Cash and cash equivalents

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 even less(if maturity period is more than 90 days (e.g., 100 days), then it will not be considered as cash and cash equivalents) from date of acquisition and when it carries an insignificant risk of changes in value. 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. Company with a pp relatively higher net assets than cash and cash equivalents is mostly 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]

Components of cash

Components of cash equivalents

Calculation of cash and cash equivalents

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.[18]

Value of Cash and Cash Equivalents at the end of period = Net Cash Flow + Value of CCE at the period of beginning[19]

Liquidity measurement ratios

Restricted cash

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, contacts 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.[23]

See also

References

  1. Hermanson, Roger (1998). Accounting A Business Perspective. USA: McGraw-Hill. p. 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.
  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. "Treasury Bill (T-Bill) Definition | Investopedia". Investopedia. Retrieved 2015-11-04.
  11. Dyson, John (2007). Accounting for Non-Accounting Students. London: Pearson. p. 436. ISBN 978-0-273-70922-0.
  12. "Commercial Paper". cucfa.org. Retrieved 2015-11-04.
  13. "Marketable Security Definition - AccountingTools". www.accountingtools.com. Retrieved 2015-11-04.
  14. "Marketable Securities". www.money-zine.com. Retrieved 2015-11-04.
  15. "Money Market Fund Definition | Investopedia". Investopedia. Retrieved 2015-11-04.
  16. "ICI - Money Market Funds: FAQs". www.ici.org. Retrieved 2015-11-04.
  17. "Government Bond Definition | Investopedia". Investopedia. Retrieved 2015-11-04.
  18. "What Is Included in a Cash & Cash-Equivalent Calculation Statement?". Small Business - Chron.com. Retrieved 2015-11-04.
  19. "What Is Included in a Cash & Cash-Equivalent Calculation Statement?". Small Business - Chron.com. Retrieved 2015-11-04.
  20. "Liquidity Measurement Ratios: Current Ratio | Investopedia". Investopedia. Retrieved 2015-11-05.
  21. "Liquidity Measurement Ratios: Quick Ratio | Investopedia". Investopedia. Retrieved 2015-11-05.
  22. "Cash Ratio | Analysis | Formula | Example". My Accounting Course. Retrieved 2015-11-05.
  23. "Cash and Cash Equivalent". www.accountingsoul.com. Retrieved 2015-11-04.
This article is issued from Wikipedia - version of the 11/19/2016. The text is available under the Creative Commons Attribution/Share Alike but additional terms may apply for the media files.