Cash Ratio

Cash Ratio

“For better or worse, cash is the oxygen of your business, and you can’t last long in any environment without it.”  – Neil Blumenthal

What is the cash ratio?

Measures a business’s ability to pay its current liabilities (due within one year) using cash and marketable securities without obtain external funding.

How is the cash ratio calculated?

Cash ratio = cash and marketable securities / current liabilities.  Marketable securities are financial instruments than can be converted to cash within twelve months; current liabilities included accounts payable, accrued wages, taxes payable or any other liabilities that are expected to come due within twelve months.  

What does the cash ratio mean to my business?  

The norms for analyzing the cash ratio are similar to the current ratio; however, it is the most conservative liquidity ratio since uses only cash and marketable securities (cash equivalent).  It is a liquidity measure that reflects a business’s ability to pay its current obligations immediately.

A cash ratio less than one means that the business does not have sufficient cash on hand to pay its short-term obligations (current liabilities).  A cash ratio equal to one means that the business has sufficient cash to pay its current liabilities.  When the ratio is greater than one, it means there is sufficient cash on hand to pay its short-term obligations and have funds left over.  The higher the ratio, the higher the amount left over.  

Negatives to the cash ratio: 
For a company that collects its accounts receivables and turns its inventory quickly, those components are excluded from the calculation of the quick ratio, meaning that the business’s ability to pay short-term obligations will be understated.