Running a business comes with ongoing expenses: rent, insurance, software, payroll, and more. For many entrepreneurs and small business owners, significant amounts of cash sit in business checking accounts earning little to no interest.
Businesses also have ongoing tax obligations, making it essential to maintain adequate reserves for estimated tax payments.
But keeping too much cash sitting idle can be a missed opportunity.
Depending on when you expect to need the money, portions of your business cash, including tax reserves, can potentially be invested conservatively while maintaining liquidity and prioritizing capital preservation.
That can allow your cash to generate additional income to help offset operating expenses rather than simply sitting in a bank account.
Let's look at three important considerations:
- Why you may want to keep business investments separate from personal investments.
- How to decide how much cash to keep readily available and how much to invest.
- How to evaluate conservative investment options such as money market funds and Treasury bills.
This article focuses on self-employed business owners operating as sole proprietors, single-member LLCs taxed as sole proprietorships, and S corporations.
Key Takeaways
- Don't let business cash sit idle: Cash that isn't needed immediately for operating expenses or tax payments can potentially generate additional income through conservative investments.
- Keep business and personal investments separate: A dedicated business investment account can simplify bookkeeping, tax preparation, and cash management.
- Match investments to your cash needs: Keep enough cash readily available for operating expenses, tax obligations, and unexpected needs. Consider investing reserves based on when you'll need the money.
- Consider money market funds and Treasury bills: Both can be useful for managing short-term business reserves while prioritizing liquidity and capital preservation.
- Focus on after-tax returns: Investment income is generally taxable, but Treasury interest is exempt from state and local income taxes, which can be particularly valuable in high-tax states.
Keep Business and Personal Investments Separate
If you decide to invest business cash, it often makes sense to use a dedicated business investment account rather than mixing those investments with your personal portfolio.
There are three reasons to consider this.
Clearer Bookkeeping and Tax Preparation
When business cash and personal investments are mixed together, it becomes harder to distinguish business-related cash flows from personal investment activity.
For example, suppose you operate a consulting business and keep $150,000 in business reserves. You decide to invest $100,000 in Treasury bills.
If those investments are held in a dedicated account, it becomes easier to track the original capital, interest income, maturities, and transfers back to your business checking account. This simplifies reconciliation, financial reporting, and year-end tax preparation.
Separation of Business Finances
Keeping business and personal finances separate is particularly important when operating through an LLC or S corporation. For these entities, a business investment account can help maintain clear financial records and demonstrate that business assets are being managed separately from personal assets.
For sole proprietors, a separate account is generally more of an organizational benefit because the business and owner are not separate legal entities. However, maintaining separate records is still useful.
A separate investment account does not, by itself, establish liability protection or change how investment income is taxed.
Manage Cash for Its Intended Purpose
Business investments serve a different purpose from long-term personal investments. You may be holding business cash to pay estimated taxes, cover operating expenses, fund an upcoming project, or maintain reserves during a period of lower revenue.
Keeping that money in a dedicated business account makes it easier to understand how much capital remains available to the business. Rather than mixing short-term business reserves with retirement savings or long-term investments, you can manage the money according to its intended use.
Decide How Much Cash to Keep Available
Before deciding where to invest your business cash, the first question should be: When will your business need the money?
Not all business cash serves the same purpose. A useful approach is to divide business capital into three categories.
1. Operating Cash
This includes money needed for routine business expenses such as payroll, rent, insurance, software subscriptions, and vendor payments.
These funds should generally remain readily accessible in a business checking or other highly liquid bank account. The priority is ensuring that your business can meet its obligations without needing to sell investments or wait for funds to settle.
2. Tax Reserves
For self-employed business owners, estimated income taxes can represent a substantial cash obligation. Rather than waiting until quarterly estimated tax payments are due, you can periodically set aside money as your business generates income.
If you know that a tax payment is due in a few months, some of those reserves may be suitable for short-term investments. For example, Treasury bills that mature before the payment deadline may allow your tax reserves to earn income while preserving a predictable maturity date.
However, it is important to allow sufficient time for the investment to mature, funds to settle, and the tax payment to be processed. Tax reserves should not be invested in volatile assets simply to pursue higher returns.
3. Additional Business Reserves
Beyond operating cash and taxes, businesses often maintain additional reserves for unexpected expenses, slower revenue periods, equipment purchases, or future expansion.
A common starting point is maintaining three to six months of operating expenses in accessible reserves, although businesses with unpredictable revenue or substantial fixed costs may need more.
