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Using Cash Flow Surpluses for Investment or to Pay Down Debt

Filed under Cash Flow. Fact checked on May 24, 2012.

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Once you've improved your cash flow, you'll likely encounter a lovely problem: a cash surplus for your business. Before paying down debt or investing with your extra capital, learn the pros and cons of each.

A cash surplus is the cash that exceeds the cash required for day-to-day operations. How you handle your cash surplus is just as important as the management of money into and out of your cash flow cycle.

Two of the most common uses of extra cash are:

  • paying down your debt
  • investing the cash surplus

Like so many other things you do for your business, deciding where to use your cash surplus requires some planning and your better judgment.

Paying Down Debt

Paying down any debt you may have is generally the first option considered when deciding what to do with a cash surplus. Rightfully so because a short-term investment of your cash surplus is not likely to yield a return equal to or greater than the rate of interest you're paying on any of your debt.

It doesn't, for example, make any sense to invest a cash surplus at 5 percent when you can pay down a bank loan that is charging interest at 12 percent. However, the decision to automatically pay down debt may not be correct in all cases.

One of the key advantages of managing your cash flow is the ability to predict the future cash requirements for your business. That is, it should help you determine when your business may need to rely on external financing as a source of cash. The need for external financing may be the result of expanding your business, purchasing new property or equipment or just getting you through a normal seasonal down period.

Whatever the reason, preparing a cash flow budget is the best way of predicting these future needs for cash. With at least some indication of your future cash needs, you can then make some decisions regarding the best way to finance those needs.

For example, you may feel that interest rates are relatively low at this time and that you look for them to rise in the near future. Therefore, instead of using your cash surplus to pay off a two-year loan at 10.5 percent, it may be beneficial to invest the surplus temporarily, and avoid a much higher interest rate on a bank loan one year from now.

Investing the Cash Surplus

When investing a cash surplus, it's only natural to seek the highest rate of return for your investment. Four factors must be considered when making your investment decisions:

  1. risk
  2. liquidity
  3. maturity
  4. yield

Each factor plays an important role in determining the rate of return you receive on your invested cash surplus. These factors can also help you determine how much to invest and when to invest your surplus.

There are many investment opportunities available for your cash surplus. You must consider the advantages and disadvantages as well as the levels of risk, maturity, liquidity and the yields of each of your investment opportunities. The following are just a few of the investment opportunities you may have:

  • checking accounts with interest
  • sweep accounts
  • treasury bills and notes
  • certificates of deposit (CDs) and money market funds

We suggest you consult with a professional before making any investments. Professionals who specialize in helping their customers make wise investment decisions can help you determine the best possible investment opportunities for you and your business. Many banks offer cash management services to their customers as part of their banking services. Contact your bank for more information about their cash management services.

Characteristics of Investment Options

The level of risk you are willing to accept ultimately determines the yield of your investment. A higher level of risk will generally provide you with a higher yield. On the other hand, a low level of risk will result in a lower yield on your investment. 

In some cases, you choose to invest in an investment with a higher level of risk to gain a higher yield. But as a rule, a conservative approach to the level of risk is recommended when investing your cash surplus.

Considering the Maturity of Investments

Maturity is the term used to describe the length or the duration of your investments. Many investments are made to be held over a certain period of time. An investment that is referred to as having been held to maturity. When an investment has reached its maturity, the original investment and any gains or losses earned by the investment are returned to the investor.

The maturities of your investments should occur so that the surplus cash is available when your business needs it. Preparing a cash flow budget is the best way for you to determine the appropriate maturities for your investments in light of your future cash inflows and outflows. 

As a general rule, you should try to stagger the maturities of your investments so all your cash isn't tied up waiting for one investment to reach maturity. Investments that mature at a time when your business does not require the surplus cash can always be easily reinvested.

The maturity of your investments has a direct impact on the yield of your investment. A longer maturity will generally provide you with a higher yield. On the other hand, an investment with a shorter maturity or no maturity at all will result in a lower yield on your investment.

Considering the Liquidity of Investments

Liquidity describes how easily you can access the cash you put into an investment. The liquidity of investments varies greatly. 

For example, investing your cash surplus in a money market account is very liquid. You can pull cash from a money market account when you need it without incurring any penalties for withdrawing the funds, although you may need to maintain a minimum balance. Other investments offer less liquidity and have penalties for withdrawing early, such as a certificate of deposit (CD) penalizes the holder for early withdrawal.

