Business owners face a constant balancing act when it comes to deciding how much cash to keep in their everyday checking account.
On one hand, the money in these accounts is available in case of an emergency or unexpected business opportunity. However, federal law prohibits banks from paying interest on business accounts. Congress often discusses changing the law, but in the meantime, you have to get creative to earn a decent rate of return on your temporary excess cash.
Certificates of Deposit
CD are normally single-deposit investments with maturity options ranging from seven days to several years. They can pay a set or variable interest rate, which is usually higher than other bank deposit investments. The reason is simple: The bank feels comfortable that the funds will stay in your account until the maturity date.
The drawback is that withdrawals from a CD before maturity generally result in a penalty. Therefore, look for promotions with no early withdrawal penalties. In some cases, this no-penalty option can be exercised after a certain length of time — sometimes as brief as two weeks. In other cases, you can withdraw money periodically over the term of the CD.
It’s smart to stagger maturity dates on several CDs, rather than having one deposit make up a single CD. That way, you get access to your cash on a rolling basis if you need it. In any event, keep in mind that interest rates may be negotiable based on the strength of your banking relationship.
Money Market Accounts
Money Markets pay interest and give you some access to your funds. With these accounts, you can write checks and make deposits whenever additional funds become available. However, you can usually make only a limited number of transactions during a given period.
That limitation means money market accounts aren’t designed to handle all of your checks or withdrawals. But with basic cash management, they can be an easy way to earn interest and have access to funds on a limited basis.
Sweep Accounts
These are essentially checking accounts in which you give the bank permission to invest or “sweep” funds into an interest-bearing account on a day-to-day basis. These accounts aren’t always promoted by banks, so you may have to ask if they’re available.
Here’s an example of how they work: Let’s say your company routinely keeps large amounts of cash on deposit for short periods. With a sweep account, you instruct the bank to transfer any amounts exceeding, for example, $25,000 into investments such as overnight paper or repurchase agreements. In essence, you transformed a no-interest account into one that pays you interest.
A word of caution: Sweep accounts may not be federally insured. This happens when your excess funds are swept from an insured bank or credit union account to an investment that isn’t covered by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA). If the financial institution fails, you may lose some of your money. With a traditional account, federal insurance generally only covers the first $250,000 on deposit at each institution.
Before making any moves, ask your accountant or financial advisor which of these short-term solutions for excess cash might be wise for your business.