For example, consider a business with $20,000 in average monthly operating expenses. A six-month operating reserve would be $120,000, before accounting for estimated taxes and other planned expenditures.
Not all of that money necessarily needs to remain in a checking account. The portion required immediately can stay in the bank, while amounts that are not expected to be needed for several months may be suitable for conservative short-term investments.
The objective is not to maximize investment returns. It is to earn a reasonable return without compromising the business's ability to meet its obligations.
Consider Money Market Funds and Treasury Bills
Once you've identified how much cash can be invested and when it will be needed, the next step is selecting investments that match those requirements. For short-term business reserves, two options worth considering are money market funds and U.S. Treasury bills.
Money Market Funds
Money market funds are mutual funds that invest in short-term debt instruments, such as Treasury securities and other high-quality, short-term obligations. They can provide a convenient way to earn income on cash that may need to remain relatively accessible.
For business owners, money market funds may be useful for holding reserves when the timing of future expenses is uncertain. They typically offer liquidity on business days, subject to applicable fund and brokerage rules.
However, money market funds are not the same as bank savings accounts. They are not FDIC-insured, and although they are generally considered relatively low-risk investments, they can lose value. Their yields also fluctuate with short-term interest rates.
Treasury Bills
Treasury bills are short-term debt securities issued by the U.S. government. They are available with maturities ranging from approximately four weeks to one year. Treasury bills are generally purchased at a discount to their face value, with the investor receiving the face value at maturity.
For example, a business might purchase a Treasury bill that matures shortly before its next estimated tax payment. If held to maturity, the investment provides a predictable payment amount, assuming the U.S. Treasury meets its obligations.
Treasury bills are backed by the full faith and credit of the U.S. government, making them attractive for investors prioritizing credit quality. They also have a potential tax advantage: Treasury interest is subject to federal income tax but exempt from state and local income taxes. This can be particularly meaningful for business owners in high-tax states such as California.
However, if Treasury bills need to be sold before maturity, their market value can fluctuate with interest rates and other market conditions.
Both options can play a role in managing business reserves. Money market funds may be more convenient for cash with uncertain withdrawal dates, while Treasury bills may be appropriate when you know when the money will be needed. A business can also use a combination of the two.
Example: Putting $200,000 in Business Reserves to Work
Let's consider a simple example. Suppose your business maintains $200,000 in cash reserves that are not required for immediate expenses.
If that cash sits in a checking account earning no interest, it generates no investment income. But if the $200,000 earns an average annualized return of 4%, it could generate approximately $8,000 in investment income over a year.
That additional income could help offset business costs such as insurance premiums, software subscriptions, or professional services.
Of course, the income is generally taxable, and a 4% return is only an illustrative assumption, not a guaranteed or current yield. The actual amount earned will depend on prevailing interest rates, investment choices, fees, and how long the money remains invested.
The important point is that even conservative investments can generate meaningful income when a business regularly maintains substantial cash reserves.
Understand the Tax Implications
For pass-through business owners, investing business cash also has tax implications. However, the treatment depends on the type of entity.
- Sole proprietorships and disregarded single-member LLCs: Interest and other portfolio investment income generally flow directly to the individual owner and are reported separately from ordinary business income, such as on Schedule B or Schedule D when applicable.
- S corporations: Interest income, dividends, and investment gains are generally reported separately through the corporation's Schedule K-1 and passed through to shareholders. Additional special rules may apply to certain S corporations.
This means that keeping investments inside a business account does not automatically make investment income ordinary business income, allow it to offset business expenses for tax purposes, or provide additional deductions.
The main reasons to maintain a dedicated business investment account are cash management, bookkeeping, and proper separation of business finances.
When comparing investment choices, consider the after-tax return rather than simply the advertised yield. For example, interest from U.S. Treasury bills is generally exempt from state and local individual income taxes, making them particularly attractive for business owners in high-tax states. However, certain state-level business taxes may still apply when Treasury bills are held through an S corporation or another business entity.
Final Thoughts
Keeping adequate cash reserves is essential for running a business. You need enough liquidity to cover operating expenses, meet tax obligations, and handle unexpected financial needs.
But maintaining those reserves doesn't necessarily mean leaving all the money in a checking account earning little or no interest.
By separating business investments from personal investments, matching investment choices to upcoming cash needs, and considering conservative options such as money market funds and Treasury bills, you may be able to generate additional income while preserving financial flexibility.
The goal is not to take more investment risk with business cash. It's to make better use of the cash your business already needs to hold.