Cash and Cash Equivalents

Cash and Cash Equivalents –  As per the IAS 7, Cash and Cash Equivalents are defined as per below – 

Cash and cash equivalents comprise cash on hand and demand deposits, together with short-term, highly liquid investments that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes in value.

source – IAS

This complete article on Cash and Cash Equivalents is sub divided as per below –


What is Cash and Cash Equivalents?

  • All companies need cash to run their business. They either need to pay to pay salaries and bills and also to run their day-to-day operations.
  • When a company is not using its cash balance it may invest its cash in very low risk liquid (easily sold) securities so it can generate interest income.
  • Therefore very liquid securities are sometimes called cash equivalents.


What is included in Cash and Cash Equivalents?

As per the definition provided by IAS, you can include the following in cash and Cash Equivalents

  • Cash equivalents are securities (e.g. US Treasury bills) that have term of less than or equal to 90 days.
  • Cash could also include an amount required to be held for deposit to satisfy the terms of a lending agreement.
  • There should be insignificant amount of risk of change in value.
  • Stocks (Equity Investments) are not included here as the stock prices fluctuate daily and can lead to significant amount of risk
  • Preferred stocks can be included within three months of the redemption date

Cash and Cash Equivalents 1

How Short Term Investments and Long Term Investments differ?

  • Cash Equivalents can be different from Short Term Investments in tenure. Cash Equivalents have a maturity of less than 3 months, whereas short term investments mature within 12 months.
  • Likewise, long term investments have maturity of greater than 12 months and are not classified as Cash Equivalents.


Why should a firm hold cash and Cash Equivalents?

There are different reasons why a firm may want to keep reasonable levels of Cash and Cash Equivalents.

Overall Operating Strategy

Most companies try to keep small amount of cash as compared to the overall turnover. It is important that the company has enough cash to run their day to day operations without running to the bank every now and then. Let us look at Procter and Gamble Annual

PG Cash and Cash Equivalents

source: Yahoo Finance

  • PG Cash and Cash Equivalents = $8.558 billion
  • PG Total Assets = $144.266 billions
  • Cash & Cash Equivalents as % of Total Assets = 8.558 / 144.266 ~ 6%
  • PG Total Sales in 2014 = $83.062
  • Cash & Cash Equivalents as % of Total Sales = 8.558 / 83.062 ~ 10.3%

Speculative Acquisition Strategy

Another thought could be to pile up cash for a speculative or planned acquisition. If we note Apple’s Balance Sheet, we will get some insights on the same.

Apple Cash and Cash Equivalents

source: Yahoo Finance

  • Apple Inc Cash and Cash Equivalents = $13.844 billion
  • Apple Inc Total Assets = $231.839 billions
  • Cash & Cash Equivalents as % of Total Assets = 13.844 / 231.839 ~ 6%
  • Apple Inc Total Sales in 2014 = $182.795
  • Cash & Cash Equivalents as % of Total Sales = 13.844 / 182.795 ~ 7.5%

Though we see that there is nothing too exciting about the Cash and Cash Equivalents here, but if we closely look at all the Investments, we note that Apple Inc has a huge pile $13.844 bn (cash & cash equivalent) + $11.233 bn (short term investments) + $130.162 bn (long term investments) = $155.2 bn. Is this for a suitable acquisition target?

No Good Reason

Some companies  may have a high cash and cash equivalents for no good reasons. Maybe the management has not yet figured out the best way to deploy cash. In this case, one of the strategies could be to provide return to the shareholders by buying back shares.

In another case, where there is huge pile of up cash and cash equivalents for capital intensive firms would imply an investment in a big project or a machinery.

Colgate’s Cash and Cash Equivalents Example

You can download Colgate’s 10K report from here

Let us try to answer a couple of quick questions on Colgate’s Cash and Cash Equivalents to master this concept further.

Where is Colgate’s Cash and Cash Equivalents found?

Colgate’s CCE is found in the balance sheet.

Colgate Cash and Cash Equivalents - Balance Sheet

How much Cash and Cash Equivalents Colgate has in 2013 and 2014?

Colgate has $0.962 bn and $1.089 billion of Cash & Cash Equivalents in 2013 and 2014, respectively.

Is this a large or small amount compared with total sales?

  • Colgate’s Cash and Cash Equivalents (2014) = $1.089 bn
  • Colgate’s Total Sales in 2014 = $17.277 bn
  • Cash & Cash Equivalents as % of Total Sales (2014) = 1.089/17.277 = 6.3% 
  • Colgate’s Cash and Cash Equivalents (2013) = $ 0.962 billion
  • Colgate’s Total Sales in 2013 = $ 17.420
  • Cash & Cash Equivalents as % of Total Sales (2013) = 0.962 / 17.420 = 5.5%

If we compare this with the PG (Proctor and Gamble) discussed above, it is in line. Looks like 6% is normal (neither small nor large)

Do you think Colgate is planning to use this cash for an acquisition?

Cash & Cash Equivalent for Colgate is around (which is not very high) ~6%. Also, if we look at the short term investments and long term investments of Colgate, they are pretty much non existent. Most likely we can deduct from above that Colgate is not looking to puruse any major acquisition strategy. Also, note that cash and cash equivalents improves the Current Ratio

How does Colgate define the Cash and Cash Equivalents in Accounting Policies?

Colgate defines Cash and Cash Equivalents as per below.

Colgate Cash and Cash Equivalents

What next?

If you learned something new or enjoyed the post, please leave a comment below. Let me know what you think. Many thanks and take care. Happy Learning!


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