What is Cash And Cash Equivalents?

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Cash and cash equivalents are a line item on the balance sheet that reports the value of a company's assets that are cash or can be converted into cash immediately. Cash equivalents include bank accounts and some types of marketable securities, such as debt securities with maturities of less than 90 days. However, cash equivalents often do not include equity or stock holdings because they can fluctuate in value.

Definition

Cash and cash equivalents are items on the balance sheet that report the portion of a company's assets that are cash or can be immediately converted into cash. Cash equivalents include bank accounts and certain types of securities, such as debt securities with maturities of less than 90 days. However, cash equivalents typically do not include stocks or equity holdings, as their value can fluctuate.

Origin

The concept of cash and cash equivalents originated from the need in accounting practices to manage liquid assets. As corporate financial management became more complex, the ability to accurately report a company's liquid assets became crucial. This concept was standardized with the development of international accounting standards in the mid-20th century.

Categories and Features

Cash and cash equivalents are primarily divided into two categories: cash and cash equivalents. Cash includes physical currency and bank deposits held by the company. Cash equivalents refer to short-term investments that can be quickly converted into a known amount of cash, such as treasury bills and commercial paper. Their main features are high liquidity and low risk.

Case Studies

Case Study 1: Apple Inc. often reports a large amount of cash and cash equivalents in its quarterly financial statements, allowing it to quickly invest or respond to market changes when needed. Case Study 2: Microsoft Corporation is also known for its strong cash flow management, with strategies for managing cash and cash equivalents that help the company remain stable during economic uncertainties.

Common Issues

Investors often misunderstand the scope of cash equivalents, assuming all short-term investments fall into this category. In reality, only those with short maturities and very low risk are considered cash equivalents. Additionally, holding too much cash can lead to opportunity costs, as these funds are not being used for potentially higher-yielding investments.

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Liquidity risk refers to the potential difficulty an entity may face in meeting its short-term financial obligations due to an inability to convert assets into cash without incurring a substantial loss. This risk is inherent in both financial institutions and corporations, significantly impacting their operational and financial stability.Liquidity risk is often characterized by two main aspects: market liquidity risk and funding liquidity risk. Market liquidity risk is associated with an entity's inability to execute transactions at prevailing market prices due to insufficient market depth or disruptions. On the other hand, funding liquidity risk pertains to the inability to obtain sufficient funding to meet financial obligations.Liquidity risk is not confined to any particular sector, as it is an important consideration across banks, financial institutions, corporations, and even some individual investors. For banks and financial institutions, liquidity risk management is underscored by regulatory frameworks that mandate certain liquidity standards to ensure financial stability and protect depositor interests. Corporations, too, need to be vigilant in managing liquidity risk to ensure they have adequate cash or credit lines to meet their operational and financial commitments. The ability to manage liquidity risk is essential for ensuring it has enough cash on hand to meet its short term needs and obligations.

Liquidity Risk

Liquidity risk refers to the potential difficulty an entity may face in meeting its short-term financial obligations due to an inability to convert assets into cash without incurring a substantial loss. This risk is inherent in both financial institutions and corporations, significantly impacting their operational and financial stability.Liquidity risk is often characterized by two main aspects: market liquidity risk and funding liquidity risk. Market liquidity risk is associated with an entity's inability to execute transactions at prevailing market prices due to insufficient market depth or disruptions. On the other hand, funding liquidity risk pertains to the inability to obtain sufficient funding to meet financial obligations.Liquidity risk is not confined to any particular sector, as it is an important consideration across banks, financial institutions, corporations, and even some individual investors. For banks and financial institutions, liquidity risk management is underscored by regulatory frameworks that mandate certain liquidity standards to ensure financial stability and protect depositor interests. Corporations, too, need to be vigilant in managing liquidity risk to ensure they have adequate cash or credit lines to meet their operational and financial commitments. The ability to manage liquidity risk is essential for ensuring it has enough cash on hand to meet its short term needs and obligations.

Zero-Proof Bookkeeping

Zero-proof bookkeeping is a manual bookkeeping procedure used in accounting in which posted entries are systematically subtracted from an ending balance to check for errors. In zero-proof bookkeeping, a balance of zero when all entries have been subtracted is proof that the accounting entries have been entered correctly. In this way, this practice is quite similar to keeping a balance sheet, which is a common financial statement issued by firms that balances assets with liabilities and shareholder's equity - such that subtracting the left side from the right side of the balance sheet results in a sum of zero.Zero-proof bookkeeping is employed as part of a double-entry bookkeeping system, where credits (liabilities) and debits (assets) are kept track of simultaneously.