When investing your cash surplus, be sure to consider the investment's liquidity. If the amount and duration of your cash surplus are uncertain, then you should consider only those investments that offer a high level of liquidity. On the other hand, if the amount of your cash surplus and the duration of the surplus are fairly certain, then less liquid investments should be considered. Preparing a cash flow budget should help you determine the amount and the duration of your cash surplus.

The liquidity of your investments also affects the yield of your investment. An investment that is highly liquid, such as a checking money market account, will generally result in a lower yield on your investment. On the other hand, an investment with a low level of liquidity, such as a CD, will generally provide you with a higher yield.

Yields of Various Types of Investment

Yield is the last factor to consider when making your cash surplus investment decisions, but it's certainly not the least important. For most investments, the yield is determined by three other factors: risk, maturity and liquidity.

Once you've determined your acceptable level of risk, maturity and liquidity, the type of investment and the yield of the investment are pretty much determined for you, or at least you've narrowed your options.

Checking Accounts with Interest

Interest-bearing checking accounts are the simplest method of investing a cash surplus. Since they operate like a regular checking account, no action is required on your part to invest your cash surplus.

A checking account that earns interest is generally required to maintain a minimum balance at all times. The bank or financial institution might also place limits on the number of transactions that can occur during one month in the account. Transactions over the maximum number of transactions will be subject to additional transaction fees.

Interest earned by the account is computed based on the daily average balance in the account. The rate of interest earned by the checking account is comparable to the rate of interest earned on a passbook savings account.

Sweep Accounts

Sweep accounts can be an effective and easy way of investing any cash surpluses you have. A sweep account is a combination of a regular checking account and a money market account. 

Sweep accounts were designed with small businesses in mind since most small business owners do not have the time or the large cash surpluses necessary to take advantage of more profitable investments. By combining a regular checking account and a money market fund, sweep accounts eliminate the need for you to estimate bank balances and move funds from your checking to an investment account when necessary.

With a sweep account, you are required to maintain a certain balance in the account. The bank then "sweeps" the account and removes any funds that exceed your required balance. 

The bank automatically invests the excess funds in a money market account selected by you. When your account drops below its required balance, the bank automatically "sweeps" back enough money to your account to bring it up to its minimum balance.

Most banks will charge a fee for operating a sweep account and only allow a certain number of transactions per account before incurring extra transaction charges. Each check written on the account and each check deposited into the account is considered a transaction. All transactions over the maximum are subject to a separate transaction fee.

The money market fund you direct the excess funds into will determine the yield on the money market portion of the sweep account.

Treasury Bills

T-Bills are direct obligations of the federal government issued at a discount for periods of three months, six months or one year. Treasury notes, on the other hand, have longer maturities. 

Treasury bills have been, and continue to be, a popular investment for short-term cash surpluses. They trade on an active market that provides instant liquidity. Treasury bills also provide your business with the option of choosing almost any term of maturity, from one day up to one year, through secondary markets.

Treasury Notes

You may be able to use treasury notes to invest any cash surpluses that you expect to have for more than one year. Treasury notes are longer-term government obligations than T-Bills. 

The maturities for treasury notes are longer than one year. The secondary market for treasury notes provides liquidity and the opportunity for you to purchase outstanding notes with shorter maturities to match your investment needs.


Certificates of deposit are a popular tool for investing the cash surpluses of a business. CDs are time deposits with banks and other financial institutions. The interest earned on CDs depends on the amount of time you're willing to part with your cash surplus and on the amount you have to invest. 

The longer you are willing to part with your cash surplus, and the more you have to invest, the higher the interest rate you'll receive. Most CDs impose a penalty if the certificate is cashed in before it reaches full maturity. Your bank should post the rates it offers for varying terms and deposit amounts.

Money Market Funds

Money market funds are pooled funds investing in various money market investments—including treasury bills and notes, CDs, and commercial paper. Money market funds minimize your risk by diversifying your investments and offer a favorable yield. Money market funds are very liquid. 

Funds can be withdrawn immediately or on one-day notice. Money market fund accounts are available at banks, but they can also be established through stockbrokers or directly with mutual fund companies.

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