RESTRICTED CASH: Definition & Its Financial Statement

restricted cash

In accounting, “cash” refers to money maintained in liquid form by a corporation that can be spent or invested in. Restricted cash is money that has been set aside for a specific purpose. Hence, it is not available for immediate or general corporate usage. According to GAAP, restricted cash is cash that a corporation owns but is not freely available to spend or reinvest in order to sustain/fund future growth. Oftentimes, it is mistaken for a non-current asset. As we’ll see in this article, restricted cash can be both a current asset and a non-current asset. Also, we will discuss how restricted cash is included in the cash flow statements as well as a balance sheet.

What is Restricted Cash?

Restricted cash is money that has been set aside for a specific purpose. Thus, it is unavailable to the corporation for immediate or general commercial usage.

It is listed separately from cash and cash equivalents on a company’s balance sheet. The cause for the restricted funds is normally revealed in the financial statements accompanying notes. Cash flow might be blocked for a variety of reasons, including debt repayment and capital investments.

Understanding Restricted Cash

Companies set aside restricted funds to be used for a specified purpose. Restricted funds might be set aside for a specific purchase or to repay a loan or debt. Cash that has been designated as restricted may not be utilized for any other reason.

Particular Considerations

The handling of restricted funds involves a number of issues. It may, for example, be held in a separate bank account designated for the purpose for which the cash is restricted. Restricted cash is reported as a cash asset in a company’s financial statements. This is irrespective of whether the cash is housed in a particular bank account or not.

If the cash is not spent as intended, it may become unrestricted cash. In this case, a corporation can transfer it to a general cash account or spend it for broad business activities. For example, a corporation may store restricted funds with the intention of making a big capital expenditure, such as a plant update, but then decide against it. The cash set aside for that reason is then kept for the corporation to spend or invest elsewhere.

Restricted Cash on a Balance Sheet

Restricted cash is often noted as a separate line item on the balance sheet. For example, the balance sheet might look like this:

Restricted cash on a balance sheet

The rationale for such restriction is usually mentioned in the financial statements’ accompanying notes. Furthermore, depending on how long the cash is restricted, the line item may appear under current assets or non-current assets. Cash restricted for a year or less is classified as a current asset. However, funds restricted for more than a year is classified as a non-current asset.

Reasons for Restrictions

Restrictions occur for a variety of reasons, including:

#1. Requirements for bank loans

When a corporation accepts a bank loan, the bank may require that it reserve (or keep) a particular amount of cash that is not accessible for spending.

#2. Deposits for payments

Prior to providing services or sending goods, a corporation may accept cash from a customer. The consumer may ask that the cash not be spent until the service or order is completed.

#3. Pledge of collateral

An insurance provider may demand a corporation to pledge a particular amount of cash as collateral against risk.

#4. Debt repayment

A corporation may set aside a specified amount of cash each quarter to make a long-term debt payment.

Financial Ratios 

Cash that is restricted is normally excluded from numerous liquidity ratios since it is not easily available for use. If cash is not excluded from the calculation of liquidity ratios, the company will appear more liquid than it is. This will be misleading. The cash ratio and the quick ratio are two examples of liquidity ratios that exclude restricted cash.

Restricted Cash Examples

Organizations can restrict a portion of their cash for a variety of reasons. However, the two most common applications for restricted cash are listed below.

Expenditures on Capital

Companies frequently maintain restricted funds for capital expenditures or as part of a third-party arrangement. Companies commonly set aside this cash when planning for large investment expenditures, such as a new building.

Payments on a loan or debt

Lenders may demand that a corporation keep restricted funds as partial collateral for a loan or line of credit. A bank or other lender may require the company to open a designated restricted cash account. This account must maintain a minimum balance equal to a certain percentage of the credit given by the bank. This is a pretty frequent practice when a bank provides a business loan to the owner of a new small firm.

A bank loan requirement is an example of a restricted fund. In this case, a borrower must have a certain percentage of the total loan amount in cash at all times.

For example, a corporation may have signed a loan arrangement to get a line of credit in which the lender requires the borrower to keep 10% of the total loan amount on hand at all times.

To prevent breaching the lending terms, the 10% minimum must be maintained for the entire term length in which the line of credit is operational (i.e. can be drawn from) – so, restricted cash is used as collateral for a loan and is legally binding.

The lender can alternatively require that the cash be held in a separate bank account to ensure the borrower’s compliance.

Cash Flow Statements with Restricted Cash

Historically, the classification and presentation of changes in restricted cash in the cash flow statements have varied. In cash flow statements, entities have categorized transfers between cash and restricted cash as operating, investing, or financing activities, or a combination of those activities. Furthermore, some organizations reported direct cash receipts, and direct cash payments made from, a bank account holding restricted cash as cash inflows and cash outflows, while others reported those cash flows as noncash investing or financing activities.

