Cash and Cash Equivalents

Definition: Cash and cash equivalents are highly liquid assets including coin, currency, and short-term investments that typically mature in 30-90 days.

CCE is actually two different groups of very similar assets that are commonly combined because they are so closely related. Letís take a look at each one of these current assets in more detail.

Cash

In economic terms, cash is the form of exchange for all business transactions and activities. In other words, itís the standard method of payment for businesses. In fact, U.S. currency has ďthis note is legal tender for all debts, public and privateĒ printed directly the face of each bill to indicate that it is backed by the federal government to be of value and able to cover any obligations.

In accounting terms, cash is the currency and coinage owned by a company. This includes the money in companyís bank account, petty cash drawer, and register. Companies can generate their cash reserves in a few different ways.

First, owners and investors can contribute money to the business in exchange for a percentage ownership in the company. Second, the company can generate money from selling goods or services to customers as part of its ongoing operations. Third, the business can borrow money from banks, financial institutions, and other lenders.

Controlling cash flow and financing is a crucial part of running any business. A business can be profitable and still not be able to pay its bills on time because money was not managed properly. Profitability does not always equate to large amount of free cash flow. Investors and creditors need to know where the companyís cash comes from and where it goes. Thatís why management details each cash activity for the period on the statement of cash flows.

Cash Equivalents

Cash equivalents are assets, typically investments that are so liquid and easily converted into cash that they might as well be currency. These are extremely low risk, short-term investments that typically mature in no more than 90 days. Some examples of cash equivalents include:

  • Treasury Bills
  • Short-term Government Bonds
  • Marketable Securities
  • Commercial Paper
  • Money Market Funds

Itís important to note that these investments are only considered equivalents if they are readily available and are not restricted by some agreement. For instance, if a company has a loan that requires it to maintain a minimum level of their treasure bills, these T-bills cannot be considered equivalents because they are restricted by the debt covenants.

Presentation

Businesses can report these two categories of assets on the balance sheet separately or together, but most companies choose to report them together.

GAAP allows this financial statement presentation because some investments are so liquid and risk adverse that they are considered cash. Take T-bills for example. These investments are backed by the U.S. government and will always be paid. Itís not like a private short-term bond or loan where the company can default or go bankrupt. T-bills are a safe, guaranteed investment that can be cashed in at any time. Thus, GAAP recognizes these investments as if they were actual currency.

If the T-bills canít be cashed in because of debt covenants or some other agreement, like in our debt restriction example above, the restricted T-bills must be reported in a separate investment account from the non-restricted T-bills on the balance sheet.