Are Short-Term Investments Considered Marketable Securities?

Companies and investors hold short-term investments to manage excess cash while earning a return. These investments are liquid and intended to be sold or converted into cash within a year. However, not all short-term investments qualify as marketable securities, which must meet specific criteria related to liquidity and marketability.

Understanding the distinction between short-term investments and marketable securities is important for financial reporting and investment decisions.

Classification Criteria

For an investment to be classified as a marketable security, it must be liquid, transferable, and have a reliable fair market value. Liquidity means the investment can be easily converted into cash without significant loss. This typically requires an active secondary market where buyers and sellers can transact efficiently. Stocks listed on major exchanges like the NYSE or Nasdaq, as well as government bonds traded in established markets, generally meet this standard.

Marketable securities must also be freely tradable. Investments subject to lock-up periods, private placements, or other restrictions do not qualify. For example, restricted stock issued to company executives may have a high market value but cannot be sold immediately, preventing classification as marketable.

Valuation is another key factor. Marketable securities must have a reliable fair value based on quoted prices or observable market data. Investments requiring complex valuation models, such as privately held equity or certain derivatives, do not qualify. Accounting standards like ASC 820 and IFRS 13 emphasize using Level 1 or Level 2 inputs—such as publicly available stock prices or recent transaction data—when measuring fair value.

Common Categories

Short-term investments that qualify as marketable securities are highly liquid, actively traded, and generally low-risk. The most common types include:

Treasury Bills

Treasury bills (T-bills) are short-term debt instruments issued by the U.S. Department of the Treasury with maturities ranging from a few days to one year. They are sold at a discount to face value, with investors earning a return when they mature. For example, a 90-day T-bill with a face value of $10,000 might be purchased for $9,800, yielding a $200 gain upon maturity.

T-bills are considered marketable securities because they are backed by the U.S. government, making them virtually risk-free. They are also highly liquid, actively trading in the secondary market. Investors can sell them before maturity through brokers or financial institutions without significant price fluctuations. Additionally, T-bills are exempt from state and local taxes but are subject to federal income tax.

Commercial Paper

Commercial paper is an unsecured, short-term debt instrument issued by corporations to finance short-term liabilities such as payroll, accounts payable, or inventory purchases. Maturities typically range from a few days to 270 days, as longer maturities require SEC registration.

Since commercial paper is not backed by collateral, its creditworthiness depends on the issuing company’s financial strength. Large corporations with high credit ratings from agencies like Moody’s or S&P can issue commercial paper at lower interest rates. For example, a company with an A-1 rating from S&P may issue 90-day commercial paper at an annualized yield of 5%, while a lower-rated issuer might need to offer 6% to attract buyers.

Commercial paper is considered a marketable security because it is actively traded in the secondary market, particularly among institutional investors such as money market funds and pension funds. However, it carries some risk, as default is possible if the issuing company faces financial distress.

Certificates of Deposit

Certificates of deposit (CDs) are time deposits issued by banks and credit unions that pay a fixed interest rate over a specified term. Short-term CDs, typically with maturities of less than a year, can be classified as marketable securities if they are negotiable, meaning they can be sold in the secondary market before maturity.

Negotiable CDs, often issued in denominations of $100,000 or more, are commonly traded among institutional investors. Unlike traditional retail CDs, which must be held until maturity or face early withdrawal penalties, negotiable CDs provide liquidity by allowing investors to sell them before the term ends. For example, a 6-month negotiable CD with a face value of $500,000 and an interest rate of 4% could be sold in the secondary market if the holder needs cash before maturity.

While CDs are generally low-risk, they are subject to interest rate risk. If market interest rates rise, the value of an existing CD with a lower rate may decline, making it less attractive to buyers. However, FDIC insurance covers CDs up to $250,000 per depositor per bank, reducing default risk for smaller investors.

Valuation in Financial Statements

The valuation of short-term investments in financial statements depends on their classification under accounting standards. Companies categorize these holdings based on intent and ability to sell, which determines whether they are recorded at cost, amortized cost, or fair value.

For publicly traded securities, fair value is typically determined using quoted market prices on active exchanges. When observable market prices are unavailable, valuation models incorporating recent transaction data or comparable assets may be used, though this introduces subjectivity.

Under U.S. GAAP, short-term investments are often classified as trading securities or available-for-sale securities. Trading securities, intended for near-term profit, are reported at fair value with unrealized gains and losses recognized in net income. Available-for-sale securities, which may be held for an indefinite period but are not actively traded, are also reported at fair value, but unrealized gains and losses are recorded in other comprehensive income (OCI) instead of net income.

For debt securities held to maturity, amortized cost valuation applies if the company has both the intent and ability to hold them until maturity. This method smooths out price fluctuations by recognizing interest income over time rather than marking the asset to market. However, impairment testing is required to assess whether a decline in value is credit-related, which would necessitate a write-down through earnings. The Financial Accounting Standards Board (FASB) updated these impairment rules under ASC 326, requiring expected credit losses to be recognized earlier, impacting financial institutions and investors holding corporate bonds or asset-backed securities.

Tax implications also play a role in valuation. The IRS treats unrealized gains on trading securities as taxable income when recognized in financial statements, while unrealized gains in OCI from available-for-sale securities do not trigger immediate tax liabilities. When these investments are sold, capital gains taxes apply, with short-term holdings taxed at ordinary income rates, which can be as high as 37% in 2024, depending on an investor’s tax bracket. Companies managing investment portfolios must consider these tax consequences when deciding whether to sell or hold securities.

Reclassifications and Disposals

Changes in business strategy, economic conditions, or financial planning can lead companies to reclassify or dispose of short-term investments. A firm may move investments between categories when its intentions evolve, such as shifting a security from an available-for-sale designation to a trading classification due to an increased focus on liquidity and short-term gains. Under ASC 320, such reclassifications require adjustments to fair value, with any unrealized gains or losses being recognized immediately in earnings if moving into the trading category. This can create earnings volatility, particularly if the market value has fluctuated significantly since acquisition.

Disposals of short-term investments can occur for several reasons, including capital reallocation, risk mitigation, or cash flow needs. When a company liquidates holdings, the realized gain or loss is determined by comparing the sale price to the recorded book value. For tax purposes, proceeds from sales must be reported under IRS guidelines, with short-term capital gains taxed at ordinary income rates. If an entity disposes of a security at a loss, it may be able to offset taxable gains, subject to the $3,000 annual limit on capital loss deductions for individuals under IRS Section 1211. Corporate entities face different limitations on net operating loss carryforwards and may need to consider tax planning strategies to optimize their financial position.