Generally:

  • Amounts commonly referred to as restricted cash and restricted cash equivalents must be included in the statement of cash flows’ total cash and cash equivalents. The total must match the amounts on the asset and statement assets.
  • Cash and restricted cash totals in the statement of cash flows are no longer needed to be the same as similarly titled line items or subtotals in the statement of assets and liabilities. If the amounts appear in more than one line item on the statement of assets and liabilities, the amounts and corresponding line items must be disclosed and reconciled to the total amounts of cash and restricted cash on the statement of cash flows – either on the face of the statement of cash flows or in the notes to the financial statements.
  • Direct third-party cash receipts and payments to and from a bank account or other financial institution containing restricted cash are classified in the statement of cash flows as cash flows from operating, investing, or financing activities based on the nature of the cash flows.
  • Transfers between unrestricted and restricted cash and cash equivalents are not included in the statement of cash flows as cash flows from operating, investing, or financing activities.

Is Restricted Cash Considered a Current Asset?

Restricted cash is classified as either a current asset (used up within one year) or a non-current asset (long-term asset). As a result, it is categorized as a current asset if it is expected to be used in the immediate term. It is equally categorized as a non-current asset if it is not expected to be used within a year. It is often reported on a company’s balance sheet as “other restricted cash” or “other assets.”

Reporting restricted funds on financial statements

The balance sheet of a business must cover all assets and liabilities, including cash. Restricted cash is recorded separately from cash and cash equivalents on a company’s balance sheet, and the reason for the restriction is often disclosed in the accompanying notes to the financial statement.

Depending on how long it is projected to stay restricted, restricted cash might be classed as a current or non-current asset. If the cash is projected to be utilized within a year of the balance sheet date, it should be classed as a current asset. However, if the cash is expected to be unavailable for usage for more than a year, it should be categorized as a non-current asset.

Compensating Balances 

A compensating balance is a minimum balance that a firm must keep in an account as part of a contract with a current or potential lender. A compensating balance is commonly used to offset a portion of a bank’s costs when lending money, and it is computed as a percentage of the loan. For example, a corporation may agree to keep $500,000 in a bank account in exchange for a $5 million line of credit from that bank. Compensating balances are classified as restricted funds and must be disclosed on a company’s financial statement.

Restricted Cash vs. Unrestricted Cash

Restricted cash differs from unrestricted cash. Restricted cash is not immediately available for spending or investing by the organization. Unrestricted cash, on the other hand, is easily accessible and can be used for any reason. It has not been pledged as collateral for a debt obligation or for any other reason.

Often, in order to meet debt covenants, corporations must keep a particular amount of cash on their balance sheets in case they default or go into nonpayment of their credit commitments.

Unrestricted cash is the remaining cash that exceeds the covenant requirements. It is part of a company’s liquid funds, which means it’s immediately accessible. Unrestricted cash is significant because it demonstrates how much cash a company has available to satisfy its short-term bills and credit obligations.

On a company’s balance sheet, unrestricted cash is listed. However, it is commonly referred to as cash and cash equivalents. Unrestricted cash or cash and cash equivalents signify money that an organization can spend today, indicating that it is easily accessible—or liquid. On the balance sheet, unrestricted cash is classified as a current asset because it may be easily accessible and spent in the short term.

Companies need liquidity because having adequate cash on hand can help them satisfy their short-term debt obligations and pay their vendors and suppliers. Current liabilities are short-term debt commitments and bills that are due within 90 days. Unrestricted cash assists businesses in ensuring that they have adequate current assets to pay their current liabilities, often known as working capital.

In Conclusion, 

Reporting restricted funds yields a more accurate balance sheet. Accounting for it can also help a company’s overall financial health because precise records can lead to smarter expenditure and resource allocation.

If the cash is not used as planned, it becomes unrestricted. The money can be transferred to a general cash account or used for normal company reasons. For example, if a firm has set aside cash to buy new equipment but later decides against it, the finance manager can utilize the cash for anything else.

Frequently Asked Questions

What is an example of restricted cash?

Refundable deposits, minimum balances on bank accounts, and assets kept in escrow are all examples of restricted cash. Restricted cash is frequently the outcome of a legally enforceable agreement.

How do you get restricted cash?

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.

Does restricted cash count as cash?

Usually, restricted cash is recorded separately from cash and cash equivalents on a company’s balance sheet, and the reason for the restriction is often disclosed in the accompanying notes to the financial statement.

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