Definition: Restricted cash is money that is not freely available for immediate investment use. In other words, it’s the amount of money that a firm puts aside and holds for a particular purpose.
What Does Restricted Cash Mean?
What is the definition of restricted cash? Firms hold restricted cash to anticipate a sudden capital expenditure, a loan repayment, a plant expansion or the purchase of equipment. In the case of capital expenditure, the firm requests a loan and the bank may request the firm to put the restricted cash as collateral against the loan. Often, firms keep restricted cash in a separate bank account, which must have a minimum balance equal to 10% of the total line of credit and they report it separately from cash and cash equivalents account because it is not money that can be used immediately.
Let’s look at an example.
Company A is a large clothing manufacturer. The company enters into an agreement with its lender for $500,000 line of credit to purchase new equipment and be able to meet customer orders. The bank asks the company to open a restricted cash account and maintain a balance of $50,000, which is the 10% of the total amount of the loan. Therefore, the clothing manufacturer enters into the credit line agreement with the lender, and as long as the agreement is active, the company has to maintain a balance of $50,000 in the restricted cash account of the lender.
The clothing manufacturer buys the new equipment and starts delivering the orders to its customers. One of the customers sends a deposit for an order to be shipped within one month. Based on the agreement with the customer, the clothing manufacturer has to maintain the amount of deposit to a separate bank account until they ship the order to the customer. Once the order is shipped, the cash is free.
Define Restricted Cash: Restricted cash means the amount of money that is reserved for a specific purpose and can’t be used for general operations or investments.