As a business, managing your financial resources effectively is critical to achieving financial stability and growth. To be successful, you need to have your finances in the right places and with the right partners. You’ll often hear about banks and custodians as places to put your cash for different needs. Which should you use, when, and how much cash should be put with each?
In this post, we'll explore the difference between banks and custodians and provide guidance on when businesses should use each type of institution.
A brief overview:
Banks are traditional financial institutions that offer a wide range of services, including deposit-taking, lending, and other financial products. They are regulated by banking authorities and insured by the government to protect deposits. Regulated banks like JP Morgan are a good place for companies to hold their operating cash (up to the FDIC insured amount), make payments, and manage their day-to-day financial needs.
Custodians, on the other hand, are financial institutions that provide safekeeping and asset servicing for their clients. They are responsible for the safeguarding of securities, cash, and other financial instruments on behalf of their clients. Funds held at custodians are subject to zero risk – if a custodian becomes insolvent or “goes under”, the funds are returned directly to the client. For this reason, custodians are the best place to hold and invest idle cash and other assets for treasury management.
Let’s dive in bit. Banks offer several key functions for businesses, including:
Deposits and payments:
Banks are a convenient place to deposit and store operating cash (again, make sure to only do so within the FDIC limit). Your bank should offer checking and savings accounts that provide easy access to on-hand funds for making payments, paying bills, and managing cash flow.
Banks often offer loans and lines of credit to businesses, which can provide an essential source of funding for companies looking to expand their operations. A caveat: some banks will only offer loans to a business if they agree to deposit their other funds, like idle cash, with that bank. This has been recently seen across the startup ecosystem with the collapse of Silicon Valley Bank. Keep an eye out for this, as you may end up in a situation where your idle cash is neither earning top returns nor secured in case of a bank run or other insolvency.
Many banks allow companies to accept credit card payments which is often an essential processing service for companies. Companies like Stripe are also well-known for this feature.
Experts often recommend that businesses hold 2-3 months operating cash in a bank. If those 2-3 months of cash are above the bank’s FDIC limit (which is usually $250,000) then a company should open up additional bank accounts so that no funds exceed the limit.
The big questions are: What to do with the rest of your company’s cash, and is there a way you can safely invest it without fear of loss or impairment? This is where a custodian comes in.
Businesses should use custodians for the following services:
Custodians provide safekeeping services for assets such as securities, cash, and other financial instruments, protecting them from loss, theft, or damage. Clients can rest assured their assets have no risk of loss if their custodian experiences financial failure.
Investing idle cash:
Companies like Treasure, which specialize in treasury management, hold all client assets in custodial accounts, which make it a safe place to invest your idle cash. The Treasure team of experts purchases government-backed securities like T-bills in the name of the client, and then manages the investment allocation so that clients are constantly receiving the highest risk-adjusted yield. As a Registered Investment Advisor (RIA) regulated by the SEC, Treasure also has a fiduciary duty to act in the best interest of the client. Not all treasury managers are fiduciaries or SEC regulated, so it is important to vet your financial partner before you invest your idle cash with them.
General asset servicing:
Custodians can provide businesses with transparent insights into their investment performance, helping them make informed decisions about their investment strategy. The Treasure platform, for example, provides clients timely and actionable analysis on their investments. Some custodians also settle transactions, such as the purchase or sale of government securities, on behalf of their clients, reducing the administrative burden on companies
The bottom line:
Companies should use banks for their day-to-day financial needs, such as deposits, payments, and lending, with 2-3 months of cash in their primary bank. The rest of their funds should be safeguarded with custodians who can securely manage and grow their cash. Businesses should choose a custodian that is reputable, trustworthy, and transparent in their investment strategies to ensure their idle cash is invested safely and effectively. By partnering with the right financial institutions, businesses can effectively manage their financial resources and achieve their financial goals.