Marketable securities and cash equivalents are two commonly used terms in finance to describe assets that are easily convertible to cash. While both are considered liquid assets, there are distinct differences between them that are critical for financial analysis and management.
What Are Marketable Securities and Cash Equivalents?
Marketable Securities
Marketable securities are financial assets that can be quickly converted into cash with minimal impact on the price received. These include a wide range of investments such as stocks, bonds, and other securities that are publicly traded on exchanges. Key characteristics of marketable securities include:
- Liquidity: They can be readily sold for cash in financial markets.
- Price stability: They typically have stable or predictable prices.
- Market Depth: There must be an active market with buyers and sellers.
Examples:
- Treasury bills
- Commercial paper
- Corporate bonds
- Equity securities (stocks)
Cash Equivalents
Cash equivalents are a subset of liquid assets that are considered extremely low-risk and highly liquid. They are short-term, highly liquid investments that are easily convertible to known amounts of cash and that are close to their maturity dates, generally within three months. These include the safest and most liquid investments available.
Examples:
- Treasury bills (short-term)
- Money market funds
- Bank certificates of deposit (maturity < 3 months)
- Commercial paper (maturity < 3 months)
Differences Between Marketable Securities and Cash Equivalents
Risk and Safety
- Cash Equivalents: These are generally considered safer as they involve minimal risk. They provide assured returns and are backed by secure financial institutions or the government.
- Marketable Securities: These carry a higher level of risk due to market volatility. The value of these securities can fluctuate based on market conditions.
Yield and Return
- Cash Equivalents: Typically offer lower returns because of their lower risk. They are more about preserving capital than generating high returns.
- Marketable Securities: Potential for higher returns exists due to the greater risk profile. Their value can appreciate, providing capital gains.
Maturity
- Cash Equivalents: Have short-term maturities, usually under three months.
- Marketable Securities: Can have a variety of maturities ranging from short-term to long-term.
Examples in Financial Statements
In financial statements, marketable securities and cash equivalents are typically listed under current assets. Cash equivalents are often reported separately due to their higher liquidity and lower risk profile.
Applicability in Financial Management
Corporate Finance
- Marketable Securities: Companies hold these to earn returns on idle cash while maintaining liquidity.
- Cash Equivalents: Held for immediate operational needs due to their high liquidity and low risk.
Investment Strategies
- Marketable Securities: Used for strategic investments, potential capital appreciation, and as part of diversified portfolios.
- Cash Equivalents: Used for emergency funds, liquidity management, and as a cushion against market volatility.
Related Terms
- Liquidity: The ease with which an asset can be converted into cash.
- Short-term Investments: Investments with a maturity period of one year or less.
- Treasury Bills: Short-term government securities with maturities of up to one year.
- Commercial Paper: Unsecured, short-term debt instrument issued by corporations.
FAQs
Q: Can marketable securities be considered cash equivalents?
Q: Are treasury bills considered marketable securities or cash equivalents?
Q: Why are cash equivalents considered safe investments?
References
- Financial Accounting Standards Board (FASB). (2021). Statement of Financial Accounting Standards No. 95: Statement of Cash Flows.
- Hillier, D., Ross, S., Westerfield, R., Jaffe, J., & Jordan, B. (2016). Corporate Finance. McGraw-Hill Education.
Summary
Understanding the distinctions between marketable securities and cash equivalents is essential for financial management and investment planning. Marketable securities offer higher potential returns with more risk, while cash equivalents provide high liquidity and safety for immediate needs. Both play crucial roles in maintaining a balanced and liquid asset portfolio in financial statements and corporate operations.
