A liquidity ratio that measures a company’s ability to pay off short-term liabilities with highly liquid assets
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
What is Cash Ratio?
The cash ratio, sometimes referred to as the cash asset ratio, is a liquidity metric that indicates a company’s capacity to pay off short-term debt obligations with its cash and cash equivalents. Compared to other liquidity ratios such as thecurrent ratioand quick ratio, the cash ratio is a stricter, more conservative measure because only cash and cash equivalents – a company’s most liquid assets – are used in the calculation.
Formula
The formula for calculating the cash ratio is as follows:
Where:
- Cash includes legal tender (coins and currency) and demand deposits (checks, checking account, bank drafts, etc.).
- Cash equivalents are assets that can be converted into cash quickly. Cash equivalents are readily convertible and subject to insignificant risk. Examples include savings accounts, T-bills, and money market instruments.
- Current liabilities are obligations due within one year. Examples include short-term debt, accounts payable, and accrued liabilities.
Example
Company A’s balance sheet lists the following items:
- Cash: $10,000
- Cash equivalents: $20,000
- Accounts receivable: $5,000
- Inventory: $30,000
- Property & equipment: $50,000
- Accounts payable: $12,000
- Short-term debt: $10,000
- Long-term debt: $20,000
The ratio for Company A would be calculated as follows:
The figure above indicates that Company A possesses enough cash and cash equivalents to pay off 136% of its current liabilities. Company A is highly liquid and can easily fund its debt.
Download the Free Template
Enter your name and email in the form below and download the free ratio template now!
Cash Ratio Template
Download the free Excel template now to advance your finance knowledge!
Interpretation of the Cash Ratio
The cash ratio indicates to creditors, analysts, and investors the percentage of a company’s current liabilities that cash and cash equivalents will cover. A ratio above 1 means that a company will be able to pay off its current liabilities with cash and cash equivalents, and have funds left over.
Creditors prefer a high cash ratio, as it indicates that a company can easily pay off its debt. Although there is no ideal figure, a ratio of not lower than 0.5 to 1 is usually preferred. The cash ratio figure provides the most conservative insight into a company’s liquidity since only cash and cash equivalents are taken into consideration.
It is important to realize that the cash ratio does not necessarily provide a good financial analysis of a company because businesses do not ordinarily keep cash and cash equivalents in the same amount as current liabilities. In fact, they are usually making poor use of their assets if they hold large amounts of cash on their balance sheet. When cash sits on the balance sheet, it is not generating a return. Therefore, excess cash is often re-invested for shareholders to realize higher returns.
Key Takeaways
- The cash ratio is a liquidity ratio that measures a company’s ability to pay off short-term liabilities with highly liquid assets.
- Compared to the current ratio and the quick ratio, it is a more conservative measure of a company’s liquidity position.
- There is no ideal figure, but a ratio of at least 0.5 to 1 is usually preferred.
- The cash ratio may not provide a good overall analysis of a company, as it is unrealistic for companies to hold large amounts of cash.
Related Readings
Thank you for reading CFI’s guide to Cash Ratio. To keep learning and advancing your career in finance, the following CFI resources will be helpful:
FAQs
A cash ratio equal to or greater than one generally indicates that a company has enough cash and cash equivalents to entirely pay off all short-term debts. A ratio above one is generally favored. A ratio under 0.5 is considered risky because the entity has twice as much short-term debt compared to cash.
What is considered a good cash ratio? ›
There is no ideal figure, but a cash ratio is considered good if it is between 0.5 and 1. For example, a company with $200,000 in cash and cash equivalents, and $150,000 in liabilities, will have a 1.33 cash ratio.
How do you comment on cash ratio? ›
A higher result means the company is more capable of paying off short-term liabilities with its short-term assets. A lower number, though, is preferable in some situations. A cash ratio over one means the company can easily cover its debts, but there may be more efficient uses for some cash on hand.
Is 0.2 cash ratio good? ›
A: If a cash ratio is 0.2, it means that a company likely has more current liabilities than it does cash or cash assets to pay them off. This can present a big problem for finance providers, who will be less likely to offer funding to a company that has more current liabilities to manage.
What if cash ratio is too high? ›
Higher Cash Ratios indicate less credit and liquidity risk, but if a company's ratio is too high, it could indicate mismanagement or misallocated capital. As with the other Liquidity Ratios, context is king for understanding the Cash Ratio.
What is a healthy debt to cash ratio? ›
By calculating the ratio between your income and your debts, you get your “debt ratio.” This is something the banks are very interested in. A debt ratio below 30% is excellent. Above 40% is critical.
What is a good price to cash ratio? ›
A good price-to-cash-flow ratio is any number below 10. Lower ratios show that a stock is undervalued when compared to its cash flows, meaning there is a better value in the stock.
How to analysis cash ratio? ›
The cash ratio is derived by adding a company's total reserves of cash and near-cash securities and dividing that sum by its total current liabilities. The cash ratio is more conservative than other liquidity ratios because it only considers a company's most liquid resources.
What is a good cash coverage ratio? ›
A ratio of 1 or higher is generally considered satisfactory, but higher ratios may be more favorable in certain industries or for companies with a higher risk profile. In the case of Company Z, the cash coverage ratio of 5.83 suggests strong financial stability and a low risk of default on its debt obligations.
What is a good cash to revenue ratio? ›
What is a good cash flow to sales ratio? A cash flow to sales ratio is considered good if it falls between 10% and 55%.
Global common size ratios express a number on a business' financial statement as a percentage of a denominating relevant number on the statement. Thus, all the percentages shown can be easily interpreted and compared to other line items in the financial statement.
What is a good operating cash ratio? ›
Generally, a ratio over 1 is considered to be desirable, while a ratio lower than that indicates strained financial standing of the firm.
What is a healthy cash conversion ratio? ›
In general, however, a CCR of 1 indicates that a business efficiently converts every dollar of net income to cash. A CCR above 1 means that you have high liquidity that you can then use to invest in business growth strategies like marketing, product development, or hiring.
What is an acceptable cash ratio? ›
There is no ideal figure, but a ratio of at least 0.5 to 1 is usually preferred. The cash ratio may not provide a good overall analysis of a company, as it is unrealistic for companies to hold large amounts of cash.
What is a healthy quick ratio for a company? ›
Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.
What is the difference between cash ratio and quick ratio? ›
The cash ratio looks at only the cash on hand divided by CL, while the quick ratio adds in cash equivalents (like money market holdings) as well as marketable securities and accounts receivable. The current ratio includes all current assets.
What is the ideal cash coverage ratio? ›
The higher your cash coverage ratio, the better the financial condition your business is in. But how do you know when you should be concerned? Any time that your cash coverage ratio drops below 2 can signal financial issues, while a drop below 1 means your business is in danger of defaulting on its debts.
What is the ideal cash flow ratio? ›
Operating Cash Flow Ratio Analysis
Generally, a ratio over 1 is considered to be desirable, while a ratio lower than that indicates strained financial standing of the firm.
What is the common size cash ratio? ›
With the cash flow statement, you can divide the statement into its three parts (financing activities, investing activities, and operating activities). Then compute the relevant common size ratio by dividing the line items by the net cash flow for the specific section of the statement.
