Cash Equivalents: Definition, Types, Features, Examples

They say you can’t really buy happiness, but having enough money to meet your needs surely feels good. However, as you move up from the minimum livable threshold, your needs grow in turn, and so managing your finances becomes more complex. How much cash can (and should) you physically store? What about getting something out of all these savings? Cash equivalents are one possible solution to these questions.

There are lots of interest-bearing strategies and ways to invest cash or store it in some inflation-resistant form. Let’s learn more about them!

What Are Cash Equivalents?

Cash is not always the best method for saving and utilizing finances, especially for business. The cash equivalents meaning refers to assets that can be quickly converted into cash with minimal risk. These include bank certificates of deposit, banker’s acceptances, treasury bills, commercial paper, and more. Cash equivalents like marketable securities are also an essential business tool, as they can help a company maintain liquidity and become more flexible in resource management.

You can also expect the assets that fall under this umbrella to have completely different conditions and value. However, they all represent a good way to preserve finances and use them to improve one’s financial situation.

Types of Cash Equivalents

Cash and cash equivalents are two sides of the same coin. The former allows you to purchase the latter, while the latter provides the opportunity to store funds short-term or even generate income from them. Here are a few common examples:

• Treasury bills (T-Bills);
• Certificates of deposit (CDs);
• Banker’s acceptances (BAs);
• Commercial paper;
• Money market funds.

Note that the assets listed here differ significantly from each other, with different risk ratios, guarantees (or the absence thereof), terms of use, levels of security, and profitability. That’s why we suggest examining them in more detail.

Treasury Bills (T-Bills)

This type of financial asset is considered one of the safest short-term investments. T-Bills are securities issued by the United States Department of the Treasury that reach maturity within a year. They are broadly considered a safe, government-guaranteed investment.

Certificates of Deposit (CDs)

A standard debt deposit in a bank account that has a defined term and a fixed interest rate. Essentially, you enter into an agreement where, for a specified period, your finances belong to the bank. In return, you regularly receive a certain amount of interest.

Banker’s Acceptances (BAs)

BA is a form of check that businesses use to transfer significant sums. The payment is guaranteed by the bank rather than the sender, which means extra security for the recipient. BAs earn returns like bonds do and are traded as such on the secondary market. Once again, these are considered a safe investment, as the payment is guaranteed by the bank.

Commercial Paper

Commercial paper is short-term (less than a year), unsecured debt used by big companies to raise funds to meet pressing liabilities such as payroll. Note that this type of asset currently has two formats: traditional, meaning directly valued paper (stock), or a token (cryptocurrency unit, the quantity of which is determined according to the current stock prices).

Money Market Funds

Money market funds are a type of mutual funds that invest only in cash and its equivalents, such as short-term government bonds. They are safe, highly liquid, but offer relatively low returns on investment. Typically, a share costs $1 and generally remains stable, even during political or economic turmoil.

Advantages and Features of Cash Equivalents

With the cash equivalent definition clear, we can move to discussing the advantages of using them. Let’s take a closer look.

High Liquidity

Securities have a high liquidity rating. This means that a company can quickly put them on the market to get some quick cash, while investors can exchange or sell existing shares on specialized exchanges.

Short Maturity Period

The risk of such investments is notably low, as the maturity period is usually around three months. This minimizes fluctuations in stock value on the market while still being sufficient to accumulate significant interest.

Low Risk of Value Fluctuation

Most securities are supported in one way or another by funds, the government, banks, or other guarantors. Therefore, market fluctuations are unlikely to render your investments unprofitable, even in the long term.

Common Uses of Cash Equivalents

Cash equivalent investments can be used in a wide range of situations. For example:

• Debt servicing;
• Risk mitigation;
• Investment opportunities;
• Working capital management;
• Strategic acquisitions.

However, these cases are more characteristic of corporate investments than personal ones. Let’s examine each of these opportunities in more detail.

Debt Servicing

In some cases, debts can be paid off using securities instead of the company’s balance. This helps avoid defaults and maintain a positive credit rating, which is especially important in the context of business expansion prospects.

Risk Mitigation

Equivalents can serve as support for current capital, including unexpected bills payment. For example, if a business faces an extraordinary financial situation, it can entirely offset the impulse by transferring or converting securities.

Investment Opportunities

Cash equivalents can also be used to expand an investment portfolio or attract investors. For example, some cryptocurrency startups take advantage of this feature by selling a stake in the company to shareholders, taking stocks or other types of valuable assets as a possible payment method.

Working Capital Management

Equivalents can stimulate the economic component of companies by decreasing or increasing the issuance of shares on the market and exchange. This way, a business can scale the finances needed for its current operations.

Strategic Acquisitions

Cash equivalents can also be used in mergers or acquisitions. For example, they can be used to settle a business’s debts, pay dividends to shareholders, or transfer a stake of shares to the previous owner of the target company.

Cash vs. Cash Equivalents

What are cash and cash equivalents but alternative methods for storing assets for companies and individuals. Equivalents, however, are somewhat trickier to manage. For example, there are several ways to handle cash equivalents in accounting, including marking them as securities, bonds, stocks, and, less commonly, tokens or other forms. In simple terms:

While cash is certainly easier to use, the equivalents typically have a range of additional benefits, such as dividends or interest, increased value through governmental and private guarantees, and risk insurance.

Cash Equivalents Examples

Here are a few examples of cash equivalents that will help you understand how these conditional units work:

• Netflix. The platform’s owners use debt obligations to defer payments to creators and content suppliers. This also helps reduce tax liabilities and improve return on capital.
• Amazon. The company utilizes a full cycle of cash equivalents conversion to diversify cash flows and meet operational needs, including a positive cycle of settlement with customers and suppliers.
• Starbucks. The company deals with both pure cash flow and its valuable equivalents to meet its needs and expand its presence in new markets.