Cash Ratio

Intermediate

The cash ratio is cash and cash equivalents, sometimes including short-term investments, divided by current liabilities. It is the most conservative measure of a company's ability to meet short-term obligations.

The cash ratio asks a strict question: if the company had to pay all its short-term obligations right now, using only cash and near-cash assets, could it do so? It ignores receivables and inventory, which take time to convert into cash.

For example, a company with cash and cash equivalents of 120,000 and current liabilities of 250,000 has a cash ratio of 0.48. It could pay about half its short-term obligations immediately from cash.

Few healthy companies have a cash ratio above 1, because holding that much cash is usually inefficient. Cash earns little return, and most businesses can rely on collecting receivables and selling inventory to meet bills as they fall due.

The cash ratio is most useful in times of stress, for example when assessing whether a company could survive a sudden drop in sales or a freeze in credit markets. Lenders and credit analysts sometimes focus on it for companies in difficulty.

Comparing the cash ratio with the current and quick ratios shows how much of a company's liquidity depends on cash, receivables and inventory respectively.

For worked examples and full lessons, visit notesbysara.org.