Restricted cash is a component of the "cash and cash equivalents" account reported on a company's balance sheet. It refers to cash that has been set aside by management for a specific use. While some portion of most companies' cash is restricted, in practice few companies break down the cash account into restricted and unrestricted components because it is immaterial.
Nature of Restricted Cash
Restricted cash arises out of a management decision to set aside funds because of, say, a legal obligation such as a statute or court order, or based on contractual requirements. For example, a company could elect to set aside a certain amount each month for the repayment of debt. This cash would be considered restricted and available exclusively to extinguish the debt. A company's earmarked cash would be aggregated to calculate the total restricted cash balance.
Short-Term and Long-Term Restricted Cash
If the restricted cash balance is material, it will be reported on a company's balance sheet separate from the unrestricted cash balance. Cash that is set aside for a period of less than 12 months would be classified as current, whereas cash that is set aside for a period of greater than 12 months would be classified as noncurrent. In our earlier example, if the debt were maturing in three months, the cash set aside would be reported under current assets. If the debt were maturing in 18 months, the amount would be reported under noncurrent assets.
Companies are required to disclose accounting policies that are relevant to an investor's understanding of its financial condition and performance. If a company has a material amount of restricted cash, consult the footnotes to the financial statements to determine the nature, characteristics and circumstances that led management to categorize the cash as restricted.
Role of Restricted Cash in Enterprise Value
When corporate financiers calculate a company's enterprise value, they adjust for the amount of restricted cash. Enterprise value is a measure of the value of a company, reflecting its market capitalization, net debt, noncontrolling interests, preferred stock and capital leases. To accurately evaluate enterprise value, subtract restricted cash from cash and cash equivalents in the net debt calculation. When companies do not explicitly report restricted cash, some practitioners estimate the industry average percentage of cash that is restricted.
Giulio Rocca's background is in investment banking and management consulting, including advising Fortune 500 companies on mergers and acquisitions and corporate strategy. He also founded GradSchoolHeaven.com, an online resource for graduate school applicants. He holds a Bachelor of Science in economics from the University of Pennsylvania, a Master of Arts in English from the University of Hawaii at Manoa, and a Master of Business Administration from Harvard University.