Cash and cash equivalents

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Cash and Cash Equivalents are recorded as current assets

Cash and cash equivalents (CCE) are the most liquid current assets found on a
business's balance sheet. Cash equivalents are short-term commitments "with
temporarily idle cash and easily convertible into a known cash amount".
[1]
 An investment normally counts to be a cash equivalent when it has a short maturity
period of 90 days or less, and can be included in the cash and cash equivalents balance
from the date of acquisition when it carries an insignificant risk of changes in the asset
value; with more than 90 days maturity, the asset is not considered as cash and cash
equivalents. Equity investments mostly are excluded from cash equivalents, unless they
are essentially cash equivalents, for instance, if the preferred shares acquired within a
short maturity period and with specified recovery date. [2]
One of the company's crucial health indicators is its ability to generate cash and cash
equivalents. So, a company with relatively high net assets and significantly less cash
and cash equivalents can mostly be considered an indication of non-liquidity. For
investors and companies cash and cash equivalents are generally counted to be "low
risk and low return" investments and sometimes analysts can estimate company's ability
to pay its bills in a short period of time by comparing CCE and current liabilities.
Nevertheless, this can happen only if there are receivables that can be converted into
cash immediately.[3]
However, companies with a big value of cash and cash equivalents are targets
for takeovers (by other companies), since their excess cash helps buyers to finance
their acquisition. High cash reserves can also indicate that the company is not effective
at deploying its CCE resources, whereas for big companies it might be a sign of
preparation for substantial purchases. The opportunity cost of saving up CCE is the
return on equity that company could earn by investing in a new product or service or
expansion of business.[4]
 Contents

 1Components of cash
 2Components of cash equivalents
 3Calculation of cash and cash equivalents
 4Liquidity measurement ratios
 5Restricted cash
 6See also
 7References

Components of cash[edit]
 Currency
 Coins
 Bank overdrafts normally are considered as financing
activities. Nevertheless, where bank borrowings which are
repayable on a demand form an integral part of company's
cash management, bank overdrafts are considered to be a
part of cash and cash equivalents.[5]
 Cash in saving accounts is generally for the saving
purposes so that they are not used for daily expenses.
 Cash in checking accounts allow to write checks and use
electronic debit to access funds in the account.
 Money order is a financial instrument issued by
government or financial institutions which is used
by payee to receive cash on demand. The advantage of
money orders over checks is that it is more trusted since it
is always prepaid. They are acceptable for payment of
personal or small business's debts and can be purchased
for a small fee at many locations such as post office and
grocery.[6]
 Petty cash is a small amount of cash that is used for
payment of insignificant expenses and the amount of it may
vary depending on the organisation. [7] For some entities $50
is adequate amount of cash, whereas for others the
minimum sum should be $200. Petty cash funds must be
safeguarded and recorded in order to avoid thefts. Often
there is a custodian appointed who is responsible for the
documentation of petty cash transactions.[8]

Components of cash equivalents[edit]

1969 $100,000 Treasury Bill

 Treasury bills, also called "T-bills", are a security issued by

the U.S. Department of Treasury, where their purchase
lends money to the U.S. government. [9] T-bills are auctioned
in denominations of $100, up to maximum amount of $5
million (or 35% of the auction offering if a competitive bid)
and lack a coupon payment, but instead are sold at a
discount, their yield being the difference between purchase
price and redemption value, which is paid at maturity.
Regular series Treasury bills mature in 4, 13, 26 & 52
weeks from their issue date, which may be purchased via
TreasuryDirect or a licensed broker. [10] [11]
 Commercial paper is a bearer document which is used by
big companies. The minimum amount permitted [by whom?] is
£100,000 and this form of borrowing is not suitable for
certain "entities".[12] Finance companies sell 2/3 of their total
commercial paper to the public, but there are also some
companies which borrow less and sell their commercial
paper to "paper dealers" who then re-sell the papers to the
investors. A "round lot" for paper dealers is approximately
£250,000.[13]
 Marketable securities make business look more liquid,
since they are also included in the calculation of current
ratio. These securities are mostly traded on public
exchange due to their ready price availability. [14] There are
two forms of Marketable Securities: Marketable Equity
Securities and Marketable Debt Securities.[15]
 Money Market funds are similar to checking accounts, but
they mostly pay higher interest rates generated on
deposited funds.[16] Net asset Value (NAV) of Money Market
funds maintains stable compared to other mutual funds and
its share price is constant: $1.00 per share. For
businesses, non-profit organizations and many other
institutions MMF are very effective "vehicle" for cash
management.[17]
  Short-term government bonds are mostly issued by
governments to support government's spending. They are
mostly issued in country's domestic currency and in the U.S
government bonds include the Saving bond, Treasury
bond, Treasury inflation-protected securities and many
others. Before investing into government bond investors
should take into account political risk, inflation and interest
rate risk.[18]

Calculation of cash and cash equivalents[edit]

Cash and cash equivalents are listed on balance sheet as "current assets" and its value
changes when different transactions are occurred. These changes are called "cash
flows" and they are recorded on accounting ledger. For instance, if a company spends
$300 on purchasing goods, this is recorded as $300 increase to its supplies and
decrease in the value of CCE. These are few formulas that are used by analysts to
calculate transactions related to cash and cash equivalents:
Change in CCE = End of Year Cash and Cash equivalents - Beginning of Year
Cash and Cash Equivalents.[19]
Value of Cash and Cash Equivalents at the end of period = Net Cash Flow + Value
of CCE at the period of beginning[20]

