Cash and Cash Equivalents

Firms can elect to focus their statement of cash flows on either cash or cash and cash equivalents.The term cash includes cash on hand and cash in bank accounts that can be withdrawn on demand. Cash equivalents are short-term,highly liquid financial instruments with maturities of less than three months; they are quickly convertible into cash. Examples include money market funds, treasury bills, and certificates of deposit (CDs). Because cash equivalents are so similar to cash, many firms prefer to combine them with cash, rather than with other investments.

Firms must consistently apply a policy of using either cash or cash and cash equivalents. Additionally, the beginning and ending balances that appear on the statement of cash flows must correspond to similarly titled items on the balance sheet.

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