Functions and Types of Cash Equivalent Assets

One type of asset that is usually present in a business is cash equivalent assets. Where this type of asset is a short-term investment that can be converted into cash in a fairly short time. Understanding the meaning of cash equivalent assets is a must for business people. Therefore, this article will explain the meaning of cash equivalent assets, their types, functions, advantages, and disadvantages.

Definition of Cash Equivalent Assets

The definition of cash equivalent assets is a short-term investment that can be converted quickly into cash. For example, such as balances in savings accounts or checking accounts, short-term certificates of deposit, and short-term government securities, for example, government securities. Another example of cash equivalent assets is short-term securities such as notes receivable that can be negotiated and issued by other companies.

Cash equivalents are a measure of the financial health of a business. Where this type of asset is a pretty good idea for investors so that they first look at the business’s cash equivalents when deciding whether to invest in a company or not. This is because it can give investors an idea of ​​whether the company will be able to pay its bills in the short term or not.

This cash equivalent has a function as one of the most important indicators of the health of a company’s financial system. This analysis can also estimate whether it is good to invest in a particular company through its ability to generate cash and cash equivalents because it reflects how the company can pay its bills in a short time.

Companies with large amounts of cash equivalents are the main target of large companies that plan to acquire small companies. When reported in the financial statements, this type of investment is often equated with cash. Therefore, cash equivalents include a company’s total cash holdings as well as similar investment advice.

Types of Cash Equivalent Assets

As we discussed earlier, cash equivalents are all currencies, be it paper or coins. This also applies at home or abroad. Where all correspondence that has a rupiah value is also included in cash equivalent assets. The following are several types of cash equivalent assets that need to be understood, including:

1. Currency

Currency is a unit that is agreed upon by the government and also the people within a country. As we know that every country has its own currency. Currency itself is useful as a medium of exchange and has its own nominal value. For example, 1 USD is equivalent to 14,000 rupiah in Indonesia. It is influenced by the exchange rate and also the exchange rate of a currency. Exchange rates here can generally change at any time depending on the rising US dollar.

Not only that, currency exchange rates are also influenced by the inflation rate of a country. Where countries have a high level of prosperity, the inflation they have will be lower. This is also influenced by the economic and political conditions of a country. Political and economic conditions of a country have an impact on currency exchange rates. Meanwhile, government control is also a factor in the high and low currency exchange rates.

2. Notes Receivable

Notes receivable are usually used by large companies to receive funds to later answer short-term debts such as company payroll. They will be supported by a bank or issuing company that promises to fulfill and pay the nominal amount on the maturity date specified and given on the note.

See also  difference between transducer and sensor

3. Securities

Securities are assets as well as instruments that can be easily converted into cash and are highly liquid. Marketable securities are liquid because their maturities tend to occur within one year or less. Then, the level at which these securities can be traded has a minimal effect on mutual funds.

4. Mutual funds

Mutual funds are an investment medium that is similar to a checking account that pays the higher interest rates provided by the money deposited. Where money market mutual funds provide a fairly effective and efficient tool for companies and organizations in managing their money. This is because they tend to be more stable than other types of funds.

5. Short Term Government Bonds

Short-term government bonds are usually provided by the government to finance various government projects. Where these bonds are issued using the domestic currency of that country. Investors will look at political risk, inflation risk, and interest rate risk when investing in government bonds.

6. Certificate of Deposit

A certificate of deposit is an agreement made with a financial institution to give the bank access to your business capital for a certain period of time. In return, for sacrificing liquidity for your money, financial institutions will often pay higher interest rates for the equity. Savers can choose the duration of their certificate of deposit.

7. Acceptance of Bankers

Banker’s acceptance is a form of payment that has been guaranteed by bank appraisers compared to individual account holders. Because the bank itself has become payment, short-term issuance by the bank is considered to be quite tight with cash. This banker’s acceptance is often used to facilitate transactions where there is little risk on one side.

8. Bank Current Accounts

Giro is a type of savings issued by a bank and can be used by its customers. The term giro savings customer has a special symbol called a giran. Giran can withdraw their money using a check issued by the bank. This is clearly very different from ordinary savings which can be disbursed through an ATM.

9. Petty cash receipts

Petty cash receipts are records of cash payments used to make small transactions. Where this petty cash receipt will be forwarded to the person responsible for office expenses.

