Cash equivalents

Cash equivalents are those liquid assets which can easily convert in cash. For example, our cash in our bank account is cash equivalent because we can easily withdraw cash from bank through our ATM. Like this, if we have govt. treasury bills like kisan vikas pater or money market’s commercial papers, all these can convert into cash within one or two days. Some part of current assets can be included in it if we are able to covert into cash without any delay. For example, we deal in gold. Gold is our inventory; it can easily be sold in the market by selling gold in the market at any time. We can get cash fastly. So, stock of gold will be our cash equivalent.

Importance of Cash Equivalents

There are many decision of management in which we have not only to see the cash but also cash equivalents. So, cash equivalents can not be ignored.

1. For calculating Quick Ratio

For calculating the quick ratio, we add cash equivalents items in cash.


2. Selling of Auction Rate Security

To know the cash equivalents is also important because its knowledge we can know the happening in the financial area. For example auction rate security is long term security but it was sold as cash equivalent. Since February 2008, most such auctions have failed, and the auction market has been largely frozen. Following is the detail which has been taken from Wikipedia.

According to multiple reports, these were widely sold as "cash equivalents", such that the cash would be available for return within as little as 7 days. However, once the auctions were abandoned by the banks, thousands of investors were left with these illiquid funds since February 2008, without knowing when their cash will be returned.

3. Banker’s Acceptance

Banker’s acceptance is also cash equivalent because the holder of bank’s acceptance draft can be sold at discount. But it is important to know if person want to collect cash from bank, he has to wait upto maturity date. So, from that point of view, it will not be cash equivalent.