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.

How can we save more in the same Income?

We all want to save more but we have limited resources, so how can we increase our savings in those resources only. In this post we will try to find out few simple tips which can be used to improve our overall savings.

1. Have a budget and follow it

We should have proper budget so that we can control the expenses within limits. Best way to do it is by fixing certain percentage of our income as saving and the remaining amount be spend or

Income - Savings = Expenses.

2. Nothing is free

We generally tend to spend more when using a credit or debit card, than when using cash. Similarly, we also treat a windfall income like a bonus and regular income like a salary differently. If we realise that the money spend by credit/ debit card will also go from our own income only and bonus is also hard-earned money, we may be more sensible while splurging this money.

One time cash flow can be invested through STP way which we have discussed in my last post (see the post How to invest large sum when market is at all time high?

3. Not Just Save but Keep on Increasing the Amount

It’s good to start saving but that is not enough. We should regularly increase the quantum of savings and investment. This can be done in line with the increase in income. In few cases like in EPF this increase happens automatically, as contributions to it is fixed as percentage of salary. However For other investment avenues, the onus of increasing contribution lies with the investor. By increasing the quantum of investments annually, we can reach to our goal faster or generate a bigger corpus.

As a thumb rule we should increase the amount by the rate of inflation. In mutual funds there are “Step-up SIPs  by which we can increase the SIP amount by certain amount or percentage  at a predefined time interval which can automatically increase our saving rate.

4. Saving is not enough, It should be invested properly

Once we have decided to save more and increase the quantum regularly, the next step is to route this savings into suitable investments. Few people are very good in saving but not good at investing. If we keep large amounts idling in savings accounts that generate 3.5% returns and in tax inefficient FDs then it is not a very sound investment strategy.

We need to overcome from loss aversion mentality, which occurs when the pain of losing money is greater than the happiness felt in gaining an equal amount. We need to understand that while keeping the money idle in bank accounts, assuming its safe we ignore the risk of inflation which ends up earning with 3.5% returns, actually lower than inflation. There are different instruments, suitable for different time period, like a cycle is good for 5 Km but not for 5000 Km equally an aeroplane is suitable for 5000 Km but not 5 Km. So we may take certain calculative risk and manage the risk in a way so as to improve our overall returns.

We should diversify our investment but also avoid overdiversification, have moderate return expectations and automating the investment process through long-term SIPs.

5. Keep a Watch and Rebalance it

It is also equally important to rebalance the portfolio based on our own requirements and market conditions. This rebalance can be between asset classes or between categories. Most people increase allocation when the market is doing well and reduce in a bear market. By Automating asset rebalancing, we can remove the biases and make it more efficient.

6. Stick to it; don’t divert the funds

Some time we start using the money earmarked for goals for other needs. We can avoid it by segregation of investments for specific goals, by this we can be clear how we are doing to achieve these specific goals.  We can stop from dipping into investments prematurely by opting for investments that restrict liquidity. Long-term lock-ins help improves the power of compounding. As the power of compounding is back-ended and the maximum benefits come in later years.

For short term and immediate requirements, emergency fund is a better way so as to not to digup from long term investment portfolios. This fund should be invested in a liquid instrument so that it is readily available.

For example, assuming a return of 12% P.a., If someone investing Rs. 5000/- monthly for 5 years will get Rs. 4.12 lakhs at the end of the period while if he continues the monthly investment for 20 years his total corpus could be almost Rs. 50 lakhs which is 12 times than five years corpus while investment amount has gone up by four times only.

These are few simple behavioural tips which can be used to improve our overall savings without putting much pressure on our spending habits, if used properly can give visible change in total portfolio.

How to improve returns from the idle cash lying in Saving/Current Account

We should not let our money idle in the savings bank account, it can be invested to earn a better returns without compromising liquidity or taking high risks.

After demonetisation about  Rs ten lakh crore is deposited in the last three weeks, the savings bank accounts of Indians are bulging with cash. As government has put restrictions on withdrawals, a large chunk of this money is going to stay put for the next few months, earning a paltry interest of 4% per year. Though the interest on the savings accounts is tax free up to Rs.10,000 per year,  Still it's not a good idea to keep Rs. 2.5 lakh idling in your bank account. The interest it will earn won't be able to beat inflation, and the purchasing power of money will come down. Of course, this money was losing value faster when it was lying in your locker as hard cash.

