Liquid Fund s: Best tool for SME’s Cash Management

Running a Small/Medium Enterprise is always a challenge as these are small companies run by entrepreneurs who need more cash to make it grow. So for these SMEs some extra cash, generated by better management of their cash flow, could be a best thing. Now the question is how should the MSME owners manage their cash flows so that they can generate some extra cashflows which could be very helpful for their business to make it grow faster or reduce the borrowings.

Normally all SMEs have current accounts which is used by them to keep cash for their day-to-day requirements. However the problem is that these accounts do not earn any interest for account holders. Hence the money kept there is available for use but does not gives anything in return.

So what could be the solution that the money should be available for use as per the requirements and also earn something without any risk?

Liquid and Low Duration funds could be a very good option for these SMEs to keep their idle funds.

Liquid Funds, invest predominantly in highly liquid money market instruments and debt securities of very short tenure and hence provide high liquidity. They invest in very short-term instruments such as Treasury Bills (T-bills), Commercial Paper (CP), Certificates Of Deposit (CD) and Collateralized Lending & Borrowing Obligations (CBLO). The average maturities of liquid funds is up to 91 days. This is basically to keep safety of the funds with high liquidity.  An investor can take get redemption from Liquid funds within one working (T+1) day.

Low Duration Funds are also quite liquid however they keep the investments in little higher maturity papers which is upto one years normally. They can give little higher returns.

So if the funds requirements is say within next 10-15 days it is better to keep ths money in liquid funds and if it more than a month or so then low duration funds could be an ideal choice.

How to use it?

Use of liquid funds need some basic understanding and also little bit planning of cashlows. For example  if a SME gets inflow of funds in the first two weeks of the month and outflows are generally concentrated in the last two weeks, then it can park the surplus amount in a liquid fund for say 10-15 days, and take it out later when required. In liquid funds it is also not necessary to invest only one time or withdraw full amount. So withdrawal can be partial based on actual cashflows rather than just keeping in current account in prediction of the future outflows.  

Even if the yearly cash flow of a SME is about Rs 5-10 crore, by investing in liquid funds the company can generate some extra Rs 40,000-Rs 80,000 per year. For a small business, this extra money could be used to pay the salary of a couple of its employees for a month or to meet some petty office expenses. As we always say that every drop counts so even this small money can also be of immense importance.

What are the Risks?

Liquid fund invests in securities that have a market price. When market price of these securities moves up or down, so does liquid fund's net asset value (NAV). But a liquid fund's NAV doesn't move up or down as much as other funds. This is because as per SEBI, if a security matures in under 60 days, it need not be marked to market. Just the interest component needs to be added. In simple words, whatever interest a debt fund earns through the tenure of a security, it will divide the total interest component equally for the number of days it holds the security. Hence, normally liquid fund's NAV movement is linear; like a steady line going up.

But still there is a risk as liquid fund can invest in scrips that mature up to 91 days. Those securities which have maturity between 60 and 91 days, needs to be mark-to-market, depending on its credit rating. Which means, if that company defaults on its interest and/or principal repayment, the scrip's credit rating drops and so does its market price. If a liquid fund has invested in such a security, its NAV falls too. However it is very rare that the NAV falls for Liquid funds as Fund Manage makes a balance of securities so overall it will not have a negative impact.

What are the tax implications?

As per tax law, liquid funds are debt funds hence if invested for less than three years then it will be added to the income of the business and taxed accordingly. After three years it gets benefit of indexation. However even after paying tax it will give positive returns as compared to nil return from Currents Accounts.

So what are the other issues?

Generally lack of knowledge about the availability of such a mutual fund product is the main reason for not investing in these funds. The other reason is unpredictability of cash inflows. However, if planned properly with proper understanding this could certainly be a very good option to keep the idle funds which is lying in current accounts. As per industry data almost 20-25% of the total AUM of mutual funds industry, which is more than 4.5 lakh crores, is beings invested through liquid funds.

Finally, Liquid/Low duration funds are good alternative option for small business by which they can earn little extra without taking any major risk on their money. This can definitely help them to increase their cash flows if managed properly.