One of the most painful realizations a business owner can experience is seeing just how little interest they're earning on the cash in their savings account.
For years, interest rates have been at historic lows. While that in itself is troubling, pair low interest rates with today's inflation rate, and you're could be losing money on your savings.
Every month that your cash earns less than the inflation rate you're effectively burning money. For example, a $50,000 savings account balance that earns 0.2 percent with inflation at 2 percent would effectively lose $4,700 over five years. If your business earns a 5 percent net profit margin, you'd need to sell an extra $94,000 in goods or services just to recoup the losses from the low interest rate.
Instead of just socking your money away in a savings account, let’s take a look at three other options for your money:
1. Make Your Money Work for Your Business
The best option may be to deploy the cash in your operations. If your business is profitable, then you could put your excess cash to work by doing what you do best. Hiring an extra sales person, purchasing additional equipment or finding another profitable use within your company can ensure that the money is put to good use instead of wasting away in an account with anemic interest rates.
The cost to your business of deploying savings is much cheaper than borrowing money or selling equity to investors. You'll also have the potential benefit of increasing your tax deductions and lowering your overall tax bill.
2. Pay Off Loans and Lines of Credit
You could use the money to pay down any loan or credit line balances on which you're paying interest. Many small-business owners prefer to keep the cash for a rainy day and pay high interest rates on credit line balances. However, it often makes more sense to pay down the credit line but keep it open in case you need it in the future. This takes care of the problem of having emergency access to cash without paying thousands of dollars in unnecessary interest costs.
3. Employ the Laddering Technique
Generally the less access you have to your cash, the higher the interest rate you’ll earn. So a financial institution will pay more to someone who's willing to invest in a certificate of deposit for five years than to someone putting the same cash into a savings account where they can pull the money out at any time without penalty.
With laddering, you divide your cash and invest each part in financial instruments with varying maturities. For instance, a business owner with $50,000 could divide it into five $10,000 tranches and invest each tranche into a savings account, a high-yield savings account, a money market fund, a one-year certificate of deposit and a five-year certificate of deposit. This would give the business owner access to at least a portion of the money at all times while also allowing them to earn higher interest rates on some of the balance. In the event that interest rates do go up, laddering also allows you to quickly reinvest the more flexible investments at higher rates.
If you have a stockpile of savings, congratulate yourself on your business savvy in turning a profit, then build upon your success by making the money you've earned work harder for your business.
The information contained in this article is for generalized informational and educational purposes only and is not designed to substitute for, or replace, a professional opinion about any particular business or situation or judgment about the risks or appropriateness of any financial or business strategy or approach for any specific business or situation. THIS ARTICLE IS NOT A SUBSTITUTE FOR PROFESSIONAL ADVICE. The views and opinions expressed in authored articles on OPEN Forum represent the opinion of their author and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions (including, without limitation, American Express OPEN). American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any opinion, advice or statement made in this article.
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This article was originally published on Nov 12, 2014.