Definition
Short-term investments, also known as marketable securities or temporary investments, are financial instruments or assets that can be converted into cash typically within a period of five years or less. They are often used by companies to store cash for near-future needs in a more profitable and productive manner than typical savings accounts. Examples include treasury bills, certificates of deposit, money market funds, and commercial paper.
Phonetic
The phonetics for “Short-Term Investments” is: ʃɔrt tɜrm ɪnˈvɛstmənts
Key Takeaways
Key Takeaways about Short-Term Investments
- Liquidity: Short-term investments are highly liquid assets which can be quickly converted into cash, typically within a year. This makes them suitable for individuals and businesses needing to meet near-term obligations.
- Risk and Return: Although they carry lower risk compared to long-term investments, the returns are generally smaller. Besides, the short duration may also limit the potential for returns. Hence they are suitable for conservative investors who prefer less risky yet steady return on investment.
- Variety of Options: These investments can come in many forms including money market funds, treasury bills, short-term bonds, and certificate of deposit (CDs). By understanding the varying features of each option, investors can determine which type of short-term investment would best meet their financial goals.
Importance
Short-term investments, also known as marketable securities or temporary investments, are important in business finance for multiple reasons. They provide companies with a level of liquidity while still allowing them to earn a return from idle cash. These investments typically mature in a year and can offer a higher return than regular savings. They also allow companies to maximize their financial flexibility and efficiency by generating short-term profits, mitigating loss due to inflation, and maintaining easy access to cash for unforeseen expenses or opportunities. Therefore, understanding short-term investments can play a critical role in improving a company’s liquidity status, risk management, and overall financial health.
Explanation
Short-term investments, also known as marketable securities or temporary investments, serve a crucial purpose in the financial planning and strategy of businesses or investors. The primary purpose is to provide a safe haven for cash while it’s not being used, with the added benefit of generating income through interest or appreciation within a brief period, which is often under a year. These investments also offer a high level of liquidity allowing businesses or investors to quickly convert the investments into cash, making them a more attractive option for unused cash instead of enabling it stay idle.Short-term investments are used for various reasons. Corporations invest short-term as part of their cash management strategy. Businesses may have future financial obligations or anticipate opportunities where they would need readily available cash. During this interim period, short-term investments can not only provide the necessary liquidity but also earn returns. On the other hand, individual investors might use short-term investments to park their money in a generally low-risk environment when they anticipate needing the cash in the near future, such as for a down payment for a home, a car, or tuition. It’s a way for both businesses and individuals to maximise benefits from their surplus cash.
Examples
1. Certificates of Deposit: Certificates of deposit, also known as CDs, are offered by banks to customers as short-term investment options. They involve the customer depositing a certain sum of money in the bank for a fixed period (anywhere between a few months to a couple of years), with a guarantee of a certain return of interest at the end of that period.2. Treasury Bills: Treasury bills, or T-bills, are government-issued securities. They are sold at a discount to their face value and mature in a year or less. For instance, the U.S. government may sell a T-bill with a $1,000 face value for $990. The buyer will then receive the full face value at maturity, effectively making a $10 profit, which is the return on the investment.3. Money Market Funds: Money market funds are types of mutual funds that invest in high-quality, short-term debt from governments, banks, or corporations. The idea is to minimize the risk while providing a modest return. The benefit is the liquidity, as investors can generally buy and sell these funds at any point without penalty.
Frequently Asked Questions(FAQ)
What are short-term investments?
Short-term investments, also known as marketable securities or temporary investments, are investments that can be easily converted into cash, typically within 5 years. Often, they’re investments in debt or equity securities.
Where are short-term investments recorded on a company’s financial statement?
Short-term investments are recorded under the current assets category on a company’s balance sheet.
What are some examples of short-term investments?
Some examples include Treasury bills, commercial paper, money market funds, and certificates of deposit (CDs).
What is the difference between short-term and long-term investments?
The main difference lies in how long the investment is held. Short-term investments are typically held for less than a year, while long-term investments are held for a year or longer.
How liquid are short-term investments?
Short-term investments are highly liquid, meaning they can be converted into cash quickly and easily.
What is the risk level of short-term investments?
Although all investments carry some level of risk, short-term investments are generally considered to be lower risk than long-term investments because of their brief duration. However, they also often provide lower returns.
Can short-term investments be used for emergency funds?
Yes, because they are relatively liquid, short-term investments can be used as part of an emergency fund strategy. However, they should not replace a more reliable cash reserve.
How does a company decide whether to make a short-term investment?
A company might choose to invest surplus cash in short-term investments in order to earn a return, while maintaining the liquidity necessary for operating activities and unexpected expenses. The decision will depend on the company’s financial position, market conditions, and risk tolerance.
Are short-term investments taxable?
Yes, any income generated from short-term investments is generally taxable. The tax rate will depend on the type of income, such as interest, and individual tax laws in your country.
Who can benefit from short-term investments?
Individuals and corporations with idle cash that they wish to earn a return on in the short term can benefit from these investments. They are also useful for those looking to maintain liquidity while having potential for some income growth.
Related Finance Terms
- Capital Gains
- Liquidity
- Maturity Date
- Portfolio Diversification
- Risk Tolerance
Sources for More Information
