Cash And Cash Equivalents
by Yuvi K - October 26, 2023
What is Cash and Cash Equivalents?
Cash and cash equivalents are assets that can be easily converted into cash within a short period of time. They are considered to be liquid assets because of their ready-cash nature. Basically, cash and cash equivalents represent any asset that can be exchanged for currency almost immediately.
Cash and cash equivalents include money invested in highly liquid securities such as deposits in banks, treasury bills, mutual funds, and short term bonds with remaining maturities of less than 90 days. Thus, they can considered to be liquid investments which can be converted into cash quickly and easily.
Examples of Cash Equivalents
| Asset | Definition |
|---|---|
| Cash in Bank Account | Funds available in bank accounts or credited to financial accounts in the form of credit cards, debit cards, lines of credit, etc. |
| Money Market Funds | Type of mutual fund which invests only in short term, high quality debt securities such as corporaterepurchase agreements, certificates of deposit, Treasury bills, etc. |
| Prepaid Cards | Payment cards that are preloaded with a given amount of money and accepted at a specific merchant establishment or for a specific service. |
| Treasury Bills | Short-term debt instruments issued by governments at fixed interest rates for a period of up to one year. |
| Short Term Debentures | Debt securities or bonds issued by a company for up to 12 months. |
Uses of Cash and Cash Equivalents
Cash and cash equivalents are often be used to cover a company’s day-to-day operations. This includes salary payments, rent payments, utility expenses, among others. Companies use cash and cash equivalents to fund their short-term obligations until long-term financing is obtained, such as loans from banks or other financial institutions. They can also help to smooth out cash flow and provide additional liquidity to pay for unexpected expenses.
Advantages of Cash and Cash Equivalents
- Low Risk: Holding cash and cash equivalents is a very safe and low risk investment. It is not likely to result in considerable losses due to factors like inflation or market fluctuatios.
- High Liquidity: Cash and cash equivalent investments can be easily converted into cash when needed and are extremely liquid investments.
- Low Cost: Basically, cash and cash equivalent investments require little to no fees or commissions, more so compared to other investments such as stocks or mutual funds.
Disadvantages of Cash and Cash Equivalents
- Low Return: Generally, the rate of return on cash and cash equivalents is very low because they are investments that are low-risk and therefore, do not offer high returns.
- Lack of Incentives: Another disadvantage of cash and cash equivalent investments is that they are not necessarily tax advantaged and therefore, have no incentives to encourage investment.
- Inflation Risk: Lastly, although being a low-risk investment, inflation risk is a potential issue with cash and cash equivalents. Constant inflation erodes the real-value of money, thereby reducing total returns.
Conclusion
Cash and cash equivalents represent a safe and liquid way of achieving short-term investment goals with minimal risk. However, they also have their limitations and should not be looked as a sufficient alternative to stocks and other higher return investments. Cash and cash equivalents are assets that can be easily converted into cash quickly with relatively low risk and low returns.
