What Are Cash and Cash Equivalents in Accounting?

Cash and cash equivalents represent a company’s most liquid assets, which are assets that can be converted into cash quickly. This combined category is an indicator of a company’s short-term financial stability. It shows the resources readily available to meet immediate spending needs, such as paying suppliers and employees. Understanding this figure allows for an assessment of a company’s ability to manage its day-to-day operational expenses without needing to sell long-term assets or secure additional financing.

Defining Cash

In accounting, cash refers to assets that are immediately available to fund current business operations. This category is not limited to just the physical currency a company might have on hand. It also includes funds held in company checking and savings accounts, known as demand deposits because they can be withdrawn at any time without penalty. If the asset can be used to pay a liability today, it is considered cash.

This includes other instruments that function like immediate money. For example, undeposited checks received from customers and money orders are treated as cash because they are accepted by banks for deposit and immediate credit. The key characteristic is unrestricted access for current use, and their value is certain and not subject to market fluctuations.

Understanding Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible to a known amount of cash. For an investment to be classified as a cash equivalent, the primary rule is that it must have a maturity of three months or less from the date it was acquired by the company. For instance, a three-year U.S. Treasury note purchased just three months before its maturity date would qualify. However, that same Treasury note, if purchased three years ago, does not become a cash equivalent when its remaining maturity is three months. This short maturity ensures the investment is not significantly exposed to the risk of changes in value due to interest rate fluctuations.

Common examples of cash equivalents include U.S. Treasury bills (T-bills), high-grade commercial paper, and money market funds. These instruments are purchased with temporarily idle cash to earn a small return, with the full intention of converting them back to cash within a very short period.

Investments in stocks, for instance, are never considered cash equivalents because their values can fluctuate significantly. Bonds with maturity dates longer than three months from the acquisition date are also excluded. The distinction is based on the minimal risk of a change in value.

Presentation on Financial Statements

On a company’s balance sheet, “Cash and Cash Equivalents” is presented as a single line item. It is almost always the first asset listed in the Current Assets section, highlighting its position as the most liquid of all company assets. The figure represents the total of all cash and qualifying equivalent instruments held by the business.

This line item also plays a role in the Statement of Cash Flows. This financial statement is designed to explain the change in the cash and cash equivalents balance over a period. The statement begins with the cash and cash equivalents balance from the prior period’s balance sheet and ends with the balance for the current period, detailing the cash inflows and outflows from operating, investing, and financing activities that caused the change.

A company must also identify any cash that is not available for general use. This is known as “restricted cash,” which refers to funds legally or contractually set aside for a specific purpose, such as collateral for a loan or a future construction project.

The accounting for restricted cash differs between financial statements. On the balance sheet, restricted cash is shown separately from unrestricted cash and cash equivalents to provide a clear view of what is truly available for immediate operational needs. However, on the statement of cash flows, the beginning and ending balances include both restricted and unrestricted cash. To clarify this, companies must provide a reconciliation between the total cash, cash equivalents, and restricted cash reported on the balance sheet and the total amount shown on the statement of cash flows.