Why Cash is High-Risk
There are many reasons why cash is usually considered a high-risk asset. One important reason is probably due to cash is an essential asset where it usually has more transactions comparing to any other asset in the company. Other reasons may include its transferability, liquidity, covenant issue, and theft.
In general, the company with many cash transactions is usually considered risky. This is due to cash is an asset that may be misstated due to many reasons, such as unauthorized use, posting in the wrong account and wrong accounting period.
Also, cash is the asset that is most prone to theft comparing to the other assets on the balance sheet. As a result, cash may be manipulated or stolen by the personnel that has high authority over cash account.
Below are the five reasons why cash is high-risk comparing to other assets:
| Why Cash is High-Risk | |
|---|---|
| Volume of Activity | In general, the cash transactions during the accounting period are usually big comparing to other accounts in the company. This due to the cash transactions themselves come from many forms of the business activities, including cash received from sales, cash received from receivables settlement, cash payment for expenses, cash payment for inventory, cash paid for payables settlement, and cash paid for debt settlement and interest.
As a result, the big volume of transactions involving cash that flow through the account during the accounting period makes it more susceptible to error than other accounts in the financial statements. This may be the most important reason why cash is high-risk as this reason alone may lead to other risks occurred to other reasons below. |
| Transferability | Cash is the asset that can be easily transferred between branches or countries. The ease of cash transfer can make it more prone to fraud or illegal activity such as money laundering. Without proper authorization control on the cash transfers, including the transfer in electronic form, can lead to the misstatement of cash due to fraud, either by an individual or a group of staff in the company.
In the case of money laundering, the transferring of cash from one bank to another is an example of trying to create the complicated transactions and cover up the trace so that auditors find it difficult to find out the truth of such transactions. It is called layering, the second stage of money laundering. |
| Liquidity | Cash is the most liquid asset in the company’s balance sheet. As a result, cash may be the most susceptible to fraud comparing the other assets in the company.
In this case, cash can be easily transferred from one place to another comparing to other assets like machinery. This is probably the unique reason why cash is high-risk comparing to are other assets in the company. |
| Debt Covenant | In general, cash is usually tied to the debt covenants which lenders place on the company as their protection. They usually do this to ensure that they have a high chance of receiving their money back from the company.
The debt covenants here may including the requirement that the company needs to maintain a certain level of cash in comparing to the total assets or to maintain minimum levels of working capital etc. As a result, management may manipulate cash account to have a certain level of cash presented on financial statements in order to meet the debt covenants. |
| Theft | Cash is considered an asset that is most prone to theft, either from internal or external people. The high risk of cash here is that it may be manipulated and stolen by the staff with high authority.
Without proper cash controls in place, the client’s staff temptation to steal cash may be high, especially if they are facing a personal financial problem. |