Restricted Cash: What Is It, Calculation & Importance

Restricted cash refers to funds that are set aside for specific purposes and are not readily accessible for general business operations. These funds are often earmarked due to contractual obligations, regulatory requirements, or agreements with creditors. While it forms part of a company’s overall cash holdings, its restricted nature means it cannot be used freely until certain conditions are met.

To evaluate the significance of restricted cash, analysts often calculate its percentage relative to total cash holdings:

Restricted Cash Percentage = (Restricted Cash / Total Cash) × 100

For example:

A company holds $400,000 in restricted cash and $2,000,000 in total cash. The percentage is calculated as:

(400,000 / 2,000,000) × 100 = 20%

This indicates that 20% of the company’s cash is restricted, leaving 80% available for general use.

To understand how restricted cash is analyzed, let’s calculate its percentage relative to total cash holdings.

Scenario

A company’s financial statement shows the following:

• Restricted Cash: $500,000
• Total Cash: $2,000,000

The formula for calculating the percentage of restricted cash is:

Restricted Cash Percentage = (Restricted Cash / Total Cash) × 100

Restricted Cash Percentage = (500,000 / 2,000,000) × 100 = 25%

In this scenario, 25% of the company’s cash is restricted, leaving the remaining 75% available for general operational use. This calculation helps analysts and stakeholders understand how much of the company’s liquidity is tied up in obligations, providing a clearer picture of financial flexibility.

Restricted cash offers crucial insights into an organization’s financial health and priorities. It reflects a company’s commitment to meeting obligations such as debt repayments, lease agreements, or future capital expenditures. For investors, analyzing restricted cash provides a clearer picture of the firm’s liquidity and risk management strategies.

By examining restricted cash, investors and stakeholders can gauge the firm’s ability to manage both short-term and long-term commitments effectively. This type of cash highlights financial prudence, ensuring that businesses meet their obligations, such as debt payments, lease agreements, or planned investments.

Restricted cash is typically recorded separately from unrestricted cash on the balance sheet to ensure transparency. Depending on the expected timeframe for its use, restricted cash may appear under current assets (if it will be used within 12 months) or non-current assets (if the restriction extends beyond a year).

• Liquidity Management: Companies must carefully balance restricted and unrestricted cash to ensure sufficient liquidity for operations.
• Transparency: Accurate disclosure of restricted cash enhances investor trust and ensures compliance with accounting standards.
• Financial Stability: Restricted cash demonstrates prudent financial planning, as it safeguards funds for critical obligations.

Transparency is key when reporting restricted cash. Accounting standards such as GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) mandate clear disclosures to avoid misleading stakeholders.

Restricted cash can appear under:

• Current Assets: If the restriction is expected to be lifted within 12 months.
• Non-Current Assets: If the restriction extends beyond 12 months.

For example, a company may report:

• Cash and Cash Equivalents: $500,000
• Restricted Cash (Current): $50,000
• Restricted Cash (Non-Current): $200,000

Companies must explain the nature, purpose, and terms of restricted cash in the financial statement notes. This ensures stakeholders understand its role and impact on liquidity.

Restricted cash arises in various situations, each tied to specific obligations. Here are some typical scenarios:

• Debt Agreements and Covenants: Lenders may require borrowers to maintain restricted cash accounts as collateral. These accounts act as a safety net, ensuring that companies meet repayment terms. 
• Legal and Regulatory Compliance: In certain industries, companies must set aside funds for environmental cleanup, legal settlements, or compliance with government mandates. For instance, mining firms may hold restricted cash for land restoration after completing operations.
• Lease Agreements: Landlords or lessors often require businesses to deposit restricted cash as a security measure. These funds may cover damages or unpaid rent and are typically released at the end of the lease term.
• Customer Deposits and Advance Payments: Companies that collect customer deposits for products or services may record these funds as restricted cash until the order is fulfilled. For example, an airline accepting advance bookings might classify ticket revenues as restricted cash until the flights occur.
• Capital Projects and Investments: Restricted cash can fund large-scale investments such as infrastructure projects or acquisitions. Businesses may set aside these funds to ensure the availability of resources when required.

Under generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), companies must disclose restricted cash clearly. Failing to do so can mislead investors and distort financial statements.

Once restrictions are lifted—for example, after fulfilling a contractual obligation—the funds can be reclassified as unrestricted cash, making them available for operational use.

Restricted cash can influence financial metrics like the current ratio and cash flow analysis, as it reduces the liquidity available for immediate expenses.

• Current Ratio: The inclusion of restricted cash in current assets can overstate a company’s short-term liquidity, especially if the funds are unavailable for immediate needs.
• Cash Flow Analysis: Cash flow statements must distinguish restricted cash from unrestricted cash to provide an accurate picture of liquidity.
• Debt-to-Equity Ratio: By affecting available cash, restricted funds may indirectly impact a company’s ability to manage debt.

InvestingPro offers detailed insights into companies’ Restricted Cash including sector benchmarks and competitor analysis.

Yes, restricted cash is included in cash flow statements, but it is typically disclosed separately. Its classification depends on whether it pertains to operating, investing, or financing activities.

Restricted cash is tied to specific obligations, while reserve accounts are discretionary funds set aside by management for unforeseen events or future needs.

Yes, as it limits the funds available for immediate operational use, restricted cash can reduce a company’s liquidity despite being part of its total cash balance.

Misreporting restricted cash can lead to regulatory penalties, loss of investor trust, and legal consequences, as it undermines financial transparency.

Yes, industries like banking, real estate, and manufacturing often deal with restricted cash due to the nature of their contractual and regulatory obligations.