complete disruption of cash flow? (Examples may be a key customer closing its business or natural disasters.)
• Aside from complete cash flow disruption, what events might reduce cash flow?

And also:

•  How likely are they?
•  And by how much would cash flow decline?
•  How long would cash flow disruption last?

Answers to these questions help define the business’s unique approach to investing cash reserves.

Balancing Benefits

Suppose, using the example above, that three months’ expenses amount to $90,000 and that the business would not need more than the first $60,000 in the first 30 days of business disruption.

In that case, it could keep the first $60,000 in a money market account and utilize a short-term CD to invest the last $30,000. The CD’s term should then be matched to the month when the business will need those funds. Another example is a business that will buy equipment for $30,000 in six months; it could invest in a six-month CD.

Varying banking products in this way can also have benefits for FDIC insurance coverage.

For more mature businesses, expenses—such as staffing, equipment, or loan payments—can easily reach $83,400 per month, and three months’ expenses can meet the maximum balance for FDIC insurance of $250,000. If the business saved six months of expenses, its balances would double the FDIC maximum.

Again, a banker can help with options, and not just for bank accounts and CDs. Small businesses can also access a network of banks through Coastal Community Bank, such as IntraFi, to secure even more insurance for their money market accounts.

With guidance in choosing these options, small businesses benefit from safe and available cash that’s growing with the help of interest.