Cash Ratio

Reviewed by Bhavana | Updated on Sep 28, 2020

Meaning of Cash Ratio

The cash ratio is a measure of the liquidity of a firm, namely the ratio of the total assets and cash equivalents of a firm to its current liabilities. The metric calculates the ability of a company to repay its short-term debt with cash or near-cash resources, such as securities which are easily marketable. This information is useful when investors determine how much money they will be willing to loan a company if any.

In the worst-case scenario, the cash ratio is more like a measure of a firm's value — say, that the company is about to quit the business. It tells analysts and creditors the worth of current assets that could be converted quickly into cash, and what percentage of the current liabilities of a company could cover those cash and near-cash assets.

Understanding Cash Ratio in Detail

Compared to other liquidity ratios, the cash ratio is generally a more conservative look at a company's ability to cover its debts and obligations, because it sticks strictly to cash or cash-equivalent holdings—leaving other assets, including accounts receivable, out of the equation.

Importance of Cash Ratio

Most commonly, the cash ratio is used as a measure of the liquidity of a firm. This measure indicates the willingness of the company to do so without having to sell or liquidate other assets if the company is required to pay its current liabilities immediately.

A cash ratio is expressed as an amount, larger or smaller than 1. When the ratio is determined, if the outcome is equal to 1, the corporation has exactly the same sum of current liabilities as assets and cash equivalents are paying off those debts.

Cash Ratio Limitations

The cash ratio is seldom used in a company's fundamental analysis by financial statements or analysts. Maintaining unsustainable amounts of cash and close cash reserves to fund current liabilities is not practical for a firm.

A company holding large amounts of cash on its balance sheet is often seen as poor utilisation of assets since this money could be returned to shareholders or used elsewhere to generate higher returns. Although offering an interesting prospect for liquidity, the utility of this ratio is minimal.

The cash ratio is more useful when compared to market averages and competitor averages, or when looking at improvements over time within the same business. A cash ratio below one sometimes indicates a firm is at risk of financial difficulty. But a low liquidity ratio may also be an indication of a company's particular policy that allows for low cash reserves to be maintained because, for example, funds are being used for growth.

Related Terms

  • Gross Working Capital

    Gross working capital refers to the total current assets of a company.   Read more


  • Statutory Audit

    A statutory audit is a legally required check of the accuracy of the financial statements and records of a company or government.   Read more


  • Deferred Revenue

    Deferred revenue, also called unearned revenue, applies to advance payments obtained by a company for goods or services that are to be provided or performed in the future.   Read more


  • Operating Revenue

    Operating revenue refers to the revenue generated by a company from its primary activities.   Read more


  • Escalator Clause

    An escalator clause is also known as an escalation clause, where the provision allows for an automatic increase in the wages or prices.   Read more


  • Agency Problem

    The agency problem is a scenario of a conflict of interest which is inherent in all relations wherein one party is anticipated to operate in the best interests of another party.   Read more


Recent Terms

  • Amortisation

    Amortisation is an accounting strategy used to regularly reduce a loan's book value or an intangible asset's book value over a given period of time.   Read more


  • Rationalisation

    The reorganisation of a firm with the view of enhancing the efficiency of the operation is referred to as the rationalisation.   Read more


  • Profit Centre

    A profit centre refers to a branch, unit, or division of a company which directly adds or which normally adds to the bottom-line or profits of the company as a whole.   Read more


  • Authorised Share Capital

    Authorised share capital is the number of stock units (shares) that a company may issue, as set out in its association memorandum or incorporation papers.   Read more