Page 135 - Accounting Best Practices

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Cash Management Best Practices
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6–13 UTILIZE AN INVESTMENT POLICY
Sometimes a controller or treasurer implements all of the cash management best
practices and experiences a singular increase in cash flows, only to have no idea
of what to do with the money. Though it is always tempting to invest the money
in some high-yield investment, there may be associated problems with risk or liq-
uidity that make such investment inappropriate. In fact, an improper investment
that results in losses or no chance of short-term liquidity to meet immediate
needs may even cost the investment officer his or her job. Consequently, this is an
area in which a best practice is needed, not to improve efficiency or profits, but to
contain risk.
An appropriate best practice for every company is an investment policy. This
is used to define the level of risk a company is willing to tolerate and defines the
exact types of investment vehicles to be used (or not used). Such a policy should
cover the level of allowable liquidity. For example, the policy may state that all
investments must be capable of total liquidation upon notification, or that some
proportion of investments must be in this class of liquidity. For example, the pol-
icy could state that 75 percent of all investments must be capable of immediate
liquidation (which rules out real estate holdings!), or that any investments over a
base level of $50 million can be invested in less-liquid instruments. Generally
speaking, the policy should severely restrict the use of any investments that can-
not be liquidated within 90 days, since this gives a company maximum use of the
money in case of special opportunities (such as an acquisition) or emergencies
(such as a natural disaster destroying a facility). Such careful delineation of
investment liquidity will leave a small number of investments that an investment
officer can safely use.
The other main policy criterion is risk. Many companies have decided that
they are not in the business of making investments and so they avoid all risk, even
though they may be losing a significant amount of investment income by putting
all excess cash in U.S. government securities. Other companies take the opposite
tack and attempt to derive a significant proportion of their profits from investment
income. No matter which direction a company takes, it is necessary to delineate
which kinds of investments can be used, thereby keeping the investment officer
focused on a specific set of investment options. The policy may go into such
detail as to define exact types of securities to be used.
Once the investment policy is in place, the investment officer can use it to
standardize the procedure for daily investing activities. For example, if only one
type of investment is authorized (a common situation), then a clerk can be autho-
rized to increase or decrease the investment amount each day, using a standard
investment form for transmission to the investing organization (e.g., a bank or
brokerage house). With this approach, investing becomes a simple and mechani-
cal activity that requires little further management attention.
An investment officer should strongly encourage the creation and use of an
investment policy, for it keeps the officer from being held liable in the event of a