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What Is A Cash Account?
What Is A Cash Account?
In accounting, a cash account, or cash book, may refer to a ledger in which all
cash transactions are recorded. The cash account includes both the cash
receipts journal and the cash payment journal.
KEY TAKEAWAYS
For example, an investor who has no cash in an account may decide on Monday
to make a stock purchase worth $10,000. To pay for this, the investor sells other
stock shares on Tuesday worth $10,000. This would be a violation because the
purchase will settle two days later, on Wednesday, before the sale settled on
Thursday. There would be no cash available in the account to cover the trade.
This is known as a "cash liquidation violation."
An active investor with a cash account and zero cash available must also not buy
security and then quickly sell it before a previous sale has settled to provide the
necessary cash. This is known as a "good faith violation."
Cash account investors with zero or near-zero cash available must also avoid
trying to pay for the purchase of a security with the sale of the same security. For
example, an investor might purchase $1,000 worth of a stock on a Monday but
fail to have enough cash to pay for it within two days. To pay for it, the investor
might then sell the same stock on Thursday, the day after the purchase was to
be settled. This is known as a "free-riding violation."
Margin accounts must maintain a certain margin ratio at all times. If the account
value falls below this limit, the client is issued a margin call. This is a demand to
bring the account value back within the limits. The client can add new cash to the
account or sell some holdings to raise the cash.
For example, an investor with a margin account may take a short position in XYZ
stock, believing the price is likely to fall. If the price does indeed fall, the investor
can cover the short position by taking a long position in XYZ stock. The investor
thus earns a profit on the difference between the amount received with the initial
short sale transaction and the amount paid to buy the shares at the lower price,
minus the margin interest charges.
With a cash account, the same investor would have to find other strategies
to hedge or produce income on the account. For example, the investor might
enter a stop order to sell XYZ stock if it drops below a certain price. That limits
the downside risk.