Introduction

Everyone knows about cash as the currency used to perform transactions. It includes physical notes and coins. Companies also use cash to complete their operations. But the way companies use cash is a little different. They have money stored in bank accounts, marketable securities, money market funds, etc., apart from liquid cash and coins. Thus, in addition to cash in its traditional sense, companies also depend on cash equivalents.

Cash equivalents refer to assets that are feasibly convertible to cash. Learn about cash and cash equivalents meaning, their types, and their differences in this article.

Cash and cash equivalents: Meaning

India follows the Ind-AS or Indian Accounting Standards. The system defines cash and cash equivalents (CCE) as stated below.

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Cash means accessible cash and demand deposits. On the other hand, cash equivalent means short-term, highly liquid assets that can be converted into defined amounts of money. They are exposed to a negligible risk of alterations in value.

Classification of cash and cash equivalents

A company can hold different types of cash and cash equivalents. Here’s an overview of the components of cash.

1. Cash and coins

This type includes liquid cash, meaning banknotes and coins used immediately for clearing trivial expenses. The amount differs for every organisation and must be kept securely to avoid thefts.

2. Cash at bank

This type of cash includes the money and other liquefiable assets saved with a banking institution. Due to its high liquidity, you can use it instantly for many short-term expenses.

3. Money order

The government or bank provides a financial statement that payees use to attain funds when required. The benefit of a money order is that it is prepaid. Thus, it is preferable to bank cheques. Moreover, you can use it to pay for small business payments and debts. Money orders are available at places like post offices for a small charge.

4. Bank overdrafts

Bank overdraft refers to a condition when your bank balance goes below zero because of excessive withdrawals.

Here’s a brief description of the different components of cash equivalents.

1. Money Market Funds (MMFs)

Money market instruments are low-risk, short-term investments like bank deposits. Their interest rates may be slightly higher. Money market funds are of three types in India.

• Commercial papers  - A company issues this short-term debt instrument to raise money from the market for a period of up to 270 days.
• Treasury bills  - The Reserve Bank of India (RBI) issues these short-term borrowing instruments on behalf of the government. Their maturity is within a year.
• Certificates of Deposit   (CD)  - The bank also issues these short-term borrowing instruments. Their period is from three months to a year.

2. Short-duration government bonds

These are debt securities that municipalities, corporations, and institutions issue. They have a maturity period of less than a year.

Cash vs cash equivalents - How are they different?

Cash and cash equivalents are highly liquid assets easily convertible into cash. They differ in the following ways:

• Cash represents the physical currency or coins available to an individual or company, such as the money kept in a small cash box or cash register. On the other hand, cash equivalents represent highly liquid assets convertible to cash when required. Cash equivalents include bank deposits, checking accounts, savings accounts, and money market funds.
• While cash and cash equivalents are highly liquid, the speed at which they can be converted to cash differs. For instance, physical cash is available for immediate use, whereas some cash equivalents' withdrawal or settlement period may be more extended and have restrictions.
• Cash equivalents can help you earn interest or other return on investment, whereas physical cash cannot. For instance, a company can earn interest from its money market funds or savings account, which aids in accumulating cash reserves over time.

Summing up

Cash and cash equivalents are essential to an individual or company’s financial assets. They refer to highly liquid assets you can convert to cash when required. Cash and bank deposits are the most common examples of cash and cash equivalents. Other highly liquid asset classes, like treasury bills and money market funds, also qualify. You must learn about cash and cash equivalents, their differences, and their types for efficient financial planning and wise investment decisions.

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