Cash Ratio Calculator | Measure the Liquidity of Companies

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What Is the Cash Ratio?

The cash ratio is a metric for determining a firm’s liquidity. It analyses the amount of total cash and cash equivalents a company has compared to its current liabilities. The indicator assesses a company’s ability to repay short-term debt using cash or near-cash resources such easily marketable securities. Creditors can use this information to determine how much money, if any, they are willing to lend a company.

Cash Ratio Formula

Compared to other liquidity ratios, the cash ratio is a more cautious assessment of a company’s capacity to cover its debts and commitments since it only considers cash or cash-equivalent holdings, excluding other assets such as accounts receivable.

The cash ratio of a corporation is calculated using the following formula:

Cash Ratio: Cash + Cash Equivalents / Current Liabilities

What Cash Ratio Can Tell You

The cash ratio is the most widely used metric for determining a company’s liquidity. This indicator indicates the company’s ability to pay all current creditors without selling or liquidating additional assets if it is obliged to do so.

A cash ratio is a number that is larger or less than one. If the outcome of the ratio calculation is 1, the corporation has exactly the same amount of current liabilities as cash and cash equivalents to pay down those debts.

The cash ratio is similar to an indicator of a company’s value in the worst-case situation, such as when it is about to go out of business. It informs creditors and analysts of the value of current assets that can be converted into cash fast, as well as the percentage of current liabilities that these cash and near-cash assets can cover.

The US Small Business Administration advises businesses on maintaining healthy levels of liquidity, capacity, and collateral by using this and other liquidity ratios, especially when forming connections with lenders.

Lenders will examine financial statements in order to assess a company’s health when it applies for a loan.

Less Than 1 Calculations

There are more current obligations than cash and cash equivalents if a company’s cash ratio is less than one. It suggests there isn’t enough cash on hand to pay off short-term debt. This may not be a negative thing if the company’s balance sheets are skewed by factors like long credit terms with suppliers, well-managed inventory, and limited credit offered to customers.

More than 1 calculation

When a company’s cash ratio exceeds one, it means it has more cash and cash equivalents than current obligations. In this case, the corporation has enough cash to pay down all short-term debt while still having cash on hand.

While a larger cash ratio is generally desirable, it could also indicate that the company is inefficiently using cash or not taking advantage of low-cost borrowing opportunities. Rather than putting money into productive ventures or expanding the company. A high cash ratio could also indicate that a corporation is concerned about future profitability and is building up a capital cushion to safeguard itself.

Cash Ratio Example

Apple, Inc. had $37.1 billion in cash and $26.8 billion in marketable securities at the end of 2021. Apple has a total of $63.9 billion in cash on hand to pay off short-term debt right away. Apple was responsible for around $123.5 billion in short-term debt, including accounts payable and other current liabilities. 2

Short-Term Ratio = $63.9 million divided by $123.5 billion is 0.52.

Apple’s operating structure demonstrates how the corporation uses debt to grow, takes advantage of attractive credit conditions, and prioritizes funds for expansion. Despite having billions in cash on hand, the corporation has roughly twice as many short-term obligations as it has long-term obligations.

The Cash Ratio’s Limitations

The cash ratio is rarely employed in financial reporting or by analysts when doing a company’s fundamental analysis. A company’s ability to cover current liabilities with excessive cash and near-cash assets is unrealistic. Large quantities of cash on a company’s balance sheet are sometimes viewed as poor asset utilisation, as this money may be returned to shareholders or employed elsewhere to generate higher returns.

When compared to industry and competitor averages, or when looking at changes in the same company over time, the cash ratio is more informative. Certain industries have higher current obligations and lesser cash reserves than others.

The cash ratio is most useful when viewed over time; a company’s measure may be low right now but has been improving in the right direction over the last year. The statistic also ignores seasonality and the timing of major future cash inflows, which could lead to an overestimation of a company during a single successful month or an underestimation during the offseason.

A cash ratio of less than one might sometimes suggest that a corporation is in financial trouble. A low cash ratio, on the other hand, could be an indicator of a company’s specific strategy, which calls for keeping cash reserves low—for example, because funds are being used for expansion.

What Is an Appropriate Cash Ratio?

Because some industries rely more heavily on short-term loans and financing, the cash ratio will vary by industry (i.e. sectors that rely on quick inventory turnover). A cash ratio of 1 or above implies that a corporation has adequate cash and cash equivalents to pay down all short-term debts in full.

A ratio of greater than one is generally preferred, however, a ratio of less than 0.5 is deemed problematic because the firm has twice as much short-term debt as cash.

What Does the Cash Ratio Indicate?

One technique to assess a company’s liquidity is to use the cash ratio. Liquidity refers to a person’s or a company’s capacity to pay current obligations. When a corporation has a lot of cash on hand, it can pay its short-term bills when they come due. When a company’s liquidity is low, it will have a harder time paying short-term bills.

How Do You Work Out Your Cash Ratio?

Cash is divided by current liabilities to arrive at the cash ratio. Cash equivalents, such as marketable securities, are included in the cash element of the computation.

Is a High Cash Ratio or a Low Cash Ratio Better?

Having a high cash ratio is often preferable. This indicates that a corporation has more cash on hand, fewer short-term liabilities, or both. It also implies that a business will be better able to pay off present debts as they become due.

It’s possible that a company’s cash ratio is excessively high. A company’s cash management may be inefficient, and it may take advantage of inexpensive credit conditions. In some situations, lowering a company’s cash ratio may be favorable.

What Can a Company Do to Improve Its Cash Ratio?

Cash and cash equivalents are divided by short-term liabilities to calculate the cash ratio. A corporation can enhance its cash ratio by aiming to have more cash on hand in case of a short-term liquidation or payment demand. Turning through inventory more quickly, storing less inventory, and not prepaying expenses are all examples of this.

A corporation can, on the other hand, lower its short-term obligations. If credit terms are no longer beneficial, the corporation might begin paying expenses with cash. The business can also assess its spending and work to lower its overall costs (thereby reducing payment obligations).