Cash equivalents and retained earnings are very different financial terms. Cash equivalents refers to a class of investments that give investors an opportunity to earn interest on their principal. Retained earnings defines a portion of a company's net earnings that the company keeps for targeted expenses.
Cash equivalents are also known as cash investments. They are short-term investments that encompass four investment tools, including certificates of deposit (CDs), U.S. Treasury bills, money market accounts and money market mutual funds. In each case, you receive either compound or simple interest on the principal in your investment, while receiving periodic payments.
Retained earnings represent a percentage of a company's net earnings that it does not distribute to investors in the form of dividends. Instead, companies use retained earnings to fund debt payments or to fund an area of their business either in need of investment or primed for new opportunities.
Cash equivalents are a safe investment, and CDs, U.S. Treasury bills and bank money market accounts each are either federally insured or backed by the federal government. You receive the benefit of those interest payments, and your investment is easily converted to cash. On the other hand, the interest rates on cash equivalents are relatively low, especially compared to some other investment choices.
Retained Earnings Considerations
A major benefit for companies using retained earnings is that it gives them a pool of funds that they can use to pursue growth opportunities. The company can use retained earnings to finance projects without the involvement of either shareholders or others. Costs related to issuing new shares, which might be needed to raise equity for the projects, are avoided. Businesses are expected to keep retained earnings in check, however, keeping dividend payments equivalent to their profits.