Throughout the course of running a business, excess cash may be generated for a short period of time that is available for the business to invest. Most entrepreneurs choose to reinvest the funds into the business through purchasing assets, while others might pay themselves through a salary or dividends. However, entrepreneurs often explore other opportunities to generate returns, which sometimes result in disaster – Ponzi schemes. This article addresses some considerations for entrepreneurs to bear in mind when assessing their next investment opportunity.
Risk and return tradeoff
The tradeoff is an investment principle that links higher risk with a higher return. Higher risk is associated with a greater probability of higher return and lower risk with a greater probability of smaller return. The appropriate tradeoff depends on various factors, including the investor’s risk profile, the time available for the investment to grow and the potential to replace lost funds. Therefore, the tradeoff can vary based on the unique circumstances that investors find themselves in.
We recommend seeking investment returns that exceed inflation in order to increase wealth over time in real terms. All investments, including cash, have risk associated with them, and it is important for an investor to assess any risks against their personal circumstances.
Most businesses keep cash at the bank, earning low returns in their current account. However, some banks don’t even offer credit interest on current accounts. This means that entrepreneurs need to evaluate cash investment accounts to earn interest.
We reviewed the cash investment return rates of five large banks in South Africa, based on a business with R100 000 in excess cash to invest for a period lock not much greater than a month:
It is typically easier to keep cash investments with the same bank as this increases the ease of transferring money between accounts. However, we encourage entrepreneurs to seek maximum returns on their cash by shopping around for the best interest rates.
In some scenarios, entrepreneurs may have excess cash that can be invested over a longer period of time and may also be willing to accept greater risk. A reasonable market-related return to expect on investments depends on the risk profile of your investments. An easy way to think about risk profiles is through three categories; aggressive, moderate and conservative:
1 Investment professional mean target return rates
2 Based on South Africa’s April Headline CPI of 4.4% as released by Stats SA on 22 May.
We recommend seeking the advice of a registered financial advisor (remember to verify registration https://www.fsca.co.za/Fais/Search_FSP.htm) before making investment decisions. We also recommend that you ask yourself three questions before making an investment decision:
1. What is your financial goal at the end of the investment period?
2. What is the risk of the underlying net assets of the investment?
3. What security or insurance (if any) can I obtain against losses?
Entrepreneurs need to be strategic and measured in how excess cash is invested. Remember the tax consequences of extracting the cash for personal gain, including holding investments in your personal capacity that were purchased with business resources.
For advice on tax or using that excess cash to invest smartly, contact Outsourced Finance.