Cash Ratio (also called Cash Asset Ratio) is the ratio of a company's cash and cash equivalent assets to its total liabilities. Cash ratio indicates the extent to which available funds can pay off current liabilities.
Cash Ratio (also called Cash Asset Ratio) is the ratio of a company's cash and cash equivalent assets to its total liabilities. Cash ratio is a refinement of quick ratio and indicates the extent to which readily available funds can pay off current liabilities. Potential creditors use this ratio as a measure of a company's liquidity and how easily it can service debt and cover short-term liabilities.
Cash Ratio Formula
Cash ratio is calculated by dividing absolute liquid assets by current liabilities. Both figures are provided on the company balance sheet.
Most companies list cash and cash equivalents together on their balance sheet, but some companies list them separately. Cash equivalents are investments and other assets that can be converted into cash within 90 days. Current liabilities are always shown separately from long-term liabilities on the face of the balance sheet.
Cash Ratio Interpretation
Cash ratio is the most stringent and conservative of the three liquidity ratios (current, quick and cash ratio). It only looks at the company's most liquid short-term assets – cash and cash equivalents – which can be most easily used to pay off current obligations.
The cash ratio shows how well a company can pay off its current liabilities with only cash and cash equivalents. This ratio shows cash and equivalents as a percentage of current liabilities.
A ratio of one means that the company has the same amount of cash and equivalents as it has current debt. In other words, in order to pay off its current debt, the company would have to use all of its cash and equivalents. A ratio above 1 means that all the current liabilities can be paid with cash and equivalents. A ratio below 1 means that the company needs more than just its cash reserves to pay off its current debt.
Cash ratio is not as popular in financial analysis as current or quick ratios, its usefulness is limited. There is no common norm for cash ratio. In some countries a cash ratio of not less than 0.2 is considered as acceptable. But ratios that are too high may show poor asset utilization for a company holding large amounts of cash on its balance sheet.
This is why many creditors look at the cash ratio. They want to see if a company maintains adequate cash balances to pay off all of their current debts as they come due. Creditors also like the fact that inventory and accounts receivable are left out of the equation because both of these accounts are not guaranteed to be available for debt servicing. Inventory could take months or years to sell and receivables could take weeks to collect. Cash is guaranteed to be available for creditors.