What is the cash ratio?
– Definition: The cash ratio is a conservative liquidity measure that shows how much of a company’s short-term obligations (current liabilities) could be paid immediately using only its most liquid assets: cash and cash equivalents. Cash equivalents are short-term investments that can be converted to cash quickly and without material loss in value (for example, marketable securities or Treasury bills).
Cash ratio formula
– Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities
– The result is a pure number (no units). A ratio of 1.0 means the firm has exactly enough cash and equivalents to cover its current liabilities right now.
Why the cash ratio matters
– It measures the firm’s ability to meet short-term obligations without selling inventory, collecting receivables, or raising external funds.
– Because it excludes accounts receivable and inventory, it gives a stricter (more conservative) view of liquidity than broader ratios such as the current ratio or quick (acid-test) ratio.
– Lenders and internal managers can use it to gauge short-term solvency under stressed conditions.
Step-by-step: how to calculate the cash ratio
1. From the balance sheet, record “cash and cash equivalents.” Include cash on hand, demand deposits, and short-term marketable instruments that qualify as equivalents.
2. Record “current liabilities.” This includes accounts payable, short-term debt, and other obligations due within 12 months.
3. Plug into the formula: (Cash + Cash Equivalents) ÷ Current Liabilities.
4. Interpret the number relative to industry norms and the company’s operating cycle.
Quick checklist before you compute
– Use period-end numbers from the balance sheet (same reporting date for both numerator and denominator).
– Confirm which items the company classifies as cash equivalents (some firms disclose components in notes).
– Compare the ratio to industry peers and historical values for the same company.
– Consider seasonality and timing of major cash inflows or outflows that might distort a single-period snapshot.
How to interpret common ranges
– Greater than 1.0: The company has more cash and equivalents than current liabilities and could, in theory, pay all near-term obligations immediately. This is conservative but may indicate underused cash.
– Around 0.5–1.0: Often viewed as acceptable for many industries; implies some cushion but not excessive idle cash.
– Below 0.5: Could signal riskier liquidity posture—short-term liabilities are at least twice as large as cash and equivalents—but contextual factors (fast collections, low receivables, supplier credit) may justify it.
– “Good” depends on industry: capital-intensive or cyclical businesses often carry different typical ratios than service firms or financial companies.
Limitations and caveats
– Snapshot only: balance-sheet figures represent one date and may not reflect cash flow timing or seasonality.
– Ignores receivables and inventory: firms that rapidly convert receivables or turn inventory may be safer than the cash ratio suggests.
– Industry differences: acceptable levels vary widely across sectors and business models.
– Does not measure profitability or long-term solvency; it’s one tool among many for liquidity analysis.
Worked numeric example (illustrative)
– Suppose a company reports:
– Cash = $30.2 billion
– Marketable securities (cash equivalents) = $23.5 billion
– Total current liabilities = $123.0 billion
– Compute numerator: 30.2 + 23.5 = $53.7 billion
– Cash Ratio = 53.7 / 123.0 ≈ 0.44
– Interpretation: The firm has roughly $0.44 of cash and equivalents for every $1.00 of current liabilities. It cannot pay all short-term obligations using only cash and equivalents; the company likely relies on supplier credit, receivables collections, or other financing to meet obligations.
When to use the cash ratio
– As a conservative check on short-term liquidity under stress scenarios.
– To compare liquidity across firms in the same industry.
– When assessing the portion of liquidity that is immediately available without conversion risk.
Summary checklist for analysis
– Confirm period-end figures and classification of cash equivalents.
– Calculate (Cash + Cash Equivalents) ÷ Current Liabilities.
– Compare to industry averages and the company’s trend.
– Assess seasonality, receivables turnover, and access to short-term financing.
– Use together with current ratio, quick ratio, and cash-flow metrics for a fuller picture.
Sources for further reading
– Investopedia — Cash Ratio: https://www.investopedia.com/terms/c/cash-ratio.asp
– Corporate Finance Institute (CFI) — Cash Ratio: https://corporatefinanceinstitute.com/resources/knowledge/finance/cash-ratio/
– U.S. Small Business Administration (SBA): general guidance on financial statements and ratios: https://www.sba.gov
Educational disclaimer
This explainer is for educational purposes only and does not constitute individualized financial, investment, or legal advice. Always confirm figures from official financial statements and consult a qualified professional before making decisions.