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What Is Restricted Cash?

When companies anticipate an upcoming expenditure that’s outside of normal operating expenses, they can set aside cash for this purpose in a restricted cash account. Restricted cash accounts can cover irregular expenses and capital investments, such as settling a lawsuit, purchasing equipment, or paying out a dividend. A company may set up a special bank account for restricted cash, but this isn't necessary. Assets allocated to restricted cash are off-limits for daily activities, regardless of the account. If the company expects to pay the expense in the current year, the asset is a current asset. Otherwise, it’s a non-current asset for balance sheet reporting purposes. Companies can report these assets on their balance sheets as “other assets” or “other restricted cash.” If they don’t incur the expense as planned, then the cash becomes unrestricted and moves back to a general cash account. In addition to reporting on the balance sheet, companies typically explain the purpose for restricted cash in the accompanying footnotes to reassure stakeholders they have the cash on hand to meet future obligations. Often lenders and other investors require this accounting as part of the terms of a loan or investment. Banks don't always require the company to have the full amount of the debt available in cash or liquid assets, but rather require the company to reserve an agreed-upon percentage of that amount in a restricted cash account. This amount, or compensating balance, is common for small business loans, so it’s important you guide your small business clients to understand and properly report these types of accounts.

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