Cash and cash equivalents

Cash and cash equivalents – Cash is defined as ‘Cash on hand and demand deposits’. ‘Demand deposits’ are not defined in IFRS, but they should have the same level of liquidity as cash and therefore should be available to be withdrawn at any time without penalty.

‘Short-term’ is not defined, but the standard encourages a cut-off of three months’ maturity from the date of acquisition. In our view, three months is a presumption that may be rebutted only in rare cases when facts and circumstances indicate that the investment is held for the purpose of meeting short-term cash commitments and when the instrument otherwise meets the definition of a cash equivalent. [IAS 7 7]

Something else -   Demand deposits and Cash and cash equivalents

Cash equivalents is defined as ‘Short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value’. [IAS 7 6–7]

‘Cash and cash equivalents’ include certain short-term investments and, in some cases, bank overdrafts.

Cash flows’ are movements in cash and cash equivalents. [IAS 7 6]

‘Cash flows used in investing activities’ relate to the acquisition and disposal of long-term assets and other investments that are not included in cash equivalents.

Cash pool systems
Larger reporting entities often use centralised cash management functions involving sweep accounts, as well as centralised cash collection and payment centers. Although not required by any specific IFRS standard it seems to make sense to separate cash and cash equivalents in a group’s cash pool system from cash and cash equivalents outside the group’s cash pool system.

Restricted cash and cash equivalents
Many times cash and cash equivalents include restricted cash relating to regulatory requirements. These are many times disclosed in the notes.

Foreign currency differences
Cash flows arising from an entity’s foreign currency transactions are translated into the functional currency at the exchange rates at the dates of the cash flows. Cash flows of foreign operations are translated at the actual rates (or appropriate averages). The effect of exchange rate changes on the balances of cash and cash equivalents is presented as part of the reconciliation of movements therein. [IAS 7 25–28]

That cash (and cash equivalents) matters makes sense: CASH IS KING is not just a saying……

Something else -   Firm purchase commitment

“Better one byrde in hande than ten in the wood.”  -John Heywood, the 16th century collector of proverbs

Bankers love liquidity. Liquidity refers to the rate at which an asset can be converted into cash and cash is king to the banker. If cash is king, then cash equivalents are the heirs to the throne. Cash equivalents represent the highest cushion of protection against a loss for the banker because they offer the highest rate of liquidity.

In other words, cash equivalents are viewed by credit analysts as almost the same as cash. This is why cash equivalents are so important — they are as good as the “one byrde in the hande” to banks. An increase in cash equivalents equals higher liquidity. A company with higher liquidity ratios is considered healthier and poses less of a risk. This company will also receive a lower interest rate on debt borrowings, which translates into higher profitability.

A Lesson From Tulipmania

In 1593 tulips were introduced to the Dutch. Some tulips contracted a virus which created unique color patterns. These color patterns increased the value of tulip bulbs. People went crazy and began trading land, life savings and anything they could to buy these bulbs. The bubble burst in 1637. A panic ensued as dealers refused to honor their contracts and that panic was followed by a depression. Bankers that categorized tulips as a cash equivalent were eventually burned. Tulips were highly liquid investments, but they also had a high risk profile.

And here is a more recent disclosure on cash and cash equivalents (From Vodafone Plc Annual Report 2018 page 141)

Cash and cash equivalents

Cash and cash equivalents

Cash and cash equivalents    Cash and cash equivalents

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