Legal Definitions - cash equivalent

A cash equivalent refers to an investment that is so liquid and secure that it can be easily and quickly converted into a known amount of cash, typically within a very short period (often 90 days or less), with minimal risk of changes in its value. These assets are considered almost as good as physical cash for financial reporting and operational purposes.

Here are some examples to illustrate this concept:

• Imagine a technology startup that has just received a large round of funding. Instead of keeping all the money in a checking account, the company's CFO decides to invest a portion of the funds in U.S. Treasury bills that mature in 45 days. These Treasury bills are considered cash equivalents because they are extremely safe, have a very short maturity period, and can be easily sold on the open market for their full value if the company needs the cash sooner.

• A local municipality needs to hold a reserve of funds for unexpected emergencies, such as a natural disaster. To ensure these funds are readily available but also earn a small return, the city treasurer invests them in a money market fund that holds very short-term government securities. This money market fund is treated as a cash equivalent because it allows the city to access its funds almost immediately without penalty, providing the same liquidity as cash while being a low-risk investment.

• A large manufacturing company has a significant amount of cash on hand from recent sales but anticipates needing it for a major equipment upgrade in two months. To maximize the use of these funds during the interim, the company purchases commercial paper from another highly rated corporation, with a maturity date aligning with their equipment purchase. This commercial paper is considered a cash equivalent because it's a short-term, unsecured promissory note from a creditworthy issuer that can be quickly converted back into cash with little risk of loss, serving as a temporary, interest-earning placeholder for their upcoming expenditure.