Become a Financial Modeling & Valuation Analyst (FMVA)®. Enroll today to advance your career!
Login to your new FMVA dashboard today!

Cash Ratio

A liquidity ratio that measures a company’s ability to pay off short-term liabilities with highly liquid assets

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 the current ratio and 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.

 

Cash Ratio

 

Formula for the Cash Ratio

The formula for calculating the cash ratio is as follows:

 

Cash Ratio Formula

 

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 of Cash Ratio

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 cash ratio for Company A would be calculated as follows:

 

Cash Ratio Example

 

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.

 

Cash Ratio Template Screenshot

 

Download the Free Template

Enter your name and email in the form below and download the free cash 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 the 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 the 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, this is the most 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 analysis of a company, as it is unrealistic for companies to hold large amounts of cash.

 

Related Readings

Thank you for reading CFI’s explanation of the cash ratio. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career in finance, the following resources will be helpful:

  • Acid-Test Ratio
  • Analysis of Financial Statements
  • Financial Analysis Ratios Glossary
  • Guide to Financial Modeling

Financial Analyst Training

Get world-class financial training with CFI’s online certified financial analyst training program!

Gain the confidence you need to move up the ladder in a high powered corporate finance career path.

 

Learn financial modeling and valuation in Excel the easy way, with step-by-step training.