Evaluating Compensating Balances | Financial Statement Analysis | Discussion Questions | Westcliff University
4–1. Companies typically report compensating balances that are required under a loan agreement as unrestricted cash classified within current assets.
a. For purposes of financial statement analysis, is this a useful classification? Explain.
b. Describe how you would evaluate compensating balances.
Yes, it is considered to be a useful classification for the purpose of financial statement analysis because it helps the organization in maintaining liquidity or we can say a certain level of cash on the balance sheet of the company than the required.
When the firm is in need of some support, these are the assets the firm can actually rely on (Griffin, 2017). Whenever there is the need for funds for the operating activities, the firm needs funds to keep the daily operations activities active and can fall on the unrestricted cash for it.
Compensating Balance is a demand deposit that is required by the commercial bank to keep on for the purpose or we can say condition for extending the loan of bank or the line of credit. This demand deposit depends upon the percentage of the loan outstanding of the subsidiary or individual/businesses.
With the help of this, the firms are able to extend the amount of loans and pursue the various opportunities regarding investment while the individual or business will usually see a lower interest rate. In case if there is a certain level of fall in the number of deposits then there is a maximum chance that the rate of interest on the loan might be increased which is for compensating the other types of risks.
Griffin, J. (2017, April 17). Restricted Cash and Compensating Balances. Retrieved from Money Zine: https://www.money-zine.com/definitions/investing-dictionary/restricted-cash-and-compensating-balances/