Information on the availability and flow of funds is necessary to determine the minimum need for funds, as well as to analyze the company’s liquidity. Cash and cash equivalents are the first items we see on the company’s Balance sheet and the most readily available part of an enterprise’s current assets.
Cash flow data is valuable in assessing an entity’s ability to make cash and its equivalents. It allows managers and other interested parties to evaluate the financial condition of a business, the future outlook, and compare data on the effectiveness of business activities of various companies.
Cash
Let’s start with the accounting term cash. Cash is simply the money of the company. It includes two components, one of which is cash on hand. This would be the physical bills and coins, checks from other companies and customers, money orders, as well as petty cash funds. If the checks are written for a future date (postdated), they cannot be counted as cash until the date written on them because the company would not be able to deposit and cash it until then. Cash valuation should be done at face value and for foreign currency – exchange rate at the moment.
The petty cash fund is used to pay small business expenses, such as advances to employees and office expenses. Some companies also have emergency funds. In addition, you would count the funds on the business savings deposit and demand deposit accounts in the financial institution, such as a bank, including foreign currency accounts of the enterprise. This is where the company deposits its collections and writes checks to fulfill its obligations.
Cash equivalents
Cash equivalents are a broad group of instruments that are deemed highly liquid. These investments are typically issued by financial institutions, often have stated interest rate paid to the investor, and are fairly low risk. One of the first cash equivalents utilized by first-time investors is the savings account and although there are some risks, one can typically withdraw money at any time.
These funds are usually held by businesses to meet their short-term obligations, and not for investment or other purposes, and are an important source of liquidity. Thus, companies want to have a cash cushion to withstand unforeseen situations such as a lack of revenue, repair or replacement of equipment, or other emergencies not budgeted for.
Assets that can be qualified as cash equivalents:
- equity securities (shares) held for sale in the next 3 months;
- debt securities (financial bills, bonds, savings certificates), the maturity or sale of which does not exceed 3 months;
- short-term loans granted to other persons (loan agreements and mortgages), the maturity of which or assignment of claims does not exceed 3 months.
To be reported as cash or equivalent of cash, an item must be unrestricted in use.
