A:

Most of the time, when an investor or analyst searches through the financial statements of a publicly traded company, he or she will run across a reference to short-term liquid assets, or cash and cash equivalents. A lot of companies explain cash positions in a couple of sentences, if not a paragraph, that is similar to the following:

Liquidity
The following summarizes our cash and cash equivalents and marketable securities:

Cash and cash equivalents: $239
Marketable securities: $154
Total: $393

This example shows that a business using short-term marketable securities classifies them as a "cash equivalent". Marketable securities generally refer to an investment in commercial paper, banker's acceptances or Treasury bills. These securities are highly liquid, and generally provide the company a bit of a return on its investment - likely just enough to keep up with inflation. If all of the company's cash equivalent reserves are tied up in cash, it will lose a little bit of spending power every year to inflation.

Investment in equity is investment in stocks, or similar securities. While these are usually recognized as being highly liquid, they have a tendency to fluctuate in value - often dramatically. Stocks are not a great investment for a cash equivalent account. Although they can be readily converted to cash, there may be a significant spread between a stock's book value and its current price. A negative spread could result in a cash crunch. (See What's the difference between book and market value?)

The essential thing to note is that a marketable security will likely only be worth significantly less than what it was purchased for if there's a spike in interest rates. Equity investments, on the other hand, have a lot more potential to drop in value and are, therefore, not considered cash equivalent investments.

For more information, see Reading The Balance Sheet, Getting To Know The Money Market and Cash-22: Is It Bad To Have Too Much Of A Good Thing?

RELATED FAQS

  1. How often should a small business owner go through a bank reconciliation process?

    Learn about the bank reconciliation process, its purpose and how often it is recommended that small businesses perform a ...
  2. What is the difference between recurring and non-recurring general and administrative ...

    Understand the expenses involved in a company's general and administrative operating costs and the difference between recurring ...
  3. How can I find net margin by looking a company's financial statements?

    Learn how to calculate a company's net margin using financial statements by dividing the company's net revenues by its net ...
  4. What can working capital turnover ratios tell a trader?

    Find out how to calculate and interpret a company's working capital turnover ratio. Learn why a high ratio is good but an ...
RELATED TERMS
  1. Chart Of Accounts

    A listing of each account a company owns, along with the account ...
  2. Convention Statement

    A document filed by an insurance or reinsurance company that ...
  3. Bond

    A debt investment in which an investor loans money to an entity ...
  4. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative ...
  5. Nonadmitted Balance

    An item on an insurer’s balance sheet that represents reinsured ...
  6. Earned Premium

    The amount of total premiums collected by an insurance company ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Direxion Daily 20 Year ...

  2. Stock Analysis

    Top 5 Emerging Market Bond ETFs

  3. Stock Analysis

    How To Analyze Netflix's Income Statements

  4. Fundamental Analysis

    The Most Crucial Financial Ratios For ...

  5. Stock Analysis

    9 Junk Bond ETFs You Should Eye Right ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!