Restricted cash is cash that is not available for immediate use and may not be utilized for any purpose until a certain event or string of events take place. During this period of restriction, the cash may be held in some type of interest-bearing account, allowing the money to generate some additional income. This approach may be used in a number of settings, including fulfilling a substantial order for a customer or as a strategy in managing long-term debt servicing.
One example of the use of restricted cash has to do with setting aside funds that will be used to retire a debt over the long term. This is sometimes used when the structure of the debt involves making balloon payments on a loan or even setting aside funds to honor debt obligations such as bond issues. This means that if a company must settle a bond issue at the end of five years, money will be periodically placed into an interest-bearing account over that time. Once the five years are up, all the money in that account is released for the express purpose of settling with the bondholders. Depending on how much restricted cash was saved over the years, the company may be able to settle the bond issue without touching any other assets.
Another application of restricted cash involves the delivery of a high-priced item to a customer. In this scenario, the client makes some sort of deposit or advance payment on that big ticket item, with a delivery date set for a specific time in the future. The identification of this future delivery date allows the manufacturer time to create the item to match the specifications agreed upon with the customer. That deposit is considered restricted cash and is placed into an interest bearing account until the item is delivered and accepted by the customer. At that point, the cash is no longer restricted and can be used by the company for any of its business expenses.
Restricted cash is accounted for in the financial records of the business, usually as a line item on the company balance sheet. If the cash is anticipated to be released within one calendar year, it is usually listed as a current asset. Should the cash remain restricted for a period longer than twelve months, the funds are usually accounted for as non-current assets. Some accounting methods call for placing the restricted cash into a trial balance account that is reflected separately from the other accounts or line items found on the balance sheet.
