Cash and Cash Equivalents consist of actual currency, bank deposits, and highly liquid investments—such as treasury bills, money market funds, and commercial paper—with original maturities of three months or less. These assets are readily available for immediate use in operations.
Why are Cash and Cash Equivalents Important?
Cash and Cash Equivalents are essential because they:
Ensure Liquidity: Provide the funds necessary to meet short-term obligations like payroll, supplier payments, and unexpected expenses.
Reflect Financial Health: A strong cash position indicates a company's ability to withstand downturns and seize growth opportunities.
Support Investment Decisions: Investors and creditors assess cash levels to evaluate creditworthiness and operational stability.
How are Cash and Cash Equivalents Calculated?
Cash and Cash Equivalents are reported on the balance sheet and calculated as the sum of:
Cash and Cash Equivalents = Cash on Hand + Cash at Bank + Short-Term, Highly Liquid Investments
Where:
Cash on Hand: Physical currency and coin held by the company.
Cash at Bank: Bank account balances available on demand.
Short-Term Investments: Investments with original maturities of three months or less that are low risk and quickly convertible to cash.
Additional Considerations
Presentation: Companies disclose cash and cash equivalents together, separate from restricted cash, which has usage limitations.
Cash Flow Analysis: Changes in cash and equivalents are detailed in the cash flow statement, highlighting operating, investing, and financing activities.
Risk Management: Maintaining an optimal level balances liquidity needs against returns from longer-term investments.