What are cash equivalents?

Cash equivalents refer to short-term, highly liquid investments that are easily convertible to known amounts of cash and have an insignificant risk of changes in value. These instruments typically have maturities of three months or less from the date of purchase. Common examples of cash equivalents include treasury bills, commercial paper, and money market funds.

The key characteristics of cash equivalents are their liquidity and the ability to quickly convert them to cash. This definition underscores why the correct choice is considered accurate. By being readily available for use in transactions or to meet obligations, cash equivalents play an essential role in a company's liquidity strategy.

In contrast, investments that are difficult to liquidate do not align with the definition of cash equivalents, as they lack the essential liquidity characteristic. Similarly, long-term assets held for appreciation do not qualify, as they are not intended for immediate conversion to cash and are often subjected to market fluctuations over time. Physical cash held on premises does not fall into the category of cash equivalents, as it refers to actual cash rather than investments that can be quickly converted to cash.