It is time for a little financial accounting 101 and a slight study into one of the most basic elements of the balance sheet - cash and cash equivalents. Typical with a lot of things in the financial accounting world, its slightly more complex that the cash in your wallet and the balance in your checking account.
Why is it important?
Anytime a business or an individual is looking to get loans or other forms of capital, the amount of cash and cash equivalents are very important in the bank or credit analyst's determinations on whether or not to grant the loan, how much money to grant, and the interest rate that will be offered to the debtor. Obviously, with a loan, a business or an individual is looking to gain access to more cash. The current cash on hand will be measured (along with other assets) against other short term debt obligations the business is already liable for.
Glossary - 230-10-20
Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the cu
stomer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made.
Demand deposits are any kind of a banking or financial account that you can withdraw cash from without any kind of prior notice or approval.
Glossary - 210-10-20
Cash equivalents are short-term, highly liquid investment assets meeting two criteria. (Note: only investments purchased within three months of their maturity dates usually satisfy these criteria.) a. Readily convertible to a known cash amount. b. Sufficiently close to their maturity date so that their market value is not sensitive to interest rate change.
The following types of assets with original maturities of less than three months are considered to be cash equivalents: savings accounts, undeposited checks, treasury bills, money market funds, and commercial paper.
What about petty cash?
Most old school business people know about petty cash, which is a small amount of cash kept on hand by a business to pay for small business expenditures. With the increased ease of using credit cards, checks that can be deposited instantly, and mobile paying options, petty cash is certainly out of style. However, petty cash certainly would qualify as cash on the balance sheet.
What does not qualify as a cash equivalent?
1) Any short term investment with an original maturity over three months
2) The balance of any account that cannot be easily withdrawn from in the form of cash
3) An bounced check deposit.