Zero-Proof Bookkeeping

Zero-proof bookkeeping is a manual bookkeeping procedure used in accounting in which posted entries are systematically subtracted from an ending balance to check for errors. In zero-proof bookkeeping, a balance of zero when all entries have been subtracted is proof that the accounting entries have been entered correctly. In this way, this practice is quite similar to keeping a balance sheet, which is a common financial statement issued by firms that balances assets with liabilities and shareholder's equity - such that subtracting the left side from the right side of the balance sheet results in a sum of zero.Zero-proof bookkeeping is employed as part of a double-entry bookkeeping system, where credits (liabilities) and debits (assets) are kept track of simultaneously.

Zero-Gap Condition

A zero-gap condition exists when a financial institution's interest-rate-sensitive assets and liabilities are in perfect balance for a given maturity. The condition derives its name from the fact that the duration gap—or the difference in the sensitivity of an institution's assets and liabilities to changes in interest rates—is exactly zero. Under this condition, a change in interest rates will not create any surplus or shortfall for the company, since the firm is immunized to its interest rate risk for a given maturity.

Zero-Gap Condition

A zero-gap condition exists when a financial institution's interest-rate-sensitive assets and liabilities are in perfect balance for a given maturity. The condition derives its name from the fact that the duration gap—or the difference in the sensitivity of an institution's assets and liabilities to changes in interest rates—is exactly zero. Under this condition, a change in interest rates will not create any surplus or shortfall for the company, since the firm is immunized to its interest rate risk for a given maturity.

Like-Kind Exchange

A like-kind exchange is a tax-deferred transaction that allows for the disposal of an asset and the acquisition of another similar asset without generating a capital gains tax liability from the sale of the first asset.Until the passage of tax legislation in December 2017, that could have included the exchange of one business for another—or one piece of tangible property, such as artwork or heavy equipment, for another. After 2017, a like-kind exchange applies only to the exchange of a business or real estate investment property for another property.

Like-Kind Exchange

A like-kind exchange is a tax-deferred transaction that allows for the disposal of an asset and the acquisition of another similar asset without generating a capital gains tax liability from the sale of the first asset.Until the passage of tax legislation in December 2017, that could have included the exchange of one business for another—or one piece of tangible property, such as artwork or heavy equipment, for another. After 2017, a like-kind exchange applies only to the exchange of a business or real estate investment property for another property.

Identifiable Asset

An identifiable asset is an asset whose commercial or fair value can be measured at a given point in time, and which is expected to provide a future benefit to the company. These assets are an important consideration in the context of mergers and acquisitions.Because not all assets on a company's balance sheet are able to be quickly and accurately valued at a point in time, only those which are may be classified as identifiable. Examples include cash, short-term liquid investments, property, inventories, and equipment, among others.Identifiable assets may be contrasted with goodwill.

Identifiable Asset

An identifiable asset is an asset whose commercial or fair value can be measured at a given point in time, and which is expected to provide a future benefit to the company. These assets are an important consideration in the context of mergers and acquisitions.Because not all assets on a company's balance sheet are able to be quickly and accurately valued at a point in time, only those which are may be classified as identifiable. Examples include cash, short-term liquid investments, property, inventories, and equipment, among others.Identifiable assets may be contrasted with goodwill.

Equity Multiplier

The term equity multiplier refers to a risk indicator that measures the portion of a company’s assets that is financed by shareholders' equity rather than by debt. The equity multiplier is calculated by dividing a company's total asset value by the total equity held in the company's stock. A high equity multiplier indicates that a company is using a high amount of debt to finance its assets. A low equity multiplier means that the company has less reliance on debt. The equity multiplier is also known as the leverage ratio or financial leverage ratio and is one of three ratios used in the DuPont analysis.

Equity Multiplier

The term equity multiplier refers to a risk indicator that measures the portion of a company’s assets that is financed by shareholders' equity rather than by debt. The equity multiplier is calculated by dividing a company's total asset value by the total equity held in the company's stock. A high equity multiplier indicates that a company is using a high amount of debt to finance its assets. A low equity multiplier means that the company has less reliance on debt. The equity multiplier is also known as the leverage ratio or financial leverage ratio and is one of three ratios used in the DuPont analysis.