# Cash and cash equivalents

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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]

In financial accounting, a balance sheet or statement of financial position or statement of financial condition is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business partnership, a corporation, private limited company or other organization such as Government or not-for-profit entity. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year.

To invest is to allocate money in the expectation of some benefit in the future.

Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.

## Contents

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]

In business, a takeover is the purchase of one company by another. In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.

## Components of cash

• 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]

A currency, in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. A more general definition is that a currency is a system of money in common use, especially for people in a nation. Under this definition, US dollars (US$), pounds sterling (£), Australian dollars (A$), European euros (€), Russian rubles (₽) and Indian Rupees (₹) are examples of currencies. These various currencies are recognized as stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.

A coin is a small, flat, round piece of metal or plastic used primarily as a medium of exchange or legal tender. They are standardized in weight, and produced in large quantities at a mint in order to facilitate trade. They are most often issued by a government. Coins often have images, numerals, or text on them.

A savings account is a deposit account held at a retail bank that pays interest but cannot be used directly as money in the narrow sense of a medium of exchange. These accounts let customers set aside a portion of their liquid assets while earning a monetary return.

## Components of cash equivalents

• 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 sold in denominations of $1000 up to maximum amount of$5 million and generally they do not pay any interest rates, but are sold at a discount, their yield being the difference between purchase price and redemption value. [10]
• Commercial paper is a bearer document which is used by big companies. The minimum amount permitted is ₤100,000 and this form of borrowing is not suitable for certain "entities". [11] 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. [12]
• 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. [13] There are two forms of Marketable Securities: Marketable Equity Securities and Marketable Debt Securities. [14]
• Money Market funds are similar to checking accounts, but they mostly pay higher interest rates generated on deposited funds. [15] 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. [16] • 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. [17] Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of not more than 270 days. A government bond or sovereign bond is a bond issued by a national government, generally with a promise to pay periodic interest payments called coupon payments and to repay the face value on the maturity date. The aim of a government bond is to support government spending. Government bonds are usually denominated in the country's own currency, in which case the government cannot be forced to default, although it may choose to do so. If a government is close to default on its debt the media often refer to this as a sovereign debt crisis. In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. ## 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:

A cash flow is a real or virtual movement of money:

A ledger is the principal book or computer file for recording and totaling economic transactions measured in terms of a monetary unit of account by account type, with debits and credits in separate columns and a beginning monetary balance and ending monetary balance for each account.

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

• 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 and etc.)The higher current ratio is, the better is for the organisation. [20]
${\displaystyle {\mbox{Current Ratio}}={{\mbox{Current Assets}} \over {\mbox{Current Liabilities}}}}$
• 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. [21] [22]
${\displaystyle {\mbox{Quick Ratio}}={{{\mbox{Current Assets}}-{\mbox{Inventories}}} \over {\mbox{Current Liabilities}}}}$
• 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.
${\displaystyle {\mbox{Cash Ratio}}={{\mbox{Cash and Cash Equivalent}} \over {\mbox{Current Liabilities}}}}$

## 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.

## Related Research Articles

In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for. In a liquid market, the trade-off is mild: selling quickly will not reduce the price much. In a relatively illiquid market, selling it quickly will require cutting its price by some amount.

The money supply is the total value of money available in an economy at a point of time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. Each country’s central bank may use its own definitions of what constitutes money for its purposes.

Money market is an important part of the economy which provides short-term fund.The money market is the part of financial market which deals in the borrowing and lending of short-term loans generally for a period of less than or equal to 365 days.

In accounting, a current asset is any asset which can reasonably be expected to be sold, consumed, or exhausted through the normal operations of a business within the current fiscal year or operating cycle. Typical current assets include cash, cash equivalents, short-term investments, accounts receivable, stock inventory, supplies, and the portion of prepaid liabilities which will be paid within a year.In simple words, assets which are held for a short period are known as current assets. Such assets are expected to be realised in cash or consumed during the normal operating cycle of the business.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be "tangible book value".

Fractional-reserve banking is the most common form of banking practised by commercial banks worldwide. It involves banks accepting deposits from customers and making loans to borrowers, while holding in reserve a fraction of the bank's deposit liabilities. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. The minimum amount that banks are required to hold in liquid assets is determined by the country's central bank, and is called the reserve requirement or reserve ratio, but each bank can hold more than this minimum amount that takes into account their particular situation and liability profile.

In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7, is the International Accounting Standard that deals with cash flow statements.

A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield.

In finance, the quick ratio, also known as the acid-test ratio is a type of liquidity ratio, which measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. It is defined as the ratio between quickly available or liquid assets and current liabilities. Quick assets are current assets that can presumably be quickly converted to cash at close to their book values.

Statutory liquidity ratio (SLR) is the

The current ratio is a liquidity ratio that measures whether a firm has enough resources to meet its short-term obligations. It compares a firm's current assets to its current liabilities, and is expressed as follows:

Financial statement analysis is the process of reviewing and analyzing a company's financial statements to make better economic decisions to earn income in future. These statements include the income statement, balance sheet, statement of cash flows, notes to accounts and a statement of changes in equity. Financial statement analysis is a method or process involving specific techniques for evaluating risks, performance, financial health, and future prospects of an organization.

Asset and liability management is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting.

In financial economics, a liquidity crisis refers to an acute shortage of liquidity. Liquidity may refer to market liquidity, funding liquidity, or accounting liquidity. Additionally, some economists define a market to be liquid if it can absorb "liquidity trades" without large changes in price. This shortage of liquidity could reflect a fall in asset prices below their long run fundamental price, deterioration in external financing conditions, reduction in the number of market participants, or simply difficulty in trading assets.

Financial management focuses on ratios, equities and debts. It is useful for portfolio management, distribution of dividend, capital raising, hedging and looking after fluctuations in foreign currency and product cycles. Financial managers are the people who will do research and based on the research, decide what sort of capital to obtain in order to fund the company's assets as well as maximizing the value of the firm for all the stakeholders. It also refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. It is the specialized function directly associated with the top management. The significance of this function is not seen in the 'Line' but also in the capacity of the 'Staff' in overall of a company. It has been defined differently by different experts in the field.

In financial accounting, an asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset. Simply stated, assets represent value of ownership that can be converted into cash. The balance sheet of a firm records the monetary value of the assets owned by that firm. It covers money and other valuables belonging to an individual or to a business.

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

Net operating assets (NOA) are a business's operating assets minus its operating liabilities. NOA is calculated by reformatting the balance sheet so that operating activities are separated from financing activities. This is done so that the operating performance of the business can be isolated and valued independently of the financing performance. Management is usually not responsible for creating value through financing activities unless the company is in the finance industry, therefore reformatting the balance sheet allows investors to value just the operating activities and hence get a more accurate valuation of the company.

A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.

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