Short-term Investments

Definition

Short-term investments are liquid assets that a company holds with the intention of converting them into cash within a year or less. These investments are part of a company's current assets and are used to generate additional income or meet short-term financial obligations.

5 Must Know Facts For Your Next Test

1. Short-term investments are typically held for less than a year and are intended to be converted into cash to meet the company's short-term financial obligations.
2. These investments are classified as current assets on a company's balance sheet, indicating that they are readily available resources.
3. Common examples of short-term investments include government securities, corporate bonds, and money market funds, which offer a higher return than cash but with minimal risk.
4. Short-term investments provide a way for companies to earn additional income on their excess cash reserves, while maintaining a high degree of liquidity.
5. The management of short-term investments is crucial for a company's working capital management, as it balances the need for liquidity with the potential for higher returns.

Review Questions

• Explain how short-term investments are classified on a company's balance sheet and how they differ from other current assets.
  • Short-term investments are classified as current assets on a company's balance sheet, indicating that they are readily available resources that can be converted into cash within one year or less. They differ from other current assets, such as accounts receivable and inventory, in that they are held primarily for the purpose of generating additional income rather than for operational use. While other current assets may be less liquid, short-term investments provide a higher degree of liquidity, allowing the company to quickly access cash to meet short-term financial obligations or take advantage of investment opportunities.
• Describe the role of short-term investments in a company's working capital management and the factors that influence the decision to hold such investments.
  • Short-term investments play a crucial role in a company's working capital management. By holding short-term investments, companies can earn a higher return on their excess cash reserves compared to holding cash alone, while maintaining a high degree of liquidity. Factors that influence the decision to hold short-term investments include the company's cash flow patterns, the expected timing of future cash needs, the prevailing interest rates, and the company's risk tolerance. Effective management of short-term investments allows companies to optimize their use of working capital, ensuring they have the necessary funds available to meet short-term obligations and take advantage of investment opportunities as they arise.
• Analyze how the accounting treatment of short-term investments, including their subsequent measurement and recognition of gains or losses, can impact a company's financial statements and financial ratios.
  • The accounting treatment of short-term investments can have a significant impact on a company's financial statements and financial ratios. Short-term investments are typically measured at fair value, with any changes in fair value recognized as gains or losses in the income statement. This can lead to fluctuations in a company's net income and earnings per share, which can influence investor perceptions and financial ratios such as the current ratio and quick ratio. Additionally, the classification of short-term investments as current assets can impact a company's working capital and liquidity measures, as these investments are considered more readily available resources compared to other current assets. The proper accounting and reporting of short-term investments is crucial for providing accurate and meaningful financial information to stakeholders, enabling them to make informed decisions about the company's financial health and performance.

Related terms

Current Assets: Current assets are assets that a company expects to convert into cash within one year or less, such as cash, accounts receivable, and inventory.

Marketable Securities: Marketable securities are short-term investments in highly liquid financial instruments, such as stocks, bonds, or money market funds, that can be easily converted into cash.

Liquidity: Liquidity refers to the ease with which an asset can be converted into cash without significant loss in value.