Cash & Marketable Securities
This article will explain cash and marketable securities and will describe how these assets function in corporate finance analysis. The article will identify the common types of cash accounts and will explain how corporations control the flow of cash to regulate their financial needs. It will also describe the various types of marketable securities, including treasury bills, commercial paper, bankers' acceptances and other forms of money market securities. In addition, discussions of the common reasons why corporations hold marketable securities are provided, such as to earn higher rates of interest than cash accounts, to take advantage of the liquidity in the short-term investment market and because marketable securities require minimal ongoing managerial oversight. Finally, the article will describe how corporations and financial analysts report and use cash and marketable securities in common business activities, such as in creating accurate balance sheets, meeting accounting and financial reporting requirements and building liquid reserves in anticipation of a significant financial transaction.
Keywords Balance Sheet; Bankers' Acceptances; Cash; Commercial Paper; Liquidity; Maturity Date; Money Market; Treasury Bills
Cash and marketable securities are current, liquid assets that companies may use for a variety of reasons, such as to pay its business obligations, to support its viability during a period of reduced sales or an economic downturn or to earn interest for a short period of time before being used for a significant acquisition. Like most people, many companies prefer to keep a reserve of cash and marketable securities on hand that can easily be sold for cash to cover unanticipated expenses or losses. While cash is readily available legal tender, marketable securities are short-term investments that are routinely sold on exchanges, have a readily determined fair market value and can be converted into cash at any time. The most common types of marketable securities are commercial paper, banker's acceptances, Treasury bills and other money market instruments.
Cash and marketable securities are considered current assets on a firm's balance sheet. The balance sheet is a type of financial statement that shows a company's overall financial position at a given moment in time. Companies typically create a balance sheet at the end of their fiscal year to get an accurate depiction of their financial standing. A balance sheet always lists a company's assets and liabilities, and these are usually displayed side by side in two separate columns: assets in one column and liabilities and shareholders' equity in the other. Under the assets column, the balance sheet lists the firm's current assets in order of their liquidity, beginning with those that are most easily converted into cash within the accounting cycle, which is typically one year. Current assets include cash and marketable securities as well as other types of assets. Thus, using balance sheet entries, companies routinely account for their cash and marketable securities holdings in order to keep an accurate depiction of their monetary position at any point in time.
The following sections provide a more in-depth explanation of cash and marketable securities and the role that they play in corporate finance and accounting.
The most common types of cash accounts are general cash accounts and other corporate accounts, such as payroll accounts, petty cash accounts and bank branch accounts. Corporations hold cash in these accounts for several reasons. The most common reason is to meet payment obligations that arise in the ordinary course of business. Another reason is so that a company has readily available assets that it can use to take advantage of temporary opportunities for investment or the purchase of a significant acquisition. A third reason companies keep cash is to maintain a cushion or buffer to meet any unexpected financial needs that may arise in the event of periodic losses or an economic downturn.
While cash accounts are relatively simple for a company to maintain, companies must also effectively manage the flow of cash that moves into and out of its accounts. For instance, when a company has received payments or experiences an inflow of cash, it must select the best investment or savings account to hold the cash, balancing its short-term and long-term need for readily available cash against the higher returns that are often available from investment options the cash could purchase. In addition, companies must also regulate the collection and distribution of cash payments using procedures that are in its best interest while being ethical and building rapport with its vendors so that it can maximize its financial position at any given point in time. To do so, a company may emphasize prompt collection of cash receipts so to ensure a steady inflow of finances while adopting disbursement methods that slow down its cash payouts to minimize the outflow of company resources. The procedures are described in more detail below.
Expediting Cash Receipts
No matter what its strategy for managing its assets and liabilities, a company must still regulate and report its cash accounts to conform with accounting and financial reporting requirements that are set by generally accepted accounting principles and government regulations. However, there are several techniques that companies can use to enhance the rate at which they send invoices and collect receipts so that their inflow of cash is enhanced. These techniques include expediting the preparation and mailing of company invoices, automating the billing and payment cycle, sending invoices with shipments or faxing invoices with prompt payment due dates and establishing a system of preauthorized debits so that a payor's funds are transferred to the company electronically.
A preauthorized debit is a transfer of funds from a payor's bank account on a specified date to the payee's bank account whereby the payor provides advance authorization for the payee to initiate the transfer when payment is due. This system can be set up so that a payor provides a payee with advance authorization for routine transfers of funds, generally for a specified amount on a specified date, and for a finite period of time or until the payor's financial obligation is fulfilled. Automated payments are a particularly advantageous means by which companies may expedite cash receipts because they minimize the time and expense that is required when an employee would otherwise have to create invoices, mail the invoices (perhaps at the company's expense), credit payments received to individual customer accounts and monitor delinquent accounts for collection efforts.
The reason companies seek to implement policies that will expedite the collection of their cash receipts is to enhance the inflow of corporate cash, which affords a company the possibility of greater returns if it invests its increased cash reserves in interest-bearing accounts or securities. By expediting and automating the process of receiving cash receipts while minimizing company expenses involved in collecting payments, a company may maximize its inflow of cash receipts so that it can use these resources for purposes that are most advantageous to its stability and growth.
