What Is a Cash Account? Definition and Use

What Is a Cash Account?

A cash account with a brokerage firm requires that all securities transactions be payable in full from funds in the account at the time of settlement. Short selling and buying on margin are prohibited in this type of account. The Federal Reserve’s Regulation T, also known as T+2, governs cash accounts and the purchase of securities on margin.

In accounting, a cash account, or cash book, refers to a ledger where all cash transactions are recorded. The cash account includes both the cash receipts journal and the cash payment journal.

Key Takeaways

• A cash account is a brokerage account that requires all transactions to be payable in full on the settlement date with available cash.
• When buying securities in a cash account, the investor must deposit enough cash to pay for the trade or sell other securities on the same trading day to have cash available for the buy order settlement.
• Cash accounts do not allow short selling or trading on margin like margin accounts.

Understanding Cash Accounts

Active traders must be careful not to violate regulations regarding cash accounts. They must ensure sufficient cash is available in their account and not attempt to pay for securities purchases by selling other securities after the purchase date.

For example, an investor with no cash in their account may decide on Monday to make a $10,000 stock purchase. They then sell other stock shares worth $10,000 on Tuesday to pay for it. This would be a violation because the purchase settles two days later, on Wednesday, before the sale settles on Thursday. There would be no available cash in the account to cover the trade, resulting in a "cash liquidation violation."

An active investor with zero available cash in a cash account must also avoid buying securities and quickly selling them before a previous sale has settled to generate the necessary cash. This is known as a "good faith violation."

Cash account investors with zero or near-zero available cash must also avoid trying to pay for a security purchase with the sale of the same security. For instance, an investor might buy $1,000 worth of a stock on a Monday but fail to have enough cash to pay for it within two days. To cover the purchase, the investor might sell the same stock on Thursday, the day after the purchase was supposed to settle. This is known as a "free-riding violation."

Cash Account vs. Margin Account

A margin account, unlike a cash account, allows an investor to borrow against their account assets’ value to purchase new positions or sell short. Margin enables investors to leverage their positions and profit from market moves, both bullish and bearish. It can also be used to make cash withdrawals as short-term loans against the account’s value.

For investors seeking leverage, a margin account can be cost-effective. However, when a margin balance (debit) is created, the outstanding balance incurs a daily interest rate charged by the firm. These rates are based on the current prime rate plus an additional charge by the lending firm, which can be quite high.

Margin accounts must maintain a certain margin ratio at all times. If the account value falls below this limit, the client receives a margin call, demanding to bring the account value back within the limits. The client can add new cash to the account or sell holdings to raise cash.

For example, an investor with a margin account may take a short position in XYZ stock, anticipating a price drop. If the price falls, the investor can cover the short position by taking a long position in XYZ stock, making a profit from the price difference minus the margin interest charges.

With a cash account, the same investor would need other strategies to hedge or generate income. For example, they might enter a stop order to sell XYZ stock if it drops below a certain price, limiting the downside risk.

With a cash account, the same investor would need other strategies to hedge or generate income. For example, they might enter a stop order to sell XYZ stock if it drops below a certain price, limiting the downside risk.