Treasury Management for Small and Medium Business

Dear Friends,

                  The purpose of his blog is to explain how professional financial management of Small and Medium Businesses (SMBs) can impact the bottom line or profits of business, especially the treasury management.

SMBs cannot afford the luxury of a dedicated Treasury Manager to be able to manage their working capital requirements and long term finances, by investing them in instruments that will be able to generate better risk adjusted returns. Their typical approach is to use Bank Current Account Deposits and Fixed Deposits, depending on their cash flow needs. The question is if this is the best approach to manage the finances of the company or there are better alternatives and if there are options what are expected returns that can be generated by investing in them and what are the additional costs.

The cash flow requirements of SMB’s can be categorized as follows:

• Less than 1 month – Immediate Needs – Category 1
• Greater than 1 month and upto 3 months – Near Term Requirements –    Category 2
• Greater than 3 months to 1 year – Medium Term Requirements – Category 3
• Greater than 1 year – Long Term requirements – Category 4

 The reason we need to categorize the requirements is because the type of product/instrument where the funds can be parked differs with the tenure. There is no hard and fast rule in the categorization and to get incremental returns from the corpus, the 1^st category or immediate needs can be made as less than 2 weeks also.

The typical approach followed by SMBs is to park the corpus requirements of category 1 in current account of Banks and park Categories 2 to 4 in fixed deposits.

The approach that I would propose remains the same for Category 1 where the immediate requirements need to be parked in Current Account. However the approach for Categories 2 to 4 will be different to achieve better risk adjusted returns.

Mutual Funds offer Debt instruments for varying tenures of investment that offer a great alternative to Bank Fixed Deposits, provide higher returns and better flexibility. These funds invest the corpus in Government Treasury Bills, Bank Deposits and Company Deposits depending on the Scheme. They offer a variety of products including Liquid Funds, Ultra Short Term funds, Short, Medium and Long Term Funds suitable for various types of investment requirement depending on the investment horizon or period.

SBI Fixed Deposit currently offers a return of 5.5% for periods of 7 days to 45 days, 6.75% for periods of 46 days to 179 days and 7.25% for periods of 180 days to and year for deposits greater than 1 crore. There is a 1% penalty charge for premature withdrawal.

Liquid Funds from Mutual Funds currently offer a return of 8.5% (which will go down if the RBI cuts interest rates but that is applicable to Bank Fixed Deposits also). The beauty of this product is that there is no lock in period and money can be parked for just 1 days also (and you will get returns for the same). For withdrawal (referred as redemption in MF parlance) if the request is given before 2pm (referred as the cut-off time), the amount will get credited back to the bank account by 10am, next day. So SMBs can clearly get about 2% additional returns by parking the corpus in Liquid Funds over Bank Fixed Deposits. Even if we assume a management fee of 0.5% (professional fees to advisors) the incremental returns work out to 1.5 Lakhs per crore on annualized basis and if the corpus size is around 5 crores this is a cool “7.5 Lakhs” of additional money for the SMB’s.

 Typically, only the Category 2 corpus would be parked in the Liquid Funds and the Category 3 and 4 can be parked in Short and Medium Term Funds which will give an additional 0.5 to 1.5% return. i.e. 9% to 10.5% depending on the product. So by managing the Corpus smartly the incremental return that can be generated for average corpus of 1 Crore will be in about 2 lakhs per crore.

Investments in Mutual Funds are considered only in the top and reputed Fund houses like Birla, Franklin and HDFC so that the quality is not compromised to generate higher returns.

The following table gives the returns generated by some of the select funds of HDFC, Franklin and Birla for periods ranging from 1 month to 3 years as on 1^st week of July 2015. The returns for period of 1 month and 3 months are not annualized.

The SMBs need to clearly categorize the requirements and do a detailed planning with the professional financial advisors so that their cash flow requirements are not jeopardized and they also understand the process involved in Mutual Fund Investing and the risks thereon.

 <Blog # PenguWIN 1029 – Treasury Management for Small and Medium Business>