Working capital investments can aid profitability

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The economic climate will most likely be a tough one for businesses this year. Merrill Lynch economists foresee a far lower growth rate than last year an increase in gross domestic product of about 3 percent, down from last year's 5 percent. |ret||ret||tab|

They also expect operating earnings for the companies in the S&P 500 to be flat this year, after last year's healthy 10 percent rate.|ret||ret||tab|

Given such expectations, profits could be hard to come by this year. Small businesses, in particular, need to look for new ways to increase profitability.|ret||ret||tab|

Returns on the investment of working capital can make a significant contribution to company revenues. |ret||ret||tab|

You could and should be generating income from your idle funds, no matter how brief or how long a time they spend in your account. The goal of working capital investment is threefold: to find income-producing opportunities for cash that is temporarily idle; to increase yields at acceptable levels of risk; and to maintain liquidity.|ret||ret||tab|

Many businesses settle for convenience and accept whatever return is offered; but if you know how, you can select alternatives that can make short- and intermediate-term investing more profitable.|ret||ret||tab|

Improving yields|ret||ret||tab|

To devise an effective investment plan, you need to evaluate your business's specific circumstances. Use historical and projected cash balances to determine how much cash is available for investment and for how long. |ret||ret||tab|

Then, divide your investable cash into three categories: very short-term operating cash that can be invested up to 30 days; short-term cash of 30 days to one year; and intermediate-term investable cash of one to seven years.|ret||ret||tab|

Within these categories, you generally have four ways to improve yields:|ret||ret||tab|

|bold_on| Maximize after-tax returns.|bold_on| If your company is in a lower tax bracket, you may want to focus on higher yields rather than tax advantages. |ret||ret||tab|

However, if your federal tax bracket is high (generally 34 percent or above), you may be able to secure a better after-tax return by investing in federally tax-exempt securities. Compare the yields on tax-free obligations to their fully taxed equivalents. |ret||ret||tab|

The tax benefits of some investments may depend on your business structure. If your business is a C corporation, you probably can take advantage of the dividends-received deduction. |ret||ret||tab|

By purchasing common and preferred stock with investment capital, a C corporation can exclude up to 70 percent of the dividend income received from other corporations whose stock you have held for at least 49 days from your taxable income.|ret||ret||tab|

|bold_on| Extend the maturities of your investments.|bold_on| Generally, longer terms can result in|bold_on| higher yields. Determine how much cash needs to be kept in liquid securities like money market funds to meet daily operating expenses and how much you can commit for a longer period. By investing that amount for as little as 90 days, you may be able to earn extra return.|ret||ret||tab|

|bold_on| Diversify credit quality. Determine whether the potential for additional yield might warrant assuming some moderate risk. Some businesses opt only for obligations backed by the U.S. government. |ret||ret||tab|

By doing so, they typically accept a lower yield than may be obtained in other obligations that have more risk but can still provide a relatively high degree of safety. High-quality corporate money market investments, for example, usually have higher yields than similar maturity Treasury obligations or CDs.|ret||ret||tab|

|bold_on| Make more cash available for investment.|bold_on| Many investment vehicles must be purchased in minimum amounts and in multiples of the same or smaller amounts. Treasury bills, for example, can be bought in multiples of $1,000 with a minimum investment of $10,000. |ret||ret||tab|

If you have a large amount of investable assets $100,000 or more take advantage of your situation. Many institutional investment vehicles require high minimum investments but offer superior yields in return.|ret||ret||tab|

|bold_on|(David W. Tralka is first vice president and chairman, business financial services, for Merrill Lynch.)|bold_on||ret||ret||tab|

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