Cash Flow Management and Investing When Interest Rates Change

In 2020, the Federal Reserve (Fed) began buying government bonds to stimulate economic growth as part of a quantitative easing monetary policy strategy to increase liquidity. It worked. This policy, along with pandemic-related stimulus packages, prompted one of the highest periods of liquidity in the U.S.

Then in 2022, the Fed stopped reinvesting proceeds of maturing securities to reduce its balance sheet — quantitative tightening — to cool the economy.

Now it’s predicted 2024 will mark the end of the high-liquidity period,1 creating cash flow challenges for corporate treasurers.

High interest rates reduce cash flow and increase cost of debt.

The federal funds rate is 4.75% - 5.00%, and the current prime rate is 8.5%. Credit card interest rates average around 24.92%. Recent rates represent a 20-year high.2 The inflation rate is inching toward normalcy. The Fed reduced the interest rate in September 2024, and Chairman Jerome Powell is optimistic there could be more.3

Compared to just a few years ago, borrowing will still be expensive. Given the continuing uncertainty, a liquidity management strategy that balances cash flow is essential. Three key elements will help develop an effective plan.

1. Examine short-, mid- and long-term capital needs.

   Whether interest rates remain high or decline, the main objective is to maximize return on assets to ensure funds are available when needed. Effective forecasting considers capital needs and timing, enabling companies to ride market waves and take advantage of strategic opportunities. David Neely, managing director, Synovus Deposit & Liquidity Solutions, however, believes many businesses are myopic in their views, focusing on short-term cash positions while ignoring future needs. “In today’s economy, it’s smart to look at longer time horizons when forecasting — not just 30-90 days but 12-24 months out,” he says.
   
   Neely suggests cash forecasting should assess what is available now, as well as whether there will be adequate access to capital in the future. “If the business is growing, will there be enough capital to accommodate an acquisition, new equipment or a new building?” Neely asks.
   
   Financial advisors and bankers can help to inform the process. “Look for experts who can help you identify and quantify short, intermediate and long-term goals, as well as the positives and negatives of varying economic conditions,” Neely explains.
   
   “For example, you may be looking a year or two out and assuming the Fed will reduce rates again. If they don’t, how will these decisions affect your business and cash flow? Do you have enough liquidity to maintain day-to-day operations? Cash flow models are essential to these types of ‘what-if’ discussions.”

2. Structure investments according to a capital continuum.

   Once you’ve identified cash flow needs, you’ll want to develop a liquidity plan to address potential gaps along the capital continuum. Again, thinking of short- to long-term capital requirements, the plan should include investments that are targeted to liquidity needs during those timeframes.
   • Primary liquidity
     These are the most liquid assets, including cash and equivalents, which are typically used for operating expenses such as rent, utilities and payroll. Primary liquidity includes corporate savings and money market accounts, checking accounts, and lines of credit.
     
     Short-term investments that mature in less than 90 days and can be quickly converted to cash are also included in this category. These include certificates of deposit, U.S. Treasury bills, government bonds, commercial paper and repurchase agreements.
   
   
   • Secondary liquidity
     Assets categorized as secondary liquidity aren’t as easy to convert to working capital and may impact operations. Equipment, inventory and facilities are examples of assets that can be sold to raise capital. Debt for which maturity, principal payments and interest rates can be renegotiated are other sources of secondary liquidity.
     
     Long-term CDs, Treasury, agency and investment-grade corporate debt, as well as ultra-short bond funds are also sources of secondary liquidity, as well as income. These investments provide “rainy day” funding for long-term goals, such as new building initiatives or long-term tax liabilities. In addition, brokerage clients can automatically “sweep” cash balances into interest-bearing core investments with longer term horizons.

3. Implement an investment policy statement that establishes rules and boundaries.

   To define investment guidelines and objectives draft an investment policy statement (IPS). The IPS is unique to every organization and reflects the company’s risk appetite and values. In addition to providing guidance, an IPS mitigates liquidity risk, enhances transparency, promotes consistency and reduces the potential for ad-hoc or imprudent investment decisions.
   
   “The goal of the IPS is to help companies manage their liquidity investments, ensuring that assets are available to meet short-term cash flow requirements and operational needs,” Neely explains.
   
   Be specific when drafting the IPS, including details on the following.
   • Asset allocation
     The objective is diversifying investments to minimize concentration risks and enhance liquidity available to meet cash flow needs.
   
   
   • Investment selection
     Consider credit quality, maturity profile and liquidity characteristics when making selections to ensure ready access to funds. Yield and safety of principal are also important.
   
   
   • Monitoring and reporting
     It’s imperative to track and assess performance, liquidity position and compliance with IPS guidelines. “Remember, the IPS is a living document,” Neely says. “It must be reviewed regularly to ensure that it’s still relevant and reflective of the company’s evolving liquidity position.”
     
     “An IPS demonstrates commitment to sound governance practices and regulatory compliance,” Neely adds. “It shows that you take stewardship of the company’s assets seriously, which in turn enhances credibility with stakeholders.”

Liquidity management is vital to company stability.

Liquidity management may seem daunting to some, however it’s necessary. “People have varying tolerances and interest in the level of discussion, detail and decision making required. But liquidity management is vital to an organization’s stability,” says Neely.

For more information, complete a short form and a Synovus Treasury & Payment Solutions Consultant will contact you with more details. You can also stop by one of our local branches.