Restricted Cash

Restricted Cash Balance Sheet Accounting

Restricted cash is cash that belongs to a company yet is neither freely available to be spent nor re-invested to sustain/fund future growth.

By contrast, “unrestricted” cash is free to be used at the company’s discretion.

The cash balance of a company should consist of only unrestricted cash, as opposed to restricted cash, which is not freely available for use by the business and is instead held for a specific purpose.

The balance sheet must differentiate between restricted and unrestricted cash, with footnotes in the disclosure section explaining the nature of the restrictions placed on the restricted cash.

Restricted cash cannot be used to fund day-to-day working capital needs or investments for growth.

The restricted cash is instead held by the company for purposes frequently related to:

• Debt Financing – i.e. Loan Agreements, Collateral
• Capital Expenditures (Capex) – i.e. Future Upgrades and Required Purchases/Maintenance

Treatment of Restricted Cash on Balance Sheet

On the balance sheet, restricted cash will be listed separately from the cash and cash equivalents line item – which contains the unrestricted cash amount as well as other qualifying short-term investments.

As mentioned earlier, there’ll be an accompanying disclosure with the reasoning as to why this certain amount of cash cannot be used.

Restricted cash can be classified as either a current or non-current asset:

• Current Asset – If anticipated to be used within one year of the balance sheet date, the amount should be classified as a current asset.
• Non-Current Asset – If unavailable to be used for more than one year, the amount should be categorized as a non-current asset.

Liquidity ratios such as the current ratio and quick ratio should also be adjusted to exclude any illiquid cash. Not doing so would cause such ratios to depict a better picture of the company’s liquidity position than in reality.

Bank Loan and Restricted Cash Example

One example of restricted cash would be a bank loan requirement, whereby a borrower must maintain a specific percentage of the total loan amount in cash at all times.

For instance, a company might have signed a loan agreement to receive a line of credit where the lender has required the borrower to maintain 10% of the total loan amount at all times.

Throughout the entire term length in which the line of credit is active (i.e. can be drawn from), the 10% minimum must be preserved to avoid breaching the lending terms – so, a certain amount of cash is set aside to serve as collateral for the loan and the obligation not to spend it is legally binding.

To avoid that risk, the lender can also request a separate bank account to hold the funds (i.e. placed in escrow) to ensure compliance by the borrower.