Every corporate entity requires working capital for the smooth flow of the business. Any deficiency in the working capital, calls for the requirement of debt. Debt is always a double-edged sword that has the capacity to create volatility in the profits of the enterprise. Volatility means both positive as well as negative profits. So, as to save from the jargon of debt, the entity can plan for investing in “Near Money”. Near money is nothing but a set of assets of the entity which can be easily converted into cash and such converted cash can further be used to satisfy the urgent financial needs of the Company. The urgent financial needs of an enterprise include emergency buying of inventory, advance payment to creditors, advances give to capital investments and many more.
Contents of this article
- Meaning of Near Money
- Money Supply & Its Tiers
- Difference Between Near Money & Money
- How Near Money Is Related To Corporate Finance?
- Examples of Near Money
- Relation of Near Money with Personal Wealth Management
- Advantages of Near Money
Meaning of Near Money
Near Money is a non-physical financial term. It represents the most liquid non-cash assets of an enterprise. The most liquid in the sense that these can be easily converted into cash within no time. Thus, near money is also called quasi-money or cash equivalent. Quasi-money means it is near to what we call “money”. Like money, it can be used in exchange for goods and services and it serves all the purposes of money. Cash equivalent, in the sense that it can be used as an alternative to physical cash.
This term is widely used in the field of wealth management, corporate treasury, and economics.
Some typical examples of near money are:
- Short term bank deposits
- Savings bank accounts
- Bonds redeemable within a short term of time
- Foreign currencies which can be exchanged with lower compliances
- Money market securities
- Government treasury securities
The existence of near money in a company has also affected the liquidity ratios of the company (i.e. current ratio, quick ratio & cash ratio).
Money Supply & Its Tiers
Money Supply is the aggregate of all the money or currency and other liquid instruments available in the market at a particular point of time. Money supply includes cash and near cash. We can say that the near supply is the component of the money supply.
Basically, there are three tiers of the money supply. Each one of these has been explained as follows:
Money in Circulation (M1):
The first tier of money includes the currencies and coins which are in circulation. This does not include the money which is kept in the Government treasury, the central bank of the country, and the treasuries of banks. Demand deposits have close nexus with M1 since the money will available to the deposit holder “on-demand”. Though usage of traveler’s checks is decreased over the past couple of years, it is categorized under M1.
Near Money (M2):
The second tier of money is broader than M1 and also includes everything of M1 or we can say the M2 extends the scope of M1. For example, savings bank account holders are generally not allowed to withdraw frequently. However, savings bank account holders are provided with the facility of ATM cards, that come under the category of M2. Time deposits wherein the account holders deposit the money with the bank for a term ranging from months to years. A longer period provides a higher rate of interest and withdrawal of such deposits before maturity results in some additional costs.
Less Liquid Money (M3):
The third tier of money includes all variants included in M1 & M2. Additionally, the third tier includes terms deposits with a longer period of deposit. The long-term funds are included in M3. Investment in equities of the company for a longer period, holding bonds that are redeemable after say 5 years, etc. are some of the examples of M3.
Difference Between Near Money & Money
|Conversion||The conversion of near money into money requires the holder to pay some fees. These are not readily available for use as hard money.||Money is readily available and hence, does not require any conversion.|
|Liquidity||It is more liquid than tier 3 money (M3).||It is the most liquid asset for any entity.|
|Tier||It is categorized as “M2”||It is categorized as “M1”|
|Medium of Exchange||This is an indirect medium of exchange.||This is a direct medium of exchange.|
|Measurement||It can only be valued and cannot be counted.||It can be valued as well as counted.|
Worksheet for Computation of DEPB Rates
Corporate finance is all about acquiring finance for business and making the optimum utilization of the financial resources. Here, optimum utilization means funds with lower cost and generate higher returns for the shareholders which ultimately leads to an increase in wealth.
