• a. Readily convertible to known amounts of cash
• b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
  
  Generally, only investments with original maturities of three months or less qualify under that definition.”

The Financial Accounting Standards Board (FASB) voted at its March 21, 2007 board meeting to remove the term “cash equivalents” from the cash account and require that cash equivalents become part of short-term investments. This change will effect the Statement of Financial Position (Balance Sheet) and the Statement of Cash Flows. The International Accounting Standards Board (IASB) on March 22, 2007 chose to follow the decision of the FASB. The exact date for implementation of the cash equivalents elimination is planned to coincide with the proposed financial reporting model which is expected not to be required before 2010.

For companies that must retain a certain level of cash and cash equivalents on their balance sheet in order to comply with debt covenants may want to take a hard look at lending documents.

Auction rate securities

The Auction Rate Securities (ARS) markets have also been in a state of flux as a result of the credit problems. Certain ARS investments securitized with mortgage debt are now going through a risk adjustment. There have been some auction failures where the underlying securities were Collateralized Debt Obligations (CDOs), Collateralized Loan Obligations (CLOs) or secured by Contingent Capital Structures. Auction rate securities where the underlying security are student loans, exempt municipals, triple A rated securities which are insured and some closed-end funds have generally been supported by the market makers who are purchasing any remaining balance during the auction.

Cash which may not be cash

As a treasurer of a corporation, your company may have accounts which have been in existence long before you and its classification as cash or cash equivalent may have been simply assumed. It is important in today’s market to assess all your cash and short-term accounts to determine if they really are short-term and carry the accepted level of risk that corporate policy allows.

Commercial paper which is extendible and money market accounts with asset backed securities may contain a risk of non-payment within the three month accepted time period. Money market accounts with asset backed securities may not reflect current fair value and may have problems in the event of too many redemption requests.

Make sure your standby lines of credit are current and available in the event that any of your cash or short-term investment redemptions become limited or restricted.

Avoid year-end surprises

Remember how the auditors came to work on your year-end audit and in one year without prior notice decided that auction rates securities no longer qualified as a cash equivalent? Remember how the auditors came in to work on your year-end audit and decided a year later that variable rate demand notes no longer qualified as a cash equivalent?

Review your commercial paper and your money market accounts before year-end to make sure that your commercial paper documentation does not include an “Extendible Notes” clause which could prevent you from receiving your cash at the expected maturity. Look at the prospectus for your money market accounts to determine if the agreement allows the fund to invest in CDOs or CLOs. Also, look at actual investments to find out if they have actually invested in any of these vehicles.

Some treasurers have called to ask about exempt money market funds where the “original maturities of the underlying investments” are greater than three months since this was the argument put forward by the auditors for ARS disqualification. It is impossible at this time to know how the auditors in light of the present risk reassessments might consider these investments.

FDIC insurance

Certain bank sweep programs may result in cash not being covered by traditional FDIC insurance. Excess funds swept out of the bank overnight may not have the protection of FDIC insurance and may place your company at the level of unsecured creditor of a bank in the event a bank had to close and FDIC had to step in and take over.

Summary

Treasurers should review all their existing cash and short-term investment accounts in light of the recent short-term liquidity problems experienced by the credit markets. Assess your cash and short-term investments including money market funds and other investments to the definition contained in FAS 95 on what cash and cash equivalents are. When cash must be available at a certain date such as for corporate payroll is critical, close monitoring and more conservative investments may be advisable and make sure that contingency plans are in place.

Copyright © 2007 Association for Financial Professionals. All Rights Reserved.