10. Check

A check is a letter that is printed by the bank and can be used by the customer as an order to withdraw money. In the check itself will be written the nominal amount of money to be withdrawn. Before getting a check, you will be required to have a checking account. A checking account is a savings or savings account for a customer or a company. Where the account can make withdrawals at any time during working hours the bank is still open.

Using a check to withdraw the amount of money you need, there are several conditions that must be met before withdrawing the money. Starting from the name of the interesting person and determining where the transaction will be carried out and must include the date when the check was cashed. In addition, checks also have a validity period of six months from the date the check was submitted. Checks themselves have several types, such as blank cheques, checks on bearer, checks on behalf, and so on.

Characteristics of Cash Equivalent Assets

Various types of cash equivalent assets have the same characteristics, the following is a complete explanation:

1. Liquid Market

This cash equivalent must be in a liquid market. That’s because this one investment must be easy to convert into cash if the holder has to liquidate his position. If an investment is illiquid, it cannot be considered a cash equivalent. One item worth mentioning is the certificate of deposit with a specific term. Although these certificates of deposit are often considered cash equivalents, companies or investors cannot get out of their position before the certificate matures. However, many certificates of deposit products allow for early exit through payment of several months’ interest waiver fees.

See also  difference between direct debit and standing order

2. Short Term Investment

Cash equivalents are intended to be held for a relatively short period of time. Because of this, the maturity of the underlying investment is often very high and cash equivalents are also often considered the most liquid current assets behind cash.

3. Low Risk or Volatility

Cash equivalents are intended as a more efficient way for investors to use their cash without incurring greater risk. While there are some considerations to be made about default risk as well as insurance, cash equivalents should also be included in low-risk investments that don’t see a lot of volatility.

4. Unlimited Access

Finally, cash equivalents are relatively unrestricted, because investors must be able to convert their cash equivalents into cash according to demand. All objectives of cash equivalents are to have a profitable investment that is liquid and cash equivalent. So that investments with inflexible ownership periods or liquidity problems are not included in cash equivalents.

Functions of Cash Equivalents for Business

There are several reasons why companies keep their capital in the form of cash equivalents. The first is part of the company’s net working capital, namely current assets minus current liabilities, which are usually used to purchase inventory, cover operational costs, and make other purchases.

In addition, cash equivalents can also act as an emergency fund for companies and investors. Instead of allowing inflation to depreciate in the bank account, an investor can earn a little more income with these cash equivalents.

Then finally, the company can deliberately carry a higher cash equivalent balance when needed to finance acquisitions. Instead of locking capital into long-term or volatile investments, companies can choose to use cash equivalents when they need to raise funds quickly.

Advantages and Disadvantages of Cash Equivalents

There are certain conditions where companies or investors must have cash equivalents. However, the advantages of cash equivalents alone also come with some drawbacks.

1. Cash Equivalent Profits

Cash equivalents are a more efficient use of capital than holding cash directly. Where cash equivalents often generate more interest than cash, although cash equivalents often sacrifice various features or accessibility in cash. Cash equivalents are reported as current assets on the balance sheet. Therefore, these assets remain highly liquid, where the benefits are expected to be received in the short term.

Unlike the case with other types of financial instruments or investments with no set time limits or very long storage requirements, these cash equivalents are not intended to be stored for a long time. Finally, many cash equivalent products carry a fixed interest rate. For example, a certificate of deposit locks investors into a fixed interest rate for a certain period of time and generates a steady income.

During that period, the investor is guaranteed this interest rate or waives any fees or penalties for breaking the term earlier. That level of security may be desirable for certain savers.

2. Shortage of Cash Equivalents

Even though cash equivalents generate higher interest or appreciation than cash, cash equivalents still have a much smaller potential income compared to other investments. In general, an investor should strive to have cash equivalents. However, capital is more likely to grow and generate business value when it is invested in companies or invested in riskier, higher-yielding products.

This is an explanation of the meaning of cash equivalent assets and their types. From the explanation above, we can conclude that the definition of cash equivalent assets is a short-term business asset that can be easily converted into cash in a predictable amount. For You who want to know more deeply about economics and other accounting, they can read related books by visiting Sinaumedia.com.