Marketable securities are short-term investments that businesses and individuals acquire to manage cash flow and generate returns. These investments, which include stocks, bonds, and treasury bills, offer liquidity and serve as a financial cushion.
Understanding the impact of purchasing marketable securities is crucial for financial planning and decision-making. This topic explores the effects of buying marketable securities, their role in a company’s financial statements, and the benefits and risks involved.
What Are Marketable Securities?
Marketable securities are highly liquid financial instruments that can be easily converted into cash. They are typically purchased by businesses to generate returns on idle cash while maintaining liquidity.
Types of Marketable Securities
- Equity Securities – Stocks and shares in publicly traded companies.
- Debt Securities – Treasury bills, corporate bonds, and commercial paper.
- Money Market Instruments – Certificates of deposit (CDs) and repurchase agreements.
How the Purchase of Marketable Securities Affects Financial Statements
1. Impact on Cash Flow Statement
Purchasing marketable securities appears in the investing activities section of the cash flow statement. It results in:
- A cash outflow from investing activities.
- A decrease in cash and cash equivalents unless the securities are highly liquid.
2. Impact on Balance Sheet
Marketable securities are recorded as current assets or long-term investments, depending on the holding period:
- Short-term holdings (less than a year) are listed under current assets.
- Long-term holdings (over a year) are classified as non-current assets.
3. Impact on Income Statement
The purchase itself does not directly impact net income, but changes in market value, dividends, and interest earned may lead to:
- Unrealized gains or losses if the securities are marked to market.
- Dividend income from equity securities.
- Interest income from debt securities.
Benefits of Purchasing Marketable Securities
1. Improves Liquidity Management
Companies invest in marketable securities to maintain liquidity without holding excessive cash, which earns little to no return.
2. Provides a Source of Passive Income
- Dividend-paying stocks offer periodic income.
- Bonds and treasury securities generate interest income.
3. Enhances Capital Allocation
Instead of keeping idle cash, firms allocate funds into marketable securities to maximize returns while keeping assets liquid.
4. Lowers Financial Risk
Marketable securities provide a diversified investment option, reducing the risk of keeping all assets in cash or operational investments.
Risks of Investing in Marketable Securities
1. Market Volatility
- Equity securities are subject to price fluctuations, which can lead to unrealized losses.
- Bond prices may decline due to interest rate changes.
2. Credit Risk
- Corporate bonds and commercial papers carry default risk if the issuer faces financial difficulties.
3. Liquidity Concerns
- Some securities may be harder to sell quickly in times of market distress.
4. Regulatory and Accounting Changes
- Companies must comply with financial reporting standards when accounting for marketable securities, which can impact financial results.
Strategic Considerations Before Purchasing Marketable Securities
1. Investment Objectives
- Short-term liquidity or long-term capital growth?
- Risk tolerance and return expectations?
2. Market Conditions
- Interest rates, stock market trends, and economic outlook influence investment decisions.
3. Accounting and Tax Implications
- Gains or losses may impact financial reporting.
- Tax treatment varies for dividends and capital gains.
The purchase of marketable securities helps businesses manage excess cash, enhance liquidity, and generate returns. While they offer advantages like passive income and financial flexibility, they also come with risks such as market volatility and credit risk. Companies must assess their financial goals and risk tolerance before investing to optimize their portfolio and maintain stability.