Question

What is the cash ratio? How do you calculate it and why is the cash ratio useful?

Answer 1

• Cash ratio is a measurement of a company's short-term liquidity. It indicates the company's ability to pay off its short-term debt obligations with cash and cash equivalents.
• It is more conservative than the current ratio. Current ratio considers all current assets whereas the cash ratio considers only cash & cash equivalents.
• Calculation: Cash ratio = (Cash & cash equivalents) ÷ (Current liabilities)
  • Cash and cash equivalents are the most liquid assets. It includes cash in hand, demand deposits with banks, and marketable securities.
  • Current liabilities are those liabilities that are due within one year or the operating cycle of the company, whichever is longer. E.g. accounts payable, accrued liabilities, short-term borrowings, etc.
• Cash ratio helps to analyze the company's ability to pay off all current liabilities without selling or liquidating other current assets such as inventory, accounts receivable, etc.