As treasurers have become used to generating a return on invested cash, the market expects interest rates to start to fall.

No one knows when rates will fall or by how much. The only certainty is that treasurers will still be required to meet their core responsibilities: preserve principal, ensure access to liquidity and generate yield within acceptable risk parameters. So, how can treasurers meet their obligations in difficult circumstances?

For many, the answer is to segment cash into one or more “buckets.” This is the classification of cash according to the likely future needs of the business and is done by using a cash forecast to categorize cash into virtual “buckets,” with each bucket representing a different time horizon and tolerance for risk. Each bucket can then be invested in instruments that reflect that tolerance.

Broadly speaking, companies can use their cash forecasts to categorize cash into three segments, the names of which vary both between companies and between asset managers.

Operating Cash

All companies need access to a certain amount of cash to pay their bills, salaries and taxes. This cash is generally committed, so the treasurer’s core objective will be to maintain principal. The payment dates are likely to be known and within a short time period, so ensuring liquidity on those dates is also a key factor. Since rates have risen from their historic post global financial crisis lows, it has been possible to generate a return on these funds, although doing so remains very much a secondary objective. Company definitions of operating cash vary significantly and can range from within a week up to about three months.

Medium-Term Cash/Working Capital

Some companies hold cash beyond operating cash for a range of reasons. Some hold cash to protect against the risk of market volatility (e.g., if sales are worse than expected), in anticipation of lower cash receipts (in a seasonal business), or as a company develops a new product line and expenses exceed receipts for a period. Investment performance in this category may be benchmarked against a six- or twelve-month rate, depending on the company’s categorization of this bucket.

Long-Term/Strategic Cash

Some companies hold long-term cash for a variety of reasons, including to provide additional security, to be used to fund an opportunistic acquisition or the company’s dividend policy or share repurchase program.

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Maintaining an Investment Policy to Support Cash Segmentation

Segmenting cash in this way can help treasurers manage risk in any interest rate environment. Furthermore, all companies should have a written short-term investment policy. This will define the company’s approach to cash segmentation and, for each identified segment or bucket, set security and liquidity requirements reflecting the company’s risk tolerance.

This means, for example, that operating cash (the cash needed to make payroll, tax and vendor payments and to meet any loan repayment schedules) can only be invested in liquid instruments issued by highly rated counterparties. This risk appetite doesn’t change; it applies whether interest rates are stable or expected to rise or fall.

The same is true for medium- and long-term cash. Knowing that sufficient cash is set aside for immediate operational purposes, companies may be prepared to set wider parameters when investing cash that won’t be required immediately to target a higher return, whether by sacrificing some liquidity or assuming extra counterparty risk. Tactically, treasurers can select different instruments within these parameters, depending on their view of the future path of interest rates.

Segmentation is the key as it allows companies to develop investment policies that set different risk tolerances for each bucket of cash.