BUS202: Principles of Finance

LEARNING OBJECTIVE

• Distinguish cash and cash equivalents from other types of assets

KEY POINTS

• Cash refers to physical currency such as banknotes and coins.
  
• Cash has now become a very small part of the money supply.
  
• A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand.
  
• Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet.
  

In common language, cash refers to physical currency such as banknotes and coins.

In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately (as in the case of money market accounts). Cash is viewed either as a reserve for payments, in case of a structural or incidental negative cash flow, or as a way to avoid a downturn in financial markets.

Cash has now become a very small part of the money supply. Its remaining role is to provide a form of currency storage and payment for those who do not wish to take part in other systems, and prefer to make small payments conveniently and promptly. This latter method, however, is being replaced more and more frequently by electronic payment systems.

A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at the end of the period, plus any cash in hand. However, many businesses are not paid immediately; they build up inventories of goods and they acquire buildings and equipment. In other words, because businesses have assets, they cannot immediately turn them into cash at the end of each period. Often, these businesses owe money to suppliers and to tax authorities, and the proprietors do not withdraw all their original capital and profits at the end of each period. This means that businesses also have liabilities. Cash and cash equivalents can be used to pay the short-term debt of a company.

Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or treasury bills, marketable securities, and commercial paper. Cash equivalents are distinguished from other investments through their short-term existence; they mature within 3 months, whereas short-term investments take 12 months or less and long-term investments take longer than 12 months. Cash equivalent investments should also have an insignificant risk of change in value: for example, common stock cannot be considered a cash equivalent, but preferred stock acquired shortly before its redemption date can.

Money

A banknote (often known as a bill, paper money, or simply a note) is a type of negotiable instrument known as a promissory note, made by a bank, payable to the bearer on demand. When banknotes were first introduced, they were, in effect, a promise to pay the bearer in coins, but gradually became a substitute for the coins and a form of money in their own right.