Restricted CashCash that isn't available for immediate or general use

Cash is one of the most important assets for a business.

It enables the business to perform its many functions.

A business can use cash to purchase important non-cash assets such as merchandise inventory, supplies, raw materials, equipment, machinery, etc.

It can also use cash to pay for expenses such as salaries, wages, rent, maintenance, insurance, etc.

Cash can just enable so much of a business that it’d be hard to find one that doesn’t have it.

A business can generally use its cash for whatever purpose it deems necessary.

In other words, a business’s cash is typically unrestricted (unless stated otherwise).

However, a portion of a business’s cash may not always be readily available for immediate or general use.

It could be that the business is reserving this portion of cash for a specific purpose (e.g. for the future purchase of a capital asset).

Or it could be that a contract requires the business to hold a certain minimum amount of cash.

We aptly refer to this portion of cash as restricted cash.

Unlike unrestricted cash, restricted cash isn’t something that a business can use for general purposes.

Restricted cash only becomes unrestricted if certain conditions are met.

In this article, we will be talking about what restricted cash is.

What qualifies as restricted cash?

Is it a current asset or a non-current asset?

Why do some businesses restrict a portion of their cash?

What is its effect on a business’s liquidity?

We will try to answer these questions as we go along with the article.

What is Restricted Cash?

Restricted cash is a portion of a business’s cash that isn’t freely available to spend or invest.

Rather, restricted cash is typically held by the business for a specific purpose.

For example, a business may be planning to make a large purchase in the future.

To ensure that this future purchase pushes through, the business may restrict a portion of its cash.

By restricting its cash, the business can ensure that it has the available funds when the time comes that it has to make the purchase.

In contrast, unrestricted cash is free for the business to use for whatever purposes it deems appropriate and/or necessary.

The business can use it for immediate or general purposes such as paying for operating expenses, purchasing materials, etc.

In accounting, restricted cash appears as a separate line item from the cash and cash equivalents account.

This is to make it easier to identify if a portion of the business’s cash is restricted or not.

And if it’s restricted, by how much.

The amount of restricted cash will appear on the balance sheet.

Details regarding the restricted cash can then be found in the accompanying notes to financial statements.

There, you can know what’s the purpose of restricting a portion of the cash.

Is Restricted Cash a Current or Non-Current Asset?

In general, cash is a current asset.

This can also mean that cash is typically liquid.

However, if it’s restricted cash, it can either be current or non-current.

To know the proper asset classification for restricted cash, we must first know if it’s expected to be used in the short-term or long-term.

If restricted cash is expected to be used within a year (short-term), then it classifies as a current asset.

For example, the business is restricting a portion of its cash to prepare for a future purchase that it will make in a month.

Since the business plans to use this restricted asset in the short-term, then it’s a current asset.

If restricted cash is not expected to be used within a year, then it classifies as a non-current asset.

For example, the business is pledging a portion of its cash to act as collateral for a 5-year loan.

This pledged portion of the cash becomes restricted cash.

Since the business has to maintain the balance of the restricted cash for the duration of the loan, it cannot use it within a one-year time frame.

Thus, it qualifies as a non-current asset.

Now, depending on whether restricted cash is current or non-current, how would it affect a business’s liquidity?

Restricted Cash and Liquidity

Cash is a business’s most liquid asset. That’s why several liquidity ratios always include cash in their calculations.

Examples of these ratios are the current ratio, quick ratio, and cash ratio. All of these ratios include cash in their calculations, with the quick and cash ratio specifically including unrestricted cash.

However, when it comes to restricted cash, it’s different.

Since restricted cash isn’t always readily available for use, we can’t exactly treat it as cash.

It may still be cash, but it isn’t as liquid as unrestricted cash.

Thus, some exclude restricted cash in the calculation of several liquidity ratios.

This is so that the calculation only includes liquid assets.

Restricted cash is technically a part of a business’s other assets.

It is not the same as “cash”.

Thus, we do not include it in the calculation of the quick and cash ratio.

This applies whether restricted cash is current or non-current.

For these two ratios, it’s important that cash is unrestricted.

On the other hand, the current ratio may include restricted cash in its calculation if it’s a current asset.

This is because the current ratio considers all current assets in determining a business’s liquidity.

Legally and Voluntary Restricted Cash

Restricted cash may be legal or voluntary depending on the purpose.

Legally Restricted Cash

Sometimes, a business will have to restrict its cash due to legal regulations or contracts.

Cash that is restricted for this purpose is legally restricted cash.

This restricted cash only becomes unrestricted upon fulfillment of the contract or when the legal regulations remove it from restriction.

For example, a business pledges a portion of its cash as collateral for a 5-year loan.

Since the restriction is governed by a contract, it’s legally restricted cash. This restricted cash only becomes unrestricted when the contract is fulfilled or the loan is fully paid.

Voluntary Restricted Cash

A business may, of its own volition (through its board of directors), restrict a portion of its cash for whatever purpose.

Since the restriction isn’t governed by any contract or legal regulation, it is voluntary restricted cash.

It becomes unrestricted if the business lifts the restriction.

It also becomes restricted if the purpose for its restriction is fulfilled.

For example, a business is planning to make a large purchase for the following year.

It wants to ensure that it has the necessary cash to make the purchase when the time comes.

As such, it reserves a portion of its cash to prepare for the purchase.

The business cannot use this portion of the cash for any other purpose, thus making it restricted cash.

Since there is no legal contract or regulation that governs the restriction, it’s voluntary restricted cash.

Restricted Cash: Examples

Here are some of the common examples of why a business restricts a portion of its cash.

Loan or debt repayments

A business may either legally or voluntarily restrict some of its cash for loan repayments.

Some lenders may require that a business maintains a certain amount of cash to partially secure a loan. This maintaining balance is restricted cash.

A business may also voluntarily restrict its cash to ensure that it doesn’t miss out on loan payments.

Delays in loan payments can result in unnecessary expenses after all (e.g. late fees, penalties).

Also, it can damage the reputation of the business. Both outcomes are things that a business should avoid.

Capital expenditures

If a business plans to make capital expenditures in the future, it may want to restrict a portion of its cash to prepare for it.

This ensures that the necessary amount of cash when the time comes to make the capital expenditure.

For example, a business restricts a portion of its cash to prepare for the purchase of new machinery.

Unless the business changes its mind, this portion of the cash is restricted cash. Since it’s restricted cash, it is not available for immediate or general use.

Refundable payment deposits

A business may sometimes require a deposit for purchases.

Depending on the agreement, this deposit may be refundable until the business delivers the goods or services.

If the business is still to deliver the goods or services, the deposit is treated as restricted cash.

It is not yet the business’s money. Only when the goods or services are delivered does it become unrestricted cash.

For example, a customer makes a deposit for his purchase.

According to the agreement, this deposit is refundable until the business successfully delivers the goods.

The business cannot use the deposit yet until it fulfills the order.

Thus, it’s restricted cash.