Cash Management 101
What is Cash Management?
When you oversee a lot of capital, how you allocate that capital matters. On the one hand, markets can be volatile, so stability and liquidity matters. On the other hand, keeping all your money in stablecoins isn't the best strategy either: inflation will eat away at your purchasing power, and even small returns on large sums of money can add up. Consider that earning 5% on $10 million is $500K. That's enough to extend the runway of a small startup by several months. In this funding environment, that could be the difference between surviving… and not.
Cash management is the practice of intelligently managing the above tension: stewarding financial resources to get the most out of your money while carefully controlling risk. It's a common function at most mature organizations. Yet despite its particular importance given market conditions today, many crypto-centric organizations and individuals don't know that much about it. In this article we'll talk about what it is, why it's important, and how it works.
The Basic Process
The process of cash management can be summarized in three key steps:
- Forecast your cash flow and needs
- Manage your liquidity to meet those needs
- Revise and update continuously
Let's dive into each.
1. Forecast your cash flow and needs
The first step is to forecast your expected cash flows This means developing a forecast for expected (cash) income and expenses. The goal is to get visibility into how much cash you expect to have on hand, by month, for the next 18-24 months. This is your starting point.
A few pointers here. First, when making such estimates, be conservative. In other words, assume less money is coming in than you expect and more is going out. As part of this, we recommend building out various ‘stress scenarios' that you could envision. What if revenue got cut in half? What if you lost your biggest customer? What if some major piece of equipment needed replacing? What if there was a lawsuit or a regulatory fine? Second, remember that what matters here is cash. This is not the place for accrual accounting. Finally, we recommend converting everything into a single base currency for the this purpose—keep it apples to apples whenever possible.
(Advanced Note: Consider also estimating the maximum intra-month cash drawdown that might be possible. For example, are any big loans coming due? This step is particularly important for financial organizations or protocols. For example, Maker has over $3.5 billion in DAI outstanding that can be redeemed at any time. Maker therefore needs to be sure that, if that were to happen, they have adequate liquid reserves available to cover those redemptions.)
2. Manage your liquidity accordingly
Once you have an idea of how much cash you're likely to have at what points in time, it's time to start planning how you're going to manage it.
If your forecast shows you might temporarily be short on cash, you can look at ways of reducing expenses, changing vendor terms, or take out loans. If it shows you might completely run out of cash, then you should take the time to plan a financing, giving yourself ample time to get it closed.
On the other hand, if your forecast show you have excess cash, you'll want to consider how to best invest it.
When it comes cash management investments, you should prioritize the following, in this order:
- Capital Preservation. The number one priority is simple: don't lose money. This isn't the place for speculative bets.
- Liquidity. You want to be able to redeem your investments for cash fairly quickly.
- Yield. You want to have your money working for you to earn a return.
In practice, there's always some degree of trade-off between these three dimensions. For example, cash or (well-backed) stablecoins preserve your capital and are liquid by default, but are not going to earn you much. On the other end of the spectrum (though still within the cash management regime), investments in short-term US Treasury bonds and short-term investment grade corporate bonds generate significantly more yield than stablecoins but typically require a few days to get your cash, should you decide to sell, and may be more volatile than stablecoins so you don't want to be a forced seller in a downturn.
Common practice, then, is to think about dividing your cash needs into three buckets, according to how soon you think you'll need the cash. The sooner you need it, the more liquid and stable (and therefore, the less yielding) an asset you'll want to invest in.
For example, here are the types of assets we might recommend for both TradFi and on-chain finance, according to how soon you think you might need access to your capital:
|How Soon You'll Need||TradFi|
|0 - 3 Months||Cash|
|3 - 12 Months||Money Market + Sweep Accounts + Short-Term US Treasuries|
|12 Months+||US Treasuries|
As you can see, in TradFi there are plenty of high-quality options.
It's for these reasons that Ondo has created our funds, making it possible for on-chain investors to contribute USDC into high-quality, liquid, real world assets:
- OUSG, backed by short-term US Treasuries
- OMMF, backed by US government money market funds
These funds invest exclusively (outside of small cash holdings) into bond Exchange-Traded Funds (ETFs) or Money Market Funds (MMF) managed by the largest, most reputable asset managers in the world.
The table below shows recent yield and annual standard deviation for the assets backing OUSG and OMMF:
|Fund||ETF Name||ETF Ticker||Estimated Portfolio Yield||Standard Deviation|
|OUSG (Ondo Short-Term US Government Bond Fund)||Blackrock Short-Term US Treasuries ETF||SHV||4.99%||0.56%|
|OMMF (Ondo Money Market Fund)||TBA||TBA||TBA||TBA|
Data as of 2023-08-07:
Using these funds, we can update our recommendations for a well-allocated cash management portfolio, now including high-quality traditional assets for on-chain finance:
|How Soon You'll Need||TradFi||On-chain Finance|
|0 - 3 Months||Cash||OMMF|
|3 - 12 Months||Money Market + Sweep Accounts + Short-Term US Treasuries||OMMF and OUSG|
|12 Months+||US Treasuries + Short-Term IG Bonds||OUSG|
3. Revise and update continuously
Once you've built your cash flow forecasts and made your initial allocations, don't forget to actively monitor your cash position and periodically update your forecasts and allocations accordingly.
The value of a strong cash management program should be obvious, but implementing such a process is a project of its own. In the TradFi world, this might include finding banking, investment, custody, accounting, and audit partners, as well as putting the necessary internal processes and controls in place. In the on-chain world, the needs are similar, but with important differences. For example, you'll want to ensure you have a secure place to custody your coins. It's also often the case that DAOs need governance approval to implement a cash management program like this.
If you're new to the world of cash management or could use help setting up your cash management, program, Ondo does provide cash management advisory services for those managing treasuries of $10 million or more. You can reach out to us here to learn more.