Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. A company may be required by an insurance company to pledge a certain amount of cash as collateral against risk.
Instead, the $10,000 is placed into an escrow account, managed by the Escrow Company. This money is “restricted” because it can’t be used freely by either party until certain conditions are met. Zoom couldn’t use these funds for anything, having set the cash aside for working out these direct stock sales. The process was largely completed by the end of 2021, returning Zoom’s restricted cash total to a modest $10.5 million. Investing in stocks involves more than just analyzing a company’s revenues and profits.
Loan or Debt Payments
Sometimes, you find yourself swimming in a sea of not-so-familiar financial jargon. One such term that might pop up every now and then is “restricted cash.” What is it, and why should you care? In the case of Zoom, for example, a sudden increase in restricted cash could have raised eyebrows. However, the explanatory footnotes revealed the temporary nature of this change, underscoring the importance of not just glancing at the numbers but also understanding the context behind them.
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Although there are various reasons companies can restrict a portion of their cash, below are two of the most frequent uses for restricted cash. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.
Companies also frequently set aside cash designated as restricted in planning for a major investment expenditure, such as a new building. It is simply cash with a specific purpose and isn’t available for general-purpose spending. When analyzing a company, compare the restricted cash to other assets and liabilities to get an overall picture of its financial state. To avoid that risk, the lender can also request a separate bank account to hold the funds (i.e. placed in escrow) to ensure compliance by the borrower. Due to the cash not being readily available for use, cash that is restricted is generally excluded in several liquidity ratios.
- Restricted cash cannot be used to fund day-to-day working capital needs or investments for growth.
- Since funds are separated on the balance sheet/income statement, restricted cash typically appears on a company’s balance sheet as either “other restricted cash” or as “other assets.”
- Instead, the $10,000 is placed into an escrow account, managed by the Escrow Company.
- In the event that the restricted cash is not spent as intended, it may then become unrestricted cash that a company can transfer to a general cash account or spend for general business purposes.
- Not doing so would cause such ratios to depict a better picture of the company’s liquidity position than in reality.
Cash can be restricted for a number of reasons, including debt reduction and capital investments. The reason for any restriction is generally revealed in the accompanying notes to the financial statements. Additionally, depending on how long the cash is restricted for, the line item may appear under current assets or non-current assets. Cash that is restricted for one year or less is categorized under current assets, while cash restricted for more than a year is categorized as a non-current asset. Restricted cash is a portion of a company’s cash reserves that is earmarked for specific purposes and not readily available for general business operations.
Understanding Restricted Cash
This presentation was emphasized and clarified by updates from standard-setting bodies like the Financial Accounting Standards Board (FASB) in the U.S. On the balance sheet, restricted cash can be classified as either a current or non-current (long-term) asset, depending on the nature of the restriction. If the cash is expected to be used or released within a year, it’s considered a current asset.
Presentation of Restricted Cash
You’ll find this line item on a company’s balance sheet next to a brief explanation of its intended use (either in a commentary section or in footnotes to the financial tables). Examples can include funds set aside for projects, legal obligations, or to comply with loan covenants. Restricted cash is classified as either a current asset, which is used up within one year, or a non-current asset, which are long-term assets. As a result, if the restricted cash is expected to be used in the short-term, it is classified as a current asset. If it is not expected to be used within a one-year time frame, it is classified as a non-current asset.
John, a junior analyst, has been instructed by the head of equity research to conduct liquidity analysis of a company. More specifically, he has been asked to determine the current ratio of a company to see if it has enough cash to pay off its short-term obligations. Recall that the quick ratio is calculated as (Cash and Cash Equivalents + Marketable Securities) / Current Liabilities. The classification may spring from the terms of a construction contract, the covenants of a loan, or other business-to-business agreements. It may be possible to move this cash back into the general cash reserves, but that depends on the specific terms of the document that created the restricted cash classification in the first place.
Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Liquidity ratios such as the current ratio and quick ratio should also be adjusted to exclude any illiquid cash. Not doing so would cause such ratios to depict a better picture of the company’s liquidity position than in reality. Restricted Cash refers to cash reserved by a company for a specified purpose and is thereby not readily available for use (e.g. fund working capital spending, capital expenditures). This deposit shouldn’t go directly to David because the sale hasn’t been finalized yet.
5 Cash, cash equivalents, and restricted cash
Restricted cash refers to money that is set aside for a specific purpose and is not available for general use by a company or individual. This money is segregated from the regular cash and cash equivalents because of its designated purpose and is often subject to restrictions on its use. The amount of any cash restrictions and the reasons for them are stated either in the financial statements of an organization, or in the accompanying footnotes.
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Lenders sometimes require a company to hold restricted cash as partial collateral against a loan or line of credit. This is a fairly common practice in situations in which a bank grants a business loan to the owner of a new small business. On the balance sheet, restricted cash will be listed separately from the cash and cash equivalents line item – which contains the unrestricted cash amount as well as other qualifying short-term investments. In the event that the restricted cash is not spent as intended, it may then become unrestricted cash that a company can transfer to a general cash account or spend for general business purposes. For example, a company may hold restricted cash for the purpose of making a large capital expenditure, such as a factory upgrade, but later decide against making the expenditure. The cash designated as restricted for that purpose is then freed up for the company to spend or invest elsewhere.
Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Let’s use a fictional scenario involving a real estate transaction to illustrate restricted cash. A company may set aside a certain amount of cash each quarter to make a payment on long-term debt. When a company receives a bank loan, the bank may require that the company reserves (or maintains) a certain amount of cash that will be unavailable for spending. Restricted cash cannot be used to fund day-to-day working capital needs or investments for growth. By contrast, “unrestricted” cash is free to be used at the company’s discretion.