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Why Are Cash & Cash Equivalents in One Caption on Financial Statements?

Original post by Wanda Thibodeaux of Demand Media

A checking account is a cash equivalent reported by most companies.

A financial statement is a formal document companies use to show all of their assets. Two assets companies must show are cash and cash equivalents. Technically, these two assets are not the same. However, they are similar enough that companies treat them roughly the same way in accounting and place them under a single heading on financial statements.

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Definitions

To understand why companies place cash and cash equivalents under one caption on a balance sheet, it's useful to know exactly what these two assets are. Cash is any money, either in coins or banknotes, issued by a government. A cash equivalent is an asset, such as a checking account or Treasury bond, that reaches maturity very quickly, generally in three months or less, and which is easily converted into cash.

Liquidity

The ability to access an asset is known as liquidity. When a company prepares a financial statement, company representatives want to show the assets the company can access quickly -- in a year or less -- first. The assets that are harder to access are listed lower on the statement. Financial statements thus show the order in which a company can access its assets. Cash and cash equivalents both have similar liquidity, with both accessible, in most cases, in just a few hours after reaching maturity. Cash can be converted to a cash equivalent and back again very quickly, so there is little reason to separate them on the financial statement.

Company Needs

Another reason companies put cash and cash equivalents together on a financial statement is that they serve the same financial function. Companies use both cash and cash equivalents to handle immediate financial needs, such as paying a bill that has come due or buying new equipment to replace broken items.

Company Strength

Some cash and cash equivalent funds come from loans. However, in general, the more cash and cash equivalents a company has, the stronger the company's financial position because it has a better ability to meet its immediate financial needs. Presenting cash and cash equivalents under one heading presents a better overall picture of the company's success. It also offers a more complete representation of the company's short-term investment options.


                   

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About the Author

Wanda Thibodeaux is a freelance writer and editor based in Eagan, Minn. She has been published in both print and Web publications and has written on everything from fly fishing to parenting. She currently works through her business website, Takingdictation.com, which functions globally and welcomes new clients.

Photo Credits

  • Thinkstock/Comstock/Getty Images


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