What are Cash and Cash Equivalents?
The lined items on a business’s balance sheet that describes the valuation of an organisation’s cash and liquid holdings are known as cash and cash equivalents. These items are liquid money or components that can be feasibly turned into money.
The cash equivalents consist of vendible securities and bank accounts that mature by 90 days or less. Sometimes, even equity or stock holdings are considered as cash equivalents as they can be sold in the stock market at short notice.
Understanding Cash and Cash Equivalents (CCE)
They are generally the group of liquid holdings acquired by an enterprise. To make it simple, it can be said that this asset category covers items that are akin to cash.
Here are some components that fall under cash and cash equivalents list.
First, take a look at the components of cash:
Foreign Currency
Companies that possess multiple currencies can sometimes undergo currency interchanging risk. The foreign currencies must be converted into reporting currency for accounting purposes. Results obtained after conversion must be similar to a value if that company would have calculated operations using a single denomination.
Translation losses garnered from the reduction of foreign currencies are not mentioned with CCE. However, these mislays are noted in the economic reporting account known as “accumulated other comprehensive income.”
Money Order
It is a financial statement given by the government or banks that a payee uses to obtain funds on the requirement. One advantage of a money order is that it is prepaid. So people prefer money orders more than checks.
They can be used to make payments for small business dues and debts as well. Moreover, money orders can be purchased with a small charge at places like post offices.
Petty Cash
It signifies the amount of money that is used for making payments of trivial outlays, and that amount may vary for every organisation. These funds must be kept secured and recorded to prevent thefts.
Cash at Bank
It is the amount of money and other liquefiable assets that are parked with a financial institution. It is a highly liquid asset and can be used to meet several short-term expenditures.
Bank Overdrafts
It refers to a situation when a bank balance passes below zero due to excessive withdrawals.
Coins
Irrespective of their material, coins that work as a medium between buying and selling are considered as cash.
Now let’s Move on to Cash Equivalents Examples.
Commercial Paper
Commercial papers are short-term unsecured debt instruments that are issued by companies. They are mainly used to finance payroll, inventories, payable accounts and various liabilities of short-duration. It comes with a fixed maturity that seldom goes above 270 days.
Marketable Securities
These are financial assets that can be quickly converted into cash. These assets are mainly traded on public platforms as they provide ready prices. Furthermore, two types of marketable securities are present: marketable debt securities and marketable equity securities.
Money Market Funds (MMF)
Money market funds are the same as checking accounts. But these funds have a high rate of interest accrual on deposited funds. Net Asset Value (NAV) of MMF remains stable in comparison to other mutual funds. For trades, non-profit enterprises, and various other organisations, money market funds are a productive tool for cash management.
Short-Duration Government Bonds
Short-term government bond funds are limited mutual funds. They are restricted concerning funding bylaws and investment objectives. That means investment can be only made on short-term liabilities of the government or related agencies.
Cash and cash equivalents in a balance sheet can be reported together or separately. In general, most organisations prefer to show them collectively.
Next, take a look at how to calculate CCE.
Evaluation of Cash and Cash Equivalents
Cash and cash equivalents are reported as current assets on a balance sheet. However, its value changes as different transactions occur. These alterations are termed as ‘cash flows’, and they are noted down on accounting ledger. For example, if a business spends Rs.1000 on buying goods, this is shown as Rs.1000 increase in cash outflow and reduction in cash and cash equivalents value.
Analysts use quite a few formulas to calculate dealings associated with CCE. The first cash and cash equivalents formula:
Change in CCE = CCE at the end of a Year - CCE at the beginning of a Year
The second:
CCE at the end of period Value = Total Cash Flow + Value of CCE at the period of beginning
However, there are exceptional items that are not considered as cash and cash equivalents. They are –
Credit Collateral
If Treasury bills are given as a mortgage for a loan, it does not fall under the list of cash equivalents. So, restricted T-bills must be shown separately.
Inventory
Inventories available in a company’s stock may not be easily convertible into cash. Hence, it is not a cash equivalent.
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FAQs on Cash and Cash Equivalents: Explained
1. What are Cash and Cash Equivalents as defined in the CBSE Class 12 Accountancy syllabus?
As per the CBSE syllabus, which aligns with Accounting Standard (AS) 3, Cash comprises cash on hand and demand deposits with banks. Cash Equivalents are short-term, highly liquid investments that are readily convertible into a known amount of cash and are subject to an insignificant risk of changes in value. These are held for meeting short-term cash commitments rather than for investment purposes.
2. What are some common examples of Cash and Cash Equivalents?
Common examples that fall under Cash and Cash Equivalents include:
- Cash in hand
- Cash at bank (in current or savings accounts)
- Cheques and drafts on hand
- Treasury Bills (with a short maturity period)
- Commercial Papers
- Short-term deposits with a maturity of three months or less
- Money Market Funds
3. What is the main difference between cash and a cash equivalent?
The primary difference lies in their form and purpose. Cash is the most liquid asset, available for immediate use (e.g., currency notes, bank balance). A cash equivalent is not cash itself but a short-term investment that can be converted into a known amount of cash very quickly, typically within three months, with minimal risk to its principal value. The purpose of holding cash equivalents is to earn a small return on idle cash.
4. What specific criteria must an investment meet to be classified as a cash equivalent?
For an investment to be classified as a cash equivalent, it must satisfy two key criteria. Firstly, it must have a short maturity, meaning it should be convertible to cash within three months or less from the date of its acquisition. Secondly, it must be subject to an insignificant risk of change in value, meaning its market price is not expected to fluctuate significantly.
5. Why are Cash and Cash Equivalents presented together in financial statements like the Cash Flow Statement?
Cash and Cash Equivalents are grouped together because they are both considered part of a company's liquidity management. From a financial perspective, there is little difference between having cash in the bank and holding a highly liquid, low-risk investment that can be converted to cash at a moment's notice. Presenting them together provides stakeholders with a clear and accurate view of the funds available to meet short-term obligations.
6. How are Cash and Cash Equivalents shown on a company's Balance Sheet?
On the Balance Sheet, Cash and Cash Equivalents are listed under the major head 'Current Assets'. They are typically presented as the first line item within this category because they are the most liquid of all current assets, reflecting their immediate availability for use.
7. Are all short-term investments considered cash equivalents? Explain why or why not.
No, not all short-term investments are cash equivalents. The deciding factor is the risk of value change. For instance, an investment in the equity shares of another company, even if intended to be sold within a month, is not a cash equivalent. This is because the value of shares can fluctuate significantly, meaning it is not readily convertible into a 'known' amount of cash, violating a core principle of cash equivalents.
8. How is a bank overdraft treated in relation to Cash and Cash Equivalents?
A bank overdraft is a short-term borrowing facility. As per Accounting Standard (AS) 3, it is considered a component of a company’s cash management and a financing activity. Therefore, a bank overdraft is typically included as a negative component within Cash and Cash Equivalents in the Cash Flow Statement, rather than being treated as a separate liability for this specific purpose.
