Cash is defined as ‘Cash on hand and demand deposits’.
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’.
That cash (and cash equivalents) matters makes sense: CASH IS KING is not just a saying……
“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)