What is Traded vs. Settled Cash?

Before we jump into the definitions of traded and settled cash, let me level set on what this is in reference to.
Typically, investment companies will have large complex accounting systems to calculate how much your investments are worth.  Behind the scenes, in this fancy accounting engine, you will actually have two cash balances. That’s right, two:
1) Traded cash – your cash balance based on the trade date of any transactions you made
2) Settled cash – your cash balance based on the settlement date of any transactions you made
Don’t understand what any of this means?  Don’t worry, I will explain with a simple example.
Example
You have $100 in your account and you decide to buy $80 worth of stock.
You buy, or “trade,” the stock on Tuesday.  Even though you buy it on Tuesday, the stock won’t actually physically move into your account until two days later. (Note: the amount of time it takes to settle will depend on the market, 2 days is just one example)  Also, the cash you used to purchase that stock won’t actually leave your account until the same day, Thursday.  Thursday in this example is called “settlement date.”
Think of this in simpler terms – look at transactions in your bank account.  Let’s say you write a check to someone on Tuesday and they deposit it into their bank account. What happens in your bank account?  Well, that cash won’t actually leave your account until it is processed on both sides.  When the cash moves a few days later, this is similar to what is called “settlement” in the investment industry.
So, back to our example.  I have created a grid for those who are more visual.
·         On Monday, before the trade, the balances will be the same, $100.
·         On Tuesday, the date of the trade, trade date cash goes to $20 (which is $100 you started with – $80 that you owe for the stock).  Settlement date cash is $100.
·         On Thursday, trade date cash is still $20, settled cash drops from $100 to $20 to reflect the fact that the cash moved

I’ve Heard People Mention Payables and Receivables Before.  What Do These Mean?

I’m glad you asked.  Payables and Receivables are fancy accounting terms used to keep track of the differences between trade and settlement date above.
·         Payables: you owe someone else cash. In the example above, we owed someone $80 in cash from the time we bought the stock (Trade Date) until we actually paid the cash (Settlement Date).
·         Receivables: cash that is owed to you by someone else.  If we had sold stock instead of bought it, then we would have been owed money and had a receivable.

Can You Show Me An Example of Traded and Settled Cash with Payables and Receivables?

Sure!  You start with $1,000, $800 is in stock and $200 is in cash.  On Tuesday, you sell stock worth $500 and you buy stock worth $400.

 

·         On Monday, before the trade, the balances will be the same, $200.
·         On Tuesday, the date of the trade, settlement date cash is still $200.  Since you sold stock worth $500 you are owed $500, which means you have a receivable of $500.  Since you bought stock worth $400, you also have a payable of $400.
Your Traded Cash = Settled Cash + Receivables – Payables
Traded Cash = $200 + $500 – $400 = $300
·         On Thursday, trade date cash is still $300, settled cash goes up from $200 to $300 to reflect the fact that the cash moved

 

 

Which is Correct – Cash Based on Settlement Date or Cash Based on Trade Date?

Well, neither one is always “more correct.”  It will depend on what you are trying to determine.
This website is dedicated to measuring returns on investments.  When measuring returns, the more appropriate balances to use are “traded cash,” or cash balances based on trade date.  Why?
Well, simply put, even though the stock and cash don’t move until Wednesday (settle date), you technically own the stock and owe the money to pay for that stock on Monday (trade date).  This is called the “economic ownership” if you want to sound fancy.  You own that stock because you will get any gains or losses from the stock price changes after the trade on Monday.
This is why performance systems typically use trade date cash.

 

Is There Any Industry Guidance on Traded vs Settled Cash?

Yes, there is.  The GIPS standards have posted the below Q&A on this topic.
What does “trade-date accounting” mean?
The GIPS standards require that “for periods beginning on or after 1 January 2005, firms must use trade-date accounting.” Trade-date accounting determines the correct economic value of the portfolio assets as of the transaction date by recognizing the asset or liability on the date of the purchase or sale and not on the settlement date. Recognizing the asset or liability within three days of the date the transaction was entered into (trade date, T+1, T+2, or T+3) satisfies the trade-date accounting requirement for the purposes of the GIPS standards. Firms must not use settlement-date accounting for periods beginning on or after 1 January 2005.
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