Harnessing Cash Payouts
Another way that a company can enhance its cash resources is to slow down the rate at which it pays its outstanding debts. This process is sometimes referred to as "playing the float," which means that a company will attempt to extend the float, or the time period between the date it makes a payment and the date the payment is debited from its account, so that it is able to draw interest on its funds as long as possible. One way a company may harness its cash payouts is by minimizing its accounts payable into a fewer number of accounts so as to reduce the number of its disbursements. Another method is to use forms of payment that delay the time in which the payee's account is credited with funds from the company's account. For instance, a company may use payable through draft instruments, which are drawn against the payor and not against a bank, as are checks. After the payee presents a payable through draft instrument to a bank for deposit, the payor may still determine whether to honor or refuse the payment, which slows down the time it takes for a payee to receive the funds and increases the time in which the company has control of the funds. In addition, a company may use a remote disbursement method, in which the firm directs checks to be drawn on a bank that is geographically remote from its customer so as to maximize the time it will take for its check to clear. For instance, a California business may pay an Illinois supplier with a check drawn on a bank in Delaware. The supplier must wait until the Delaware bank clears the check in order for the funds to be credited to its account. Finally, a company may also use controlled disbursements, in which the company directs checks to be drawn on a bank that can provide it with notification each morning of the total dollar amount of checks that will be presented against its account later that day so that the company may more accurately predict its total disbursements on a day-to-day basis.
Cash Accounting Procedures
While companies may use different methodologies to control the inflow and outflow of corporate cash, companies must still comply with proper accounting procedures and governmental regulations regarding corporate finance reporting. Companies must set up proper cash management procedures to ensure that all cash receipts and payments have been promptly and accurately deposited and recorded so that their financial statements remain correct and current. In addition, companies must consider how best to hold and invest cash reserves so that their financial well-being and growth objectives are considered along with the interests of their shareholders, if they are publicly owned. Most companies maintain cash balances that are adequate to meet their financial needs but not excessive, as extra cash can be used to invest in securities and other investments that typically pay higher interest rates than most savings accounts, where cash is typically held.
Understanding Marketable Securities
Marketable securities are highly liquid, short-term securities that tend to have maturity dates of less than one year. Companies invest in marketable securities to recoup relatively higher interest rates while retaining the convenience of being able to easily convert these securities into cash should the need arise. Marketable securities are listed as a current asset on a balance sheet. Examples of marketable securities include commercial paper, banker's acceptances and Treasury bills. In addition, marketable securities can include money market instruments such as repurchase agreements, which are agreements to buy securities and resell them at a higher price at a later date; federal agency securities, which are debt securities issued by federal agencies and government-sponsored enterprises and money market preferred stock, or preferred stock that has a dividend rate that is reset at auction every 49 days.
The following sections describe the most common forms of marketable securities in more detail.
Treasury Bills <<<
Treasury bills, often referred to as "T-bills," are short-term debt obligations that are backed by the U.S. government and have a maturity date of less than one year. T-bills are sold in denominations of $1,000 and usually have maturities of four weeks, 13 weeks (about three months) or 26 weeks (about six months). T-bills are issued through a competitive bidding process and are sold at a discount and redeemed at maturity for full face value. This means that investors who purchase T-bills do not receive fixed interest payments while holding the bills, but instead receive the appreciation of the T-bill when the U.S. government pays back its IOU on the T-bills' maturity date. For example, if an investor buys a 13-week Treasury bill priced at a discount at $980, the U.S. government essentially writes an IOU promising to pay back the investor $1,000 in three months. The investor does not receive any dividend payments during the time the T-bill is held. Instead, the investor receives the T-bill's appreciation ($20), or the difference between the discounted value she originally paid for the bill ($980) and the amount she receives back at its maturity ($1,000). The interest rate of a T-bill can be determined by dividing its appreciation by its discounted purchase price. For instance, if a T-bill appreciates by $20 during the three months it is held by an investor, who purchased the bill at a discounted rate of $980, the interest rate of the T-bill is 2% over three months ($20/$980 = 2%).
Treasury bills differ from Treasury notes and Treasury bonds. The differences among these three forms of government securities lie in the length of their maturity, the types of returns holders receive and the purposes for which these securities are held. Treasury notes are medium-term debt securities of the U.S. Treasury that have a fixed interest rate, a maturity period of one to ten years and pay interest every six months until maturity. Treasury bonds are long-term obligations of the U.S. Treasury that also have a fixed interest rate, but have a maturity period of more than 10 years and pay interest semiannually until maturity. Treasury notes and bonds are also issued with a minimum denomination of $1,000, and are considered some of the safest mid- to long-term investment options. Thus, unlike Treasury bills, which pay no direct interest but are bought at a discount and sold at full value, Treasury notes and Treasury bonds do pay interest at a fixed interest rate until their maturity date.
Every week, the Treasury Department auctions off new Treasury bills of varying maturities, ranging from one month to one year, with three-month and six-month T-bills being the most common. T-bills are considered very safe investments because they are backed by the full faith and credit of the U.S. Treasury. Because Treasury bills are short-term, low risk investments that are highly liquid, they are one of the most common forms of...
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