Financial accounting allows a business to record its transactions, providing a place for leaders to go when they need information about the organization's fiscal health. In particular, balance sheets are comprehensive financial statements that show how a business' finances are structured. Restricted cash is among the items a business must account for on its balance sheet to comply with accounting standards and keep its books accurately.
Restricted Cash Definition
In the broadest sense, restricted cash is money a business has in its possession but can't use immediately. Instead the cash is subject to special limitations, such as a waiting period or being earmarked for a future use. Restricted cash is usually held in a special account so it remains separate from the rest of a business' cash. It may represent cash on its way into the business, or money that is being held before spending.
Restricted cash can take many forms, which a balance sheet should note, explaining where the money is going or where it has come from. Payment deposits are one type of restricted cash. They represent money a business receives from a customer prior to providing services or shipping goods but can't spend until satisfying the order due to a contractual agreement. Legal fees in escrow that will go to an attorney following the completion of a lawsuit are another example of restricted cash. Businesses can also set money aside to pay future debt, labeling it restricted cash to protect it from spending for other purposes.
Restricted cash appears on a balance sheet as an asset. It has the same value as cash and cash equivalents. However, to denote the fact that restricted cash is not available for use, the row of the balance sheet that contains it includes the term "restricted cash" and a note about the reason for the restriction. This allows a balance sheet to maintain a balance until the money is paid out as an expense or brought in as revenue and accounted for normally.
A cash flow statement is another form of financial statement a business uses to account for its restricted cash and keep its accounts balanced. Cash flow refers to the rate at which money moves in and out of a business. While restricted cash on a balance sheet is counted in the same way other assets are, restricted cash doesn't figure into a business' current cash flow. This is because cash flow is useful for determining available funds for making payments, which restricted cash does not impact. Instead, it indicates money that will enter or leave the business at a defined time in the future, affecting cash flow projections.