Cash sweep is an effective cash management tool where the excess cash flows are automatically transferred to pay off existing debt or to investments offering higher interest. Banks offer sweep accounts with such facilities. Such a facility is ideal for large firms or individuals with variability in receiving funds.
A cash sweep is an automatic bank process where a company asks the bank to transfer a certain amount of funds from an investment account to the deposit account or vice versa. To execute cash sweeps, a company must specify the amount and account to which the excess funds need to be transferred to the banks.
Cash Sweep Calculation
From the free cash flow from operations, deduct the permitted CAPEX or maintenance, interest payments, and any EMIs. The remaining cash (whole or part) is available to use for cash sweep.
How Cash Sweep is used to Pay Debt?
Companies borrow money to fund expansion or get cash for day-to-day operations. Debts have the ability to impact a company’s balance sheet adversely. So, it is very important for a company to pay off such debts and ensure the business’s stable health. Thus, to accelerate the process of paying the debt, a company uses a cash sweep.
Such an option allows a company to pay outstanding debts even before their due date. It helps the company not only to minimize risk and liability but also to pay its debt faster.
How Cash Sweep is used to Earn Higher Interest?
Cash Sweep also allows a business or an individual to ensure that the extra money does not sit idle in a low-interest account. Instead, the excess money is put into better liquid cash investment vehicles to earn higher interest rates. Such investment options not only offer higher interest rates but also liquidity. Sweep accounts usually invest money in money market mutual funds, savings accounts, or even short-term certificates.
Businesses or individuals must also keep a check on the cost of operating such accounts. It is very much possible that the account maintenance fees offset the higher interest earned from investing the excess cash. Such accounts usually carry a flat fee.
Sweep accounts originally came in use to bypass a government regulation, which limited banks from giving interest on commercial checking accounts. Many brokerage accounts also started offering similar features to enable investors to earn a return on unused cash.
Both Individuals and Companies
For individuals, brokerages usually use sweep accounts to put the funds that are waiting to be reinvested – like dividends. Such funds remain in the sweep accounts until an investor decides the future course of action or the broker executes the already standing orders.
It is an effective tool for businesses that rely on daily cash flow but intend to maximize earning potential while sitting on cash reserves. A business can specify the minimum balance for its account. Any amount over it is put into a higher-interest investment product or pays the debt. And if the balance goes below the minimum balance, the funds are swept back from the investment account.
- Saves time by eliminating personal intervention.
- Helps companies or individuals efficiently achieve their financial goals.
- In the case of investment, a cash sweep ensures that the excess money earns the highest possible interest.
- In the case of debt payment, it ensures speedy payment of debt.
- Improves the credit image of an individual or a company.
Good for Banks as well
Cash Sweep is also good for banks. It helps in lowering the default probability. Often, banks insist customers go for such an account.
Banks usually offer several types of cash sweep options to an account holder. For instance, Wells Fargo offers three options – Standard Bank Deposit Sweep, Expanded Bank Deposit Sweep, and the Money Market Fund Sweep.