In financial ratio analysis, cash ratio is a conservative measure of a firm's liquidity. It is more conservative compared to the current ratio and quick ratio since only cash and marketable securities are compared with current liabilities.
Cash ratio is computed using the following formula:
Cash ratio = (Cash and cash equivalents + Marketable securities) ÷ Current liabilities
The current ratio measures liquidity by comparing all current assets with current liabilities.
The quick ratio is more conservative in that it measures liquidity using quick assets (cash and cash equivalents, marketable securities, and short-term receivables).
Cash ratio is an even more conservative ratio since it considers cash and marketable securities only.
RST Company had the following figures extracted from its balance sheet.
| Current assets: | ||
| Cash and cash equivalents | $ 110,000 | |
| Marketable securities | 180,000 | |
| Trade and other receivables | 220,000 | |
| Inventories | 450,000 | |
| Prepayments | 90,000 | |
| Total current assets | $ 1,050,000 | |
| Non-current assets: | ||
| Long-term investments | $ 400,000 | |
| Fixed assets | 1,300,000 | |
| Total current assets | $ 1,700,000 | |
| TOTAL ASSETS | $ 2,750,000 | |
| Current liabilities | $ 460,000 |
| Non-current liabilities | 1,000,000 |
| Stockholders' equity | 1,290,000 |
| TOTAL LIABILITIES & EQUITY | $ 2,750,000 |
| Computation of cash ratio: | ||
| Cash ratio | = | (C&CE + MS) ÷ CL |
| = | ($110,000 + $180,000) ÷ $460,000 | |
| Cash ratio | = | 0.63 |
If the company has enough cash & cash equivalents and marketable securities to cover for current liabilities, the cash ratio will result in an amount greater than 1; otherwise, less than 1.
In the above example, the total cash & cash equivalents and marketable securities of RST Company is not enough to cover for all current liabilities. For every dollar of current liability, the company only has $0.63 of cash and marketable securities to pay for it. Nonetheless, the company has other current assets that it can liquidate to be able to settle its current obligations.
Just like any other ratio, the cash ratio should be compared with relevant benchmarks such as industry standards and/or performance in prior years. A very low cash ratio indicates that the company is not keeping enough cash to fund its operations. However, a very high cash ratio might mean that too much cash is left idle.
The cash ratio is a conservative way to measure liquidity.
Cash ratio is equal to cash and marketable securities divided by total current liabilities.
A high cash ratio implies that the company has a lot of cash available to pay maturing liabilities. However, a very high ratio could also mean that too much cash is left idle or unproductive.