Corporate finance especially focuses on two key ratios namely, current ratio and quick ratio. The current ratio presents the capability of the company to honor (i.e., to pay) the short-term obligations which are due within a year. It means the value of current assets per rupee of current liability. The standard industry average for the current ratio is 1.2 i.e., 1.2 rupees of current assets for every 1 rupee of current liability. However, the current ratio takes into consideration the monetary assets which are convertible into cash within a year or near money, such as inventory, prepaid expenses, current investments, etc. To counterfeit this drawback of the current ratio, we have a little stricter liquidity ratio named “Quick ratio”.
As the name suggests, it considers only the current assets which can be quickly converted into cash. Quick ratio considers the liquid assets of the Company and hence called as Acid-Test Ratio. The numerator is more liquid here as compared to that in the current ratio. An Industry-standard average of 1.0 is an acceptable quick ratio. It means that the company has 1 rupee of quick assets to satisfy 1 rupee of current liability. Companies with an acceptable quick ratio do not have to depend on external funds (i.e., debt) for working capital. Such companies are said to be financially independent. However, a very high quick ratio depicts the company’s inability to manage the excess funds for increasing the overall efficiency of the organization.
Examples of Near Money
Savings Bank account:
Individuals have the option of opening a savings bank account to park the excess funds after appropriation of expenses. Savings account backed by an ATM card gives 24/7 access to the money. However, due to a higher level of liquidity, the rate of interest offered is on the lower side which does not even cover the general inflation cost in the economy.
Certificates of deposit (CDs):
can park their money to earn interest higher than that offered by a savings bank account. CDs are considered liquid since the corporate investor can redeem the funds before the maturity date. However, such early redemption comes with a penal interest to be deducted from the interest accrued.
Close to expiration bonds:
Corporate investors also have the option of investing in bonds that are about to expire in near future. Since the period of expiration is near, the premium left in the bond is low. The liquidity is based on the time left for maturity. The return on such bonds is based on the difference between the redemption price and purchase price.
Government treasury securities (T-bills):
These are also known as Treasury bills (T-bills) issued by the Government treasury. The maturity period is lower and it is backed by a Government guarantee. Such instruments, thereby, have no default risk and no liquidity risk. Thus, the present 364-day treasury bill has an interest rate of only 3.71% (source: rbi.org). One cannot doubt the repaying capacity of the central government. Such instruments are redeemable at par and issued at discount. The difference between the issue price and redemption is the return for the holding period. Such holding period return is then annualized to compute the per annum return.
Money market securities:
Banker’s acceptance, certificate of deposits, and commercial papers are some of the classic examples of money market securities. The term of investment is usually up to 1 year. These are more liquid than CDs with years of investment. However, the rate of interest offered in MM securities hardly covers the inflationary rise in costs.
Investment in Foreign Currencies:
Not all foreign currencies are categorized under near money. Liquidity in foreign currencies means the high volume of transactions which facilitates the easy buying and selling of securities. Out of all currencies around the globe, US Dollar is considered to be a liquid foreign currency. Investment or borrowing in USD also facilitates the hedging of foreign trade receivables as well as payables.
Relation of Near Money with Personal Wealth Management
As a matter of personal wealth management, the Companies can educate their employees to build corpus using near money. If the employees of the Company are highly dependent on the near money, they can invest in low-risk category funds such as savings account, T-bills, etc. However, lower risk means low return. Employees with lower risk appetite, should not expect faster growth of their net worth.
On the other hand, if the employees (especially young employees) do have a high-risk appetite, they can invest in the stock market for a short period of time. Presently, the liquidity in the stock market is available in T+2 days. However, such employees should not blindly invest in the market. Rather, they should trade with the help of portfolio managers to generate assured returns.
On a concluding thought, the Corporate entities should educate their employees to first decide on their financial goals, keep emergency money parked in liquid FDs and invest the balance funds according to their respective risk-return profile.
Advantages of Near Money
- Availability of near money helps lower the usage of credit cards.
- Sufficient near money means sufficiency of liquidity.
- It helps to manage the emergency financial needs of the business.
- It lowers the risk of bankruptcy in the business.
- Also, the credibility of business is increased
- It forms an easy source of leverage for the organization.