What’s it: Cash is money in the form of banknotes or coins. In accounting, other examples of cash are checks, notes, and demand deposits.
Cash is the most liquid asset and vital to the liquidity of the company. Companies can use them immediately to pay suppliers, creditors, or purchase capital equipment.
How to present cash in financial statements
The company presents cash in current assets. You can see it at the top line of assets if the company reports its balance sheet in order of liquidity. And, companies usually join it with cash equivalent accounts. So, the accounts you are looking at are probably cash and cash equivalents.
Cash equivalents are very liquid. They are financial instruments with maturities of less than 3 months and carry minimal price risk. In other words, the company can use it immediately without losing value at the time of disbursement.
Companies choose cash equivalents to fulfill two purposes. First, the company can use it immediately to meet short-term liquidity needs. Second, the company gets a return. It makes more sense than holding paper money (cash) without getting a return.
What are the sources of cash in and cash out
The sources of cash income and payments fall into three categories:
- Cash from operating activities – related to the company’s day-to-day operations, such as cash inflows from the sale of goods, payments to suppliers, and salary payments.
- Cash from investing activities – includes purchases of fixed assets and long-term investments in the company. Examples are the purchase of new machines and the sale of logistics vehicles.
- Cash from financing activities – related to collecting and paying to capital providers such as issuing bonds/shares, paying dividends, and paying off debts.
You can find a breakdown of all three in the cash flow statement section.
What are the advantages and disadvantages of holding cash
Analysts are happy that the company has a lot of cash. There is a saying, “Cash is King.”
Cash is so liquid that companies can use it when needed. This becomes significant if the company has debt that matures shortly. Without sufficient cash, the company suffers from liquidity problems.
Ample cash provides a buffer during hard times. When income is temporarily decreased or delayed, the company still has enough cash to meet its short-term liabilities.
Having a significant cash position is also advantageous when market opportunities arise. Companies can immediately exploit it.
Cash has no price risk like other securities. Equity and debt securities can decline in value when holding them for some time.
But analysts are also unhappy if the company has too much cash.
Holding cash has opportunity costs. Companies cannot make more money by just holding banknotes in hand. Companies should invest in various asset classes such as equity, debt securities, or real estate. That way, they get a return (but possibly a loss).
Cash also has a higher exposure to inflation risk. If inflation soars, the money the company holds today is less valuable than it was before. For the same amount of money, they could only buy fewer items than before. To compensate for the decrease in purchasing power, companies should place it into safe instruments such as government bonds.