Cash equivalents are the most liquid assets, i.e. those that can be rapidly converted into cash. Examples include Treasury bills, marketable securities, money market funds, short-term government bonds, foreign currency, and commercial paper.
Cash equivalents mature within three months, unlike short-term investments which mature at up to 12 months, and long-term ones which mature at later than 12 months.
Cash equivalents must also have insignificant risk of change in value. Common shares are not classed as cash equivalents, but preferred shares acquired just before their redemption date may be.
Sometimes it is possible that a company has cash that is not showing up in ‘Cash and Cash Equivalents’ because it is restricted for some kind of non-current obligation and will be a non-current asset.
Put simply, cash equivalents are investment securities that are highly liquid, have a high credit quality, and are very short-term.
The FT Lexicon defines cash equivalents as:
“Assets that can be quickly converted into cash, in other words that are highly liquid. Examples include money market funds and Treasury bills. In a company’s financial statement, cash equivalents are normally grouped with cash.”
In a company’s financial statement
In a company’s balance sheet, cash equivalents are generally grouped with cash (cash and cash equivalents), and are also called near money.
“Cash and cash equivalents includes currency, coins, checks received but not yet deposited, checking accounts, petty cash, savings accounts, money market accounts, and short-term, highly liquid investments with a maturity of three months or less at the time of purchase such as U.S. treasury bills and commercial paper. The items included as cash and cash equivalents must also be unrestricted.”
Cash and cash equivalents will appear on the balance sheet as the first item in the list of current assets, given that line items are stated in their order of liquidity.
Video – Cash and Cash Equivalents
In this video, the speaker explains what cash and cash equivalents are, and discusses when restricted cash is classed as a current or non-current asset.