Definition

Cash and Cash Equivalents are basically the line item on the balance sheet, which reflects the overall cash or liquidity position of the particular business. They are basically those assets, that can be converted to cash in a relatively quicker span of time.

Therefore, it can be seen that Cash and Cash Equivalents are a group of assets that are owned by the company.

In most cases, the company has a variety of cash and cash equivalents, the aggregate of which is mostly shown on the top line of the balance sheet.

The main reason behind their positioning in the balance sheet is the fact that they are current assets, and within current assets, they are mainly the most liquid amidst all the other short-term assets.

What is included in Cash and Cash Equivalents?

Cash includes bills, coins, undeposited checks, and any other liquid item that can be considered legal tender.

It also includes money that is kept in checking and savings accounts. Cash in Hand basically includes all the items that are similar to cash. As a matter of fact, it can be seen that the overall liquid assets, which can readily be converted to cash are considered as Cash or Cash Equivalents.

Cash

As far as cash in its pure form is concerned, it can be seen that it basically is the money that exists in the form of currency.

It also includes all bills, coins, and other currency notes. In the same manner, demand deposits are further considered as a type of account from which funds can readily be withdrawn without any prior notice.

Examples of demand deposit accounts are mainly all saving accounts, or checking accounts. Therefore, all demand account balances are also included in the balances at the end of a subsequent year.

Foreign Currency

In a lot of instances, it can be seen that companies have more than one currency. They mainly keep alternate currencies in order to hedge themselves from the currency exchange risk.

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Therefore, in the same manner, currency from foreign currencies, are also considered as liquid and easily convertible assets.

However, currency from other foreign countries must also be converted and then reported in the financial statements for the report.

This is to ensure that the overall balances are in one currency so that stakeholders have proper clarity regarding the overall cash equivalents that the company has at the end of a particular given financial year.

Cash Equivalent

 In the same manner, it can be seen that cash equivalents are investments that can be converted into cash in a quick manner of time.

However, the main contingency in this regard is the fact that these investments have to be short term, and the overall investment duration should be three months or less. In the case where the investment is for a longer time duration, it should be classified into other investments.

The main rationale behind this is the fact that cash equivalents should be highly liquid and should be easily sold on the market. In the same manner, the buyers of these investments should also be easily accessible.

However, in order to declare cash equivalents as liquid assets, it also becomes important to have the known market price for all these instruments.

The main premise in this regard is to ensure that these instruments are relatively stable, and are not subject to significant fluctuations before redemption or maturity.

Which items should not be included in Cash and Cash Equivalents?

In certain instances, there are situations where companies tend to be confused regarding the overall items which should be included in cash and cash equivalents, and which should not be included.

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Despite the clear distinction in the liquidity cycle, it is also rudimentary to realize that there are certain elements that should also be accounted for when it comes to the items not necessarily included as cash or cash equivalents.

Firstly, inventory should not be included as a cash equivalent, predominantly because of the reason that it cannot be readily converted to cash.

In the same manner, because of the fact that the net realizable value is still uncertain, it can be seen that including inventor might be a deception, because there is no certainty about the value which it will be sold for.

In the same manner, credit collaterals are also not supposed to be included as cash equivalents, because of the reason that there is ambiguity regarding the overall timeline the amount will actually be realized.

However, in the case of Treasury Bills, it can still be made possible, because it is certain that the amount will be paid upon maturity.

How does Cash and Cash Equivalents report in the balance sheet?

Basically, cash and cash equivalents are reporting in the balance sheet showing the total balance at the reporting with a comparative figure of previous reporting balance. In general, it is reporting total in the current assets section of total assets.

The breakdown of the total cash and cash equivalents is showing in the note to financial statements. The breakdown of the noted normally showing the balance of cash on hand, cash at bank, other cash equivalent items.

How does Cash and Cash Equivalents report in the statement of cash flow?

In the statement of cash flow, cash and cash equivalent show the balance of two different dates or times. Normally, the statement of cash flow shows the cash generate from operating activities, financial activities and then the cash generate from investing activities.

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The accumulation of cash from all of these activities will come up with the net change in cash and cash equivalents during the period.

This net change in cash and cash equivalents during the period plus cash and cash equivalent at the beginning of the period will get total cash and cash equivalent at the end of the period. This amount should be equal to the total balance in the balance sheet.

Conclusion

The overall reasoning behind the proper calculation of Cash and Cash Equivalents is the fact that it is directly related to the overall liquidity structure of the company.

It is a clear reflection about the overall ability of the company to meet its day to day expenses, and ensure that they honor their financial commitments on time.

Therefore, this particular line item has a very high impact on the overall working capital of the company and also speaks volumes about the overall manner in which working capital is managed within the company.

Furthermore, Cash and Cash Equivalents are also a very important factor for the calculation of numerous other ratios and calculations. It provides very useful insight regarding cash management at the company, and how it can be improved as a result of better management practices.

Therefore, Cash and Cash Equivalents can be regarded as a very important asset for any organization, because it mirrors their ability to harness and foster better relationships.

To summarize the information mentioned above, it can be seen that cash and cash equivalents include any liquid cash that the company presently has available, and other bank accounts and marketable securities that can readily be converted to cash.

However, the main determinant of an item to be included as a Cash Equivalent is the premise that they should have maturities of three months or less.