The cash that companies carry on their balance sheets istypically divided into three categories: working capital,liquidity, and strategic cash. Working capital is the cash neededto fund day-to-day operations. Liquidity is cash that anorganization keeps on hand to meet an unexpected shortfall inworking capital. Businesses traditionally have held their workingcapital funds in bank accounts and held the cash designated forliquidity in prime money market funds, which deliver low yields butoffer withdrawal at any time.

Strategic cash is the cash left over after the first two bucketsare filled. Strategic cash is typically held as a buffer againstunanticipated needs like a major acquisition or facility build-out,as well as to strengthen the balance sheet. Liquidity is definitelya concern for strategic cash holdings, but companies tend to seekout somewhat higher returns than they get on their working capitaland liquidity. So cash in the “strategic” bucket is usuallyinvested in bonds—typically corporate or agency securities withmaturities inside five years.

Before the 2008 crisis in the financial markets, many companiesworked to minimize the amount of cash in their working capital andliquidity accounts, in favor of higher-yielding strategic cashaccounts. Then, in the immediate aftermath of the financial crisis,preferences experienced a dramatic reversal. The bankruptcy ofLehman Brothers and the subsequent failure of the Reserve Primarymoney market fund caused corporate investors to flee strategiccash, which was suddenly perceived as unacceptably risky, for thesafety of bank deposits. According to the Federal Reserve,institutional money fund balances declined by 30 percent betweenAugust 2008 and the end of 2012.

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