Cash equivalents – definition and meaning
Cash equivalents are the most liquid assets there are. In other words, they are assets that we can rapidly convert into cash. Examples include Treasury bills, marketable securities, money market funds, and short-term government bonds. Foreign currency is a cash equivalent and so is commercial paper.
They mature within three months, unlike short-term, medium-term, and long-term investments. Short-term investments mature at up to 12 months, while long-term investments mature later.
A cash equivalent must also have an insignificant risk of change in value. We do not classify common stock as a cash equivalent because a stock’s value changes. However, preferred shares that investors acquired just before their redemption date may be.
Sometimes a company may have cash that is not showing up in ‘Cash and Cash Equivalents.’ It does not show up because we have restricted it for some non-current obligation and it 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 a cash equivalent as any asset that we can quickly convert into cash.
Cash equivalents in the balance sheet
In a company’s balance sheet, accountants group cash equivalents with cash. We also call them near money.
The terms near money or quasi-money refer to highly liquid assets that we can quickly turn into cash. Near money is any non-cash asset that is extremely liquid but which we cannot use directly for transactions.
Cash and cash equivalents will appear on the balance sheet as the first item in the list of current assets. We list them first because they are very liquid. We state line items in their order of liquidity.
Cash equivalents – foreign currency
Foreign currency is only a cash equivalent if you can rapidly turn it into your local currency. In other words, if you can convert it into cash quickly.
For example, I can convert US dollars into my currency rapidly. Trying to convert Venezuelan Bolivars into cash is extremely difficult. Therefore, Venezuela’s currency is not a cash equivalent, but the US dollar is.