What Are Cash Equivalents in Accounting?
In the accounting world of cash, cash equivalents are close but no cigar! Now, the basic premise of cash equivalents is that they’re just a hair away from being available for withdrawal on demand. They’re short term, readily convertible to cash; if they have a maturity date, it’s so close to that date that the chance of them devaluing is negligible.
A “close” maturity date for a cash equivalent is three months or less.
Examples of cash equivalents are Treasury bills, commercial paper, and money market funds.
Treasury bills: These items are debt instruments the U.S. Department of Treasury issues that mature in less than one year.
Don’t confuse Treasury bills with treasury stock which is when a company reacquires their own stock.
Commercial paper: This term refers to notes receivable with no collateral to back up the debt. Commercial paper has a maturity date of less than 270 days.
Money market funds: Money market accounts are similar to checking accounts, except they generally pay a higher interest rate on deposited funds than regular checking. However, they also usually require maintaining minimum balances.
Because of the minimum balance requirement, money market funds aren’t considered readily available, which is why they classify as a cash equivalent instead of straight-out cash.
Businesses usually put any type of short-term investment into play to get some use out of temporarily idle cash. If “extra” money is sitting in the company checking account earning no interest, it’s a smart move to make every attempt to invest it short term in an interest-bearing vehicle.