Definition
The cash ratio is a measure of liquidity. The calculation only requires three inputs from the balance sheet: cash, marketable securities, and current liabilities. The cash ratio is one of several measures used by investors to understand a company's ability to pay debt coming due in the next 12 months.
Calculation
Cash Ratio = (Cash + Marketable Securities) / Current Liabilities
Explanation
The cash ratio is the most restrictive of the three liquidity ratios that utilize the balance sheet. The current ratio includes all current assets, while the quick ratio removes inventories and prepaid expenses. The cash ratio goes one step further by removing accounts receivable from current assets. In doing so, this measure only considers current assets that are in complete control of the company.
Marketable securities can be quickly turned into cash. As this ratio approaches 1.0, the company no longer has to worry about collecting money from customers (accounts receivable) to meet its short term debt obligations.
While some sources will state creditors would like a cash ratio of 0.5 or greater, others state the value should be closer to 1.0. As is the case with the other liquidity metrics, a ratio that is too high can indicate the inefficient use of capital resources. When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Company A's balance sheet indicates cash and cash equivalents of $2,219,000 and short term investments of $1,461,000. Total current liabilities are $5,441,000. The cash ratio for Company A would then be:
= ($2,219,000 + $1,461,000) / $5,441,000 = $3,680,000 / $5,441,000, or 0.68
Related Terms
The current ratio is a measure of liquidity. The calculation only requires two inputs from the balance sheet: current assets and current liabilities. The current ratio measures a company's ability to pay debt coming due in the next 12 months.
Moneyzine EditorJanuary 12th, 2024- Also known as the acid test, the quick ratio is a measure of liquidity, which is the ability of a company to pay its short term debt obligations using a subset of current assets known as quick assets. The calculation of the quick ratio requires information found on a company's balance sheet.Moneyzine EditorSeptember 21st, 2023
A financial metric that is used to measure a company's ability to repay its short term debt obligations is called a liquidity ratio. The three most common liquidity ratios include the current, quick, and the cash ratio.Moneyzine EditorJanuary 23rd, 2024- The debt ratio is a simple indicator of the leverage used by a company. The debt ratio measures the proportion of the total assets that are financed by debt, and not by stockholders.Moneyzine EditorSeptember 19th, 2023
- The financial accounting term prepaid expense refers to the portion of an advance payment that has not been used up at the end of an accounting period. Prepaid expenses are an asset and appear on a company's balance sheet.Moneyzine EditorSeptember 21st, 2023
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The term liquidity is used to describe the relative time it takes until an asset is converted into cash, or the payment of a liability is due. Liquidity is a comparative term, meaning it may be easier to convert one asset into cash than another.Moneyzine EditorJanuary 23rd, 2024
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