Cash and cash equivalents are financial instruments that are valued at fair value. In most cases, the amount recorded in the records approximates fair value, and most businesses and other entities consider cash equivalents to be very safe investments. Companies often invest these funds in money market funds to earn interest with cash when they don’t need cash for current operations. Money market funds usually invest in very safe securities, such as commercial paper, which is shortterm debt of other entities. Although money market funds are not guaranteed,investors do not expect losses on these investments. However, in recent years a few of these funds invested in batches of subprime mortgages in an attempt to earn a little higher interest rate. The result has been traumatic for all parties. Bank of America, for instance, shut down its $34 billion Columbia Strategic Cash Portfolio money market fund when investors pulled out $21 billion because the fund was losing so much money from investing in subprime loans.
Cash is the most liquid asset a business can own. Most firms devote considerable effort to the management and control of cash. Because a firm’s creditors expect payment in cash, a sufficient amount of cash must always be available to meet obligations as they become due. This necessitates careful scheduling of cash inflows and outflows.
Although an adequate cash balance is essential, excessive holdings of cash should be avoided. Cash deposited in checking accounts (or even savings accounts) usually does not earn very much, if any, interest. Cash amounts over and above those needed to meet obligations due in the near future should be invested in assets earning higher returns.
The liquidity of cash also makes it easily pilfered. Firms must institute internal control procedures so that cash is properly accounted for and safeguarded. Failure to do so may tempt employees to misappropriate the firm’s cash and may also result in various accounting errors.
- Composition of Cash
- Control of Cash
- Analysis of Cash
- Implications for Managers