In this glossary entry, we’ll break down what cash equivalents are, how they work, and why they matter. You’ll learn how they’re used in financial reporting, what counts (and what doesn’t), and how they help you stay prepared for short-term needs without locking up your money.
Cash equivalent definition
Cash equivalents are short-term, low-risk investments that can be quickly converted into cash, typically within three months. They’re stable, easy to access, and typically used to cover day-to-day business expenses.
Examples include Treasury bills, money market funds, and commercial paper. These show up on the balance sheet under cash and cash equivalents as part of current assets.
Regulatory definitions and accounting standards
Under Generally Accepted Accounting Principles (GAAP) in the U.S., the Financial Accounting Standards Board (FASB) defines cash equivalents as “short-term, highly liquid investments that are readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value.”
The International Financial Reporting Standards (IFRS) define cash equivalents in almost the same way. According to IAS 7: Statement of Cash Flows, cash equivalents are “short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value.”
Why are cash equivalents important?
Cash equivalents help businesses stay liquid, secure, and prepared. They’re important because they give you fast access to funds without tying up cash in long-term investments.
They keep your business flexible
If you need to pay bills, cover payroll, or handle an emergency, you can quickly convert cash equivalents into usable cash.
They reduce financial risk
These investments are low-risk and stable, so you’re not likely to lose money if you need to cash out fast.
They strengthen your balance sheet
Lenders, investors, and partners typically look at your cash and cash equivalents to gauge your financial health. The more liquid assets you have, the more confident they’ll feel that you’ll meet short-term obligations.
They support financial planning
Whether you’re building a budget, applying for a small business loan, or managing growth, having cash equivalents gives you more control over your money.
They help you calculate key liquidity ratios
Tools like the cash ratio, quick ratio, and current ratio rely on cash equivalents to measure how prepared your business is to handle financial obligations.
Key features of cash equivalents
Here are some of the key characteristics of cash equivalents:
- Short-term maturity: They usually mature in three months or less from the date of purchase, making them easy to turn into cash without delay.
- High liquidity: You can quickly convert them into cash without losing value, which is why they’re grouped with cash on the balance sheet.
- Low risk: They’re not likely to change in value, even with market shifts or interest rate changes.
- Known cash value: You know exactly how much they’re worth when they mature, so there are no surprises.
- Readily available: These are widely used and easy to buy or sell, which makes them a practical choice for businesses that need fast access to funds.
Examples of cash equivalents
Each of these investments is considered safe, easily accessible, and suitable for covering short-term obligations. Here are some examples of cash equivalents:
- Treasury bills (T-bills): These are short-term loans to the U.S. government. They’re about as safe as it gets and usually mature in a few weeks to a few months.
- Commercial paper: This is unsecured, short-term debt issued by corporations to finance payroll, accounts payable, or inventory. It usually matures within 270 days.
- Money market funds: These are mutual funds that invest in short-term debt instruments like T-bills and commercial paper. They offer liquidity and stability, making them a popular place to hold excess cash.
- Short-term CDs (certificates of deposit): If a CD matures in three months or less and you can pull the money without a penalty, it counts as a cash equivalent.
- Bankers’ acceptances: These short-term debt instruments guaranteed by a bank, typically used in international trade. They’re short-term, low-risk, and easy to convert into cash.
- Repurchase agreements (repos): In a repo, someone sells a security and agrees to buy it back soon after. If it matures in under three months and carries little risk, it qualifies as a cash equivalent.
Who can use cash equivalents
Any business or individual managing short-term finances can benefit from understanding and using cash equivalents. In every case, the goal is the same: protect your money while keeping it readily available.
Take a look at the chart below for some of the most common users:
