{"### Introduction
Cash equivalents are securities geared towards short-term investing. Featuring robust credit quality and high liquidity, these securities are almost as accessible as cash, allowing for quick conversion. They often appear on balance sheets under current assets and serve as a mainstay in the trio of asset classes: stocks, bonds, and cash equivalents.
Key Takeaways
- Cash and cash equivalents represent immediate cash and securities akin to cash.
- Listed at the top of a company\u2019s balance sheet, they are the most liquid assets.
- Forming one of the three main asset classes, they consist of low-risk, low-return instruments.
- Typical securities include U.S. government T-Bills, bank CDs, commercial paper, and other money market instruments.
- The presence of ample cash and cash equivalents suggest a company’s ability to settle short-term liabilities, reflecting its financial health.
Understanding Cash Equivalents
Cash equivalents encompass U.S. government Treasury bills, bank certificates of deposit, bankers’ acceptances, corporate commercial paper, and other money market instruments. They are known for their short maturities, highly liquid markets, and minimal risk. Moreover, they project a firm’s financial health, being indicative of its capability to pay short-term obligations and potentially attract acquisitions. These liquid investments, when stated on financial statements, often get combined with actual cash, representing a firm’s total holdings in liquid assets.
Types of Cash Equivalents
Treasury Bills
Issued by the U.S. Department of Treasury, Treasury Bills (T-bills) mature within a year. They are sold at a discount and redeemed at face value upon maturity. They are prolific for quick, short-term lending to the government.
Commercial Paper
Commercial paper is unsecured, short-term debt issued by large corporations to cover short-term liabilities. These are issued at a discount and mature within 1 to 270 days.
Marketable Securities
These are highly liquid financial assets convertible into cash, traded on public exchanges with strong secondary markets. Examples include T-bills, CDs, bankers’ acceptances, and mutual funds.
Money Market Funds
Money market funds invest solely in cash equivalents with substantial liquidity and credit quality. They stabilize portfolios by offering conservative and short-term investment options, maintaining a consistent share price of $1.
Short-Term Government Bonds
These liquid securities, issued by the government, fund various government projects. Although liquid and low-risk, interest rate and inflation risks must be considered.
Certificate of Deposit (CD)
A certificate of deposit is a saver’s investment giving a fixed return over a specified period, typically ranging from one month to five years. Such investments are insured up to $250,000 at federally-insured banks.
Banker’s Acceptance
With bank guarantees, bankers\u2019 acceptances facilitate safe and reliable transactions, often used for international trade, acting as a near-cash asset.
Features of Cash Equivalents
Regular overlap in characteristics defines cash equivalents: liquidity, short-term investment horizon, low volatility, and unrestricted access. These assure flexibility and much-needed accessibility similar to cash.
Uses of Cash Equivalents
Cash equivalents are vital for organizations to meet short-term obligations, build emergency funds, prepare for future projects, or comply with debt agreements. They offer secure, lower-risk returns on idle funds compared to holding cash.
Advantages
- Higher yields than standard bank accounts while retaining high liquidity.
- Fixed interest rates appeal to conservative investors needing assured returns.
Disadvantages
- Returns lower than those of longer-term, less liquid investments.
- Risk of issuer default and often not covered by federal insurance.
- Fees possible with early redemption of products like CDs.
Example of Cash Equivalents
To illustrate, in 2021, Microsoft maintained substantial holdings in cash equivalents. It managed acquisitions, such as Ze niMax Media Inc., and ended the fiscal year with $130.3 billion in liquid investments, cementing its solid financial stance.
Conclusion
Cash equivalents offer a strategic blend of safety, liquidity, and modest returns. They enable companies to safeguard assets, remain prepared for unforeseen demands, and steadily grow their returns without enduring high risks typically associated with long-term investments.":"
Related Terms: Treasury Bills, Commercial Paper, Marketable Securities, Money Market Funds, Short-Term Government Bonds, Certificate of Deposit (CD), Banker’s Acceptance.
References
- TreasuryDirect. “Treasury Bills”.
- Berkshire Hathaway. “3rdqtr22-Form 10Q”.
- Federal Deposit Insurance Corporation. “Your Insured Deposits”.
- Microsoft. “2021 Annual Report”, Page 30
- Microsoft. “2021 Annual Report”, Page 50
- Microsoft. “2021 Annual Report”, Page 42
