What are Cash and Cash Equivalents?

Cash and Cash Equivalents, usually found as a line item on the top of the balance sheet asset, are those sets of assets that are short-term and highly liquid investments that can be readily convertible into cash and are subject to low risk of price change. Examples include Cash and Paper Money, US Treasury bills, undeposited receipts, Money Market funds, etc.

When a company is not using its cash balance, it may invest its cash in low-risk liquid (easily sold) securities to generate interest income. Therefore very liquid securities are sometimes called cash equivalents.

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List of Cash and Cash Equivalents

  • Cash equivalents are securities (e.g., US Treasury billsTreasury BillsTreasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government.read more) that have less than or equal to 90 days.Stocks (Equity InvestmentsEquity InvestmentsEquity investment is the amount pooled in by the investors in the shares of the companies listed on the stock exchange for trading. The shareholders make gain from such holdings in the form of returns or increase in stock value.read more) are not included here as the stock prices fluctuate daily and can lead to a significant amount of risk.Preferred stocks can be included within three months of the redemption date.

How do Cash Equivalents differ from Investments?

  • Cash Equivalents can be different from Short-Term Investments in tenure. Cash Equivalents have a maturity of fewer than three months, whereas short-term investments mature within 12 months.Likewise, long-term investments have a maturity of greater than 12 months and are not classified as Cash Equivalents.

Why Firms hold Cash?

There are different reasons why a firm may want to keep reasonable levels of CCE.

#1 – Overall Operating Strategy

Most companies try to keep a small amount of cash compared to the overall turnover. The company must have enough cash to run its day-to-day operations without running to the bank now and then. Let us look at Procter and Gamble’s example –

source: Yahoo Finance

  • PG Cash = $8.558 billionPG Total Assets = $144.266 billionsCash as % of Total Assets = 8.558 / 144.266 ~ 6%PG Total Sales in 2014 = $83.062Cash as % of Total Sales = 8.558 / 83.062 ~ 10.3%

#2 – Speculative Acquisition Strategy

Another thought could be to pile up cash for a speculative or planned acquisition. But, again, if we note Apple’s example, we will get some insights into the same.

  • Apple Inc Cash = $13.844 billionApple Inc Total Assets = $231.839 billionsCash as % of Total Assets = 13.844 / 231.839 ~ 6%Apple Inc Total Sales in 2014 = $182.795Cash as % of Total Sales = 13.844 / 182.795 ~ 7.5%

Though we see that there is nothing too exciting about the cash here, if we closely look at all the Investments, we note that Apple Inc has a huge pile of $13.844 bn (cash & cash equivalent) + $11.233 bn (short term investmentsShort Term InvestmentsShort term investments are those financial instruments which can be easily converted into cash in the next three to twelve months and are classified as current assets on the balance sheet. Most companies opt for such investments and park excess cash due to liquidity and solvency reasons.read more) + $130.162 bn (long term investments) = $155.2 bn. So is this for a suitable acquisition target?

#3 – No Good Reason

Some companies may have high cash for no good reasons. For example, maybe the management has not figured out the best way to deploy cash. In this case, one of the strategies could be to provide a return to the shareholders by buying back shares.

In another case, a huge pile of up cash for capital-intensive firms would imply an investment in a big project or machinery.

Colgate’s Cash and Cash Equivalents Example

You can download Colgate’s 10K report from here

Let us take an example of Colgate. Here we will answer a couple of quick questions on Colgate’s Cash to master this concept further.

Where is Colgate’s CCE found?

Colgate’s CCE is found in the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more.

How much CCE Colgate has in 2013 and 2014?

Colgate has $0.962 bn and $1.089 billion of CCE in 2013 and 2014, respectively.

Is this a large or small amount compared with total sales?

  • Colgate’s Cash (2014) = $1.089 bnColgate’s Total Sales in 2014 = $17.277 bnCash % of Total Sales (2014) = 1.089/17.277 = 6.3%

  • Colgate’s Cash (2013) = $ 0.962 billionColgate’s Total Sales in 2013 = $ 17.420Cash as % of Total Sales (2013) = 0.962 / 17.420 = 5.5%

It is in line if we compare this with the PG (Proctor and Gamble) discussed above. It looks like 6% is normal (neither small nor large)

Do you think Colgate is planning to use this cash for an acquisition?

Cash for Colgate is around (which is not very high) ~6%. Also, if we look at Colgate’s short-term and long-term investments, they are pretty much nonexistent. So, most likely, we can deduct from the above that Colgate is not looking to pursue any major acquisition strategy. Also, note that cash and cash equivalents improve the Current Ratio.

How does Colgate define this in Accounting Policies?

Colgate defines Cash as per below.

What next?

This has been a guide to Cash and Cash Equivalents, its definition, and its basics. Here we discuss the list of Cash and Cash Equivalents, examples of Colgate, P&G, and Apple, and the top 3 reasons firms hold cash. If you learned something new or enjoyed the post, please comment below. Let me know what you think. Many thanks, and take care. Happy Learning!

Cash and Cash Equivalents Video

  • Cash EquivalentsCash Ratio FormulaAccounts Receivables ExamplesShareholders Equity Financial Statements