We have various options to deploy this idle money to earn higher returns without compromising liquidity or incurring high risks. The choice should depend on how soon the money will be needed and income tax bracket and also the willingness to make a little effort.

1. Bank fixed deposit

The simplest and easiest way to deploy saving/current account bank balance is to open a fixed deposit, though the returns may not be very exciting and Banks have already slashed the interest rates on short-term deposits. A one-year deposit in the State Bank of India will now fetch only 4%, which is equal to what a savings bank account earns. The rates for longer term deposits are little higher, but mind it the interest earned on fixed deposits is fully taxable. If an investor is in the highest tax bracket, the post-tax return could be even less than saving interest rate. Also, unless we have a online/Netbanking account, opening a fixed deposit won't be easy at a time when visiting the bank is like entering a war zone.

The best way out is to open a long-term deposit of 3-5 years and break it when money is required, we can also keep small denominations FD so that it can be used if only a part of the money is needed. Most of the banks no longer levy a penalty for premature withdrawals. But interest rate to be paid will be applicable rate for the period we remained invested, which is usually lower than the longer-term rate. Also, if the interest income exceeds Rs. 10,000 in a year, the bank will deduct TDS.

This is fine if a person’s income is above the basic exemption limit of Rs. 2.5 lakh per year. But investors in the zero tax bracket will have to file their returns to get a refund of the TDS, or submit the Form 15 G or H to escape the TDS.

Now for recurring deposits too, the interest earned is fully taxable. These deposits were not subject to TDS, but the rules have now been amended.

An investor can also consider opening a sweep-in bank account, where any excess amount in savings account automatically flows into a fixed deposit. If we withdraw from savings account, the fixed deposit is automatically broken.

2. Liquid funds and ultra-short-term funds

Mutual fund is another smart way of earning more income without compromising on liquidity. We can invest in liquid mutual funds. These are ultra-safe schemes that can deliver up to 7-8% returns in a year. The biggest benefit is that the income from mutual funds is treated as capital gains and taxed at a lower rate if the investment is held for at least three years.

They are also more flexible. We can withdraw small amounts whenever required or invest more when we have surplus cash. Now various online platforms are available through which we can invest and redeem very easily and instantly.

The risk of losing money in a liquid fund is almost negligible. The investment is also very liquid. If you redeem before the cut-off time (usually 12.30 pm), the money is in your bank account the next morning at the latest. There is no minimum investing period either. Some mutual funds also offers instants redemption by which money can be credited to an investors account within 30 minutes (upto Rs. 2 lakhs) including holidays and Sundays.

3. Short-term debt funds

Those who don't need the money for the next 6-12 months can opt for short-term debt funds. These are also debt schemes, but invest in a mix of short term and medium-term bonds. The returns are slightly higher than what liquid funds and ultra short-term debt funds give, but there is also an exit load payable if we redeem before a minimum period that ranges from 3-12 months. In few schemes, the minimum investment period can be up to 36 months. Before investing we should check the exit load of the income fund or where a penalty of 0.5-1 % can pare the returns.

In the current scenario as interest rates are expected to decline, these funds can give attractive returns in the short to medium terms. Even in the long term, they will give better post-tax returns than fixed deposits. However, these funds also carry an interest rate risk. Of late these schemes have delivered good returns because interest rates have been consistently declining. If interest rates rise, these funds can decline, resulting in losses.

4. Arbitrage funds

Arbitrage funds are for those Investors who can hold for one year or more as they offer tax-free returns. These funds invest in stocks and equity instruments but don't carry market risk. The gains are taxed at 15% if redeemed within one year however dividend received is tax free. After one year, the capital gains are  also tax free. Before investments we should also check the exit load of the arbitrage fund, otherwise the penalty of 0.5-1% can pare the returns.

5. Monthly income plans

If an investor can bear certain degree of risk, monthly income plans (MIPs) from mutual funds can be a low-risk entry point to the equity markets. MIP schemes follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest in safer bonds and instruments. Their returns are better than debt funds, though they also carry a moderate risk. These funds have exit loads so check the terms and conditions.

Bank deposits were traditionally the only and safer option for the investors to keep money and withdraw as per convenience however now when the bank FD rates are historically low and there is lot of awareness regarding mutual funds, we should look at various type of mutual funds which can give safety as well as better returns compare to traditional products.