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Restricted Cash

Cash that is not available for immediate business use

What is Restricted Cash?

Restricted cash refers to cash that is held on by the company for specific reasons and is not available for immediate business use. It can be contrasted to unrestricted cash, which refers to cash that can be used for any purpose.

 

Restricted Cash

 

Quick Summary:

  • Restricted cash refers to cash that is held on by the company for specific reasons and not available for immediate business use.
  • Restricted cash is commonly found on the balance sheet with a description of why the cash is restricted in the accompanying notes to the financial statements.
  • Reasons for cash being restricted include bank loan requirements, payment deposits, collateral pledge, and paying off debt.

 

Restricted Cash on the Balance Sheet

Restricted cash can be commonly found on the balance sheet as a separate line item. For example, the balance sheet of a company with restricted cash may look as follows:

 

Restricted Cash on the Balance Sheet

 

The reason that the cash is restricted is generally revealed in the accompanying notes to the financial statements. Additionally, depending on how long the cash is restricted, the line item can appear under current assets or non-current assets. Cash that is restricted for one year or less is categorized under current assets, while cash that is restricted for over a year is categorized as non-current assets.

 

Reasons for Restricting Cash

There are several reasons why cash can be restricted:

 

1. Bank loan requirements

When a company receives a bank loan, the bank may require that the company reserves (or maintain) a certain amount of cash that will be unavailable for spending.

 

2. Payment deposits

A company may receive cash from a customer prior to providing services or shipping goods. The customer may require, through a clause in the agreement, that the company cannot spend the cash until the service or order is fulfilled.

 

3. Collateral pledge

A company may be required by an insurance company to pledge a certain amount of cash as collateral against risk.

 

4. Paying off debt

A company may set aside a certain amount of cash each quarter to make payment for long-term debt.

 

Financial Ratios

Due to the cash not being readily available for use, restricted cash is generally excluded in several liquidity ratios. Failure to exclude restricted cash in the calculation of liquidity ratios will make the company look more liquid than it is and mislead others. Examples of liquidity ratios that will exclude restricted cash include cash ratio and quick ratio.

 

Example of Restricted Cash

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 company’s balance sheet is provided as follows:

 

Sample Balance Sheet

 

Under accompanying notes to the financial statements, John notes that the restricted cash is in relation to a payment deposit where the company agreed with a customer to keep $350,000 in cash until its obligation with the customer is settled. The obligation is expected to settle in a year.

John excludes restricted cash and determines the quick ratio as $150,000 / ($500,000 + $57,500) = 0.27.

Had John used restricted cash in his calculation of quick ratio, he would have a quick ratio of ($150,000 + $350,000) / ($500,000 + $57,000) = 0.90 and mistakenly deemed the company more liquid than it is.

 

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Idle Cash
  • Projecting Balance Sheet Line Items
  • Sinking Fund
  • Statement of Cash Flows

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