Liquidity measurement ratios[edit]

 Current ratio is generally used to estimate company's
liquidity by "deriving the proportion of current assets
available to cover current liabilities". The main idea behind
this concept is to decide whether current assets which also
include cash and cash equivalents are available pay off its
short term liabilities (taxes, notes payable, etc.) The higher
current ratio is, the better is for the organisation. [21]

 Quick ratio is liquidity indicator that defines current ratio by

measuring the most liquid current assets in the company
that are available to cover liabilities. Unlike to the current
ratio, inventories and other assets that are difficult to
convert into the cash are excluded from the calculation
of quick ratio.[22][23]

 Cash ratio is more restrictive than above mentioned ratios

because no other current assets than cash can be used to
pay off current debt. Most of the creditors give importance
to cash ratio of the company, since it give them idea
whether the entity is able to maintain stable cash balances
in order to pay off their current debts as they come due.
Restricted cash[edit]

How Restricted Cash is presented in a balance sheet

Restricted cash is the amount of cash and cash equivalent items which are restricted for
withdrawal and usage. The restrictions might include legally restricted deposits, which
are held as compensating balances against short-term borrowings, contracts entered
into with others or entity statements of intention with regard to specific deposits;
nevertheless, time deposits and short-term certificates of deposit are excluded from
legally restricted deposits. Restricted cash can be also set aside for other purposes
such as expansion of the entity, dividend funds or "retirement of long-term debt".
Depending on its immateriality or materiality, restricted cash may be recorded as "cash"
in the financial statement or it might be classified based on the date of
availability disbursements. Moreover, if cash is expected to be used within one year
after the balance sheet date it can be classified as "current asset", but in a longer period
of time it is mentioned as non- current asset. For example, a large machine
manufacturing company receives an advance payment (deposit) from its customer for a
machine that should be produced and shipped to another country within 2 months.
Based on the customer contract the manufacturer should put the deposit into separate
bank account and not withdraw or use the money until the equipment is shipped and
delivered. This is a restricted cash, since manufacturer has the deposit, but he can not
use it for operations until the equipment is shipped.

See also[edit]
 Balance sheet
  United States Treasury security
 Currency

References[edit]
1. ^ Hermanson, Roger (1998).  Accounting A Business Perspective.
USA: McGraw-Hill. pp.  150. ISBN 0-256-16732-X.
2. ^ Denis, Durant (22–23 January 2013). "IAS 7 Statement of Cash
Flows- identification of cash equivalents"  (PDF). IFRS. Archived
from  the original  (PDF)  on 28 May 2016. Retrieved 2
November 2015.
3. ^ "What are cash and cash equivalents? - Questions & Answers -
AccountingTools". www.accountingtools.com. Retrieved 2015-11-03.
4. ^ "Cash and Cash Equivalent".  www.accountingsoul.com.
Retrieved 2015-11-04.
5. ^ "Ready for IFRS: The Components of Cash and Cash Equivalents
(IAS 7)".  faainc.blogspot.co.uk. Retrieved 2015-11-03.
6. ^ "ICI - Money Market Funds: FAQs".  www.ici.org. Retrieved 2015-11-
05.
7. ^ Nobes, Christopher (2006).  Penguin Dictionary of Accounting.
London: Penguin Books. p.  227. ISBN 978-0-14-102525-4.
8. ^ "Petty Cash Definition | Investopedia". Investopedia.
Retrieved 2015-11-05.
9. ^ "How Treasury Bills Work".  HowStuffWorks. Retrieved 2015-11-04.
10. ^ "Individual - Treasury Bills In Depth".  www.treasurydirect.gov.
Retrieved 2020-07-11.
11. ^ "Treasury Bill (T-Bill) Definition | Investopedia". Investopedia.
Retrieved 2015-11-04.
12. ^ Dyson, John (2007). Accounting for Non-Accounting Students.
London: Pearson. p.  436. ISBN 978-0-273-70922-0.
13. ^ "Commercial Paper". cucfa.org. Retrieved 2015-11-04.
14. ^ "Marketable Security Definition -
AccountingTools". www.accountingtools.com. Retrieved 2015-11-04.
15. ^ "Marketable Securities". www.money-zine.com. Retrieved 2015-11-
04.
16. ^ "Money Market Fund Definition | Investopedia". Investopedia.
Retrieved 2015-11-04.
17. ^ "ICI - Money Market Funds: FAQs".  www.ici.org. Retrieved 2015-11-
04.
18. ^ "Government Bond Definition | Investopedia".  Investopedia.
Retrieved 2015-11-04.
19. ^ "What Is Included in a Cash & Cash-Equivalent Calculation
Statement?".  Small Business - Chron.com. Retrieved 2015-11-04.
20. ^ "What Is Included in a Cash & Cash-Equivalent Calculation
Statement?".  Small Business - Chron.com. Retrieved 2015-11-04.
21. ^ "Liquidity Measurement Ratios: Current Ratio |
Investopedia".  Investopedia. Retrieved 2015-11-05.
22. ^ "Liquidity Measurement Ratios: Quick Ratio |
Investopedia".  Investopedia. Retrieved 2015-11-05.
 23. ^ http://financial-dictionary.thefreedictionary.com/quick+ratio
Categories: 
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 Cash
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