Ques : What is Investing Surplus Cash ?

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The demand for working capital fluctuates as per the level of production, inventory, debtor’s, creditors etc. The working capital requirements are not uniform throughout the year due to the seasonality of the product being manufactured and business cycles. Apart from this, the working capital requirement would also depend upon the demand of the product and demand-supply situation of the raw material. Interplay of all these variables would determine the need for working capital at any point of time.

In situations where the working capital requirement is reduced, it results in excess cash. This excess cash may be needed when the demand picks up. The firms may hold this excess cash as buffer to meet unpredictable financial needs. Since this excess cash does not earn any return the firms may invest this cash balance in marketable securities and other investment avenues.

Since this excess cash balance is available only for a short period of time, it should be invested in highly safe and liquid securities. The three basic features - safety, maturity and marketability should be kept in mind while making investment decisions regarding temporary surplus cash. Here safety implies that the default risk (viz., payment of interest and principal amount on maturity) should be minimum. Since the prices of long-term securities are more sensitive to interest rate changes as compared to short-term securities the firms should invest in securities of short-term maturity.
Marketability refers to convenience, speed and transaction cost with which a security or an investment can be converted into cash.

Types of Short Term Investment Opportunities

The following short-term investment opportunities are available to companies in India
to invest their temporary surplus cash.

a) Treasury Bills: Treasury Bills are short-term government securities, they are sold at a discount to their face value and redeemed at par on maturity. They are highly liquid instruments and the default risk is negligible.

b) Commercial Papers: Commercial papers are short term, unsecured securities issued by highly creditworthy and large companies. The maturity of these instruments ranges from 15 days to one year. These instruments are marketable
hence they are liquid instruments.

c) Certificate of Deposits: Certificate of Deposits are papers issued by banks acknowledging fixed deposits for a specified period of time, they are negotiable instruments, this makes them liquid.

d) Bank Deposits: Firms can deposit excess/surplus cash in a bank for a period of time. The interest rate will depend upon the maturity period. This is also a liquid instrument in the sense that, in case of premature withdrawal only a part of interest earned has to be foregone.

e) Inter-corporate Deposit: Companies having surplus cash can deposit its funds in a sister or associate company or to other companies with high credit standing.

f) Money Market Mutual Funds: Money market mutual funds invest in short term marketable securities. These instruments have a minimum lock in period of 30 days and returns are usually two percent above that of bank deposits with the same maturity.

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