What Are Cash Equivalents?

What Are Cash Equivalents?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Cash equivalents are investment securities that are for short-term investing, and they have high credit quality and are highly liquid. They include Treasury bills, bank certificates of deposit, bankers’ acceptances, corporate commercial paper, and other money market instruments. Their conversion to cash is easy due to their close-to-cash nature, and the risk of change in their value is low because they are typically invested for less than 3 months.

Related Questions

1. What is the role of cash equivalents in a company’s financial management?

Cash equivalents play a crucial role in an organization’s financial management. They provide liquidity and flexibility. Companies can quickly and easily convert these assets into cash, making them an excellent choice for emergency funds or for periods of market instability.

2. What’s the difference between cash and cash equivalents?

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Cash is actual currency and coins, checks from customers, and money orders. Cash equivalents are short-term commitments “nearly” as good as cash. While both can be used almost immediately to finance operations, the main difference resides in their liquidity and value stability.

3. Can stocks be considered as cash equivalents?

Generally, stocks are not considered as cash equivalents. Although they can be converted into cash, this process can take longer and it’s subjected to price volatility. Cash equivalents need to have a maturity date of three months or less, which is not typical for stocks.

4. Are mutual funds considered cash equivalents?

Some money market mutual funds could be considered cash equivalents due their liquidity, but not all mutual funds qualify. To be considered a cash equivalent, the investment must be short-term, highly liquid, and have low risk of value change.

5. Why are cash equivalents important in the calculation of free cash flow?

Cash equivalents are counted in the calculation of free cash flow because they can be easily converted into cash. Free cash flow reflects the financial health of a company and its ability to generate cash—it reflects the cash that a company has left from its operations that can be used for expansion, paying down debt, or distributed to shareholders.