In financial accounting, cash is defined as the sum of: Cash equivalents are short-term investments that can be converted quickly into cash. They include such things as balances in savings accounts and money market funds, short-term certificates of deposit, and short-term government securities (e.g., treasury bills). Another example of a cash equivalent is short-term commercial paper (negotiable notes receivable issued by other companies). Cash and cash equivalents can be combined on the balance sheet or reported as separate items. Some firms combine cash with short-term investments in marketable equity securities. As a practical matter, efficient financial management results in a very low cash balance because any excess funds are invested in cash equivalents. The availability of highly liquid investments tends to make the distinction between cash and cash equivalents less meaningful. In general, the short-run solvency of a firm is strengthened by having additional cash and cash equivalents because the firm is better able to meet to short-term obligations; correspondingly, having less creates greater risk. An excess of cash redirects management’s attention from financing to investing. A shortage has just the opposite effect. The nature of cash and cash equivalents creates the need for two types of management control. First, controls should be implemented to prevent misappropriation of cash. The study of these controls falls within the scope of an auditing course. Second, management attention should be directed to planning future cash flows in order to assure the sufficiency of the balance and to maximize investment income. This subject is covered in management accounting and financial management courses. In response to statement users’ needs for assessing earning power, accountants report material amounts of investment income separately from operating income. To help users assess solvency, the balance sheet reports the balance of cash and cash equivalents. This number (either by itself or in combination with others) can be compared with liabilities that demand settlement in the short run. To accomplish this goal, GAAP also call for disclosures about restrictions on the availability of cash in terms of either the purposes to which it can be applied or the time that it must be left invested. The balance of cash is also potentially helpful in assessing earning power in that an excess available for investment may allow the firm to expand or take advantage of other opportunities as they arise. Accounting practices related to cash and cash equivalents are relatively uncomplicated. The primary reason for this simplicity is the absence of substantive measurement problems. The goal of financial accounting for cash is the disclosure of the balance on hand at the balance sheet date. In most cases, the task of verifying the cash account balance consists primarily of examining bank statements, deposit slips, and canceled checks. Where currency, coins, and undeposited items are material, this verification involves a physical tabulation of the amount.Definitions
Cash
Cash Equivalents
Explanation
Impact on the Firm
Accounting Objectives
Accounting Practice
Cash and Cash Equivalents FAQs
Cash and cash equivalents refer to liquid assets that can be readily converted into known amounts of cash, such as bank deposits, certificates of deposit, treasury bills and money market funds.
Examples of cash equivalents include short-term fixed income investments with a maturity period of three months or less, currency on hand, commercial paper and government bonds.
Cash and its equivalents are important sources of liquidity for businesses as they allow companies to quickly convert them into available funds when needed. Additionally, they help improve a company's creditworthiness as creditors view them as a sign of financial stability.
Cash and its equivalents are typically reported under current assets on the balance sheet, since they are liquid assets that can easily be converted into cash.
Businesses often use their available cash or cash equivalents to fund daily operations, pay for short-term investments or purchase necessary supplies/equipment. Additionally, companies may use these funds to pay off debts and taxes or to provide reserves for unexpected situations.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
