Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Cash

What it is:

Cash is an asset that is in currency form.

How it works (Example):

Although there is some leeway for judgment in particular situations, common examples of cash at the corporate level typically include bank accounts and money market funds. Marketable securities and Treasury bills are easily converted into cash and are thus usually called "cash equivalents." The Financial Accounting Standards Board requires companies to establish policies concerning which types of short-term, highly liquid investments are treated as cash equivalents.

The balance sheet shows the amount of cash at a given point in time; the statement of cash flows explains the change in cash over time.

Why it Matters:

The amount of cash a company holds is very important and has implications for the company's overall operating strategy. For instance, companies with high amounts of cash are better able to get through hard times when sales are low or expenses are particularly high. However, companies with a lot of cash on hand are often takeover targets because their excess cash essentially helps buyers finance their purchase.

High cash reserves also could indicate that management has not figured out how to best deploy the cash, but for capital-intensive companies, high cash reserves could signal that the company is "saving up" to make some significant purchases.

It is important to note that there is an opportunity cost to holding cash; that cost is the return on equity that company could have earned by investing the cash in a new product or expanding business.

Many theories exist about how much cash certain kinds of companies should hold, and the current ratio and the quick ratio help investors and analysts compare company cash levels in relation to certain expenses.

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