By Richard Loth (Contact | Biography)
The cash ratio is an indicator of a company's liquidity that further refines both the current ratio and the quick ratio by measuring the amount of cash, cash equivalents or invested funds there are in current assets to cover current liabilities.
As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings' cash assets amounted to $233.20 (balance sheet); while current liabilities amounted to $606.90 (balance sheet). By dividing, the equation gives us a cash ratio of 0.4
The cash ratio is the most stringent and conservative of the three short-term liquidity ratios (current, quick and cash). It only looks at the most liquid short-term assets of the company, which are those that can be most easily used to pay off current obligations. It also ignores inventory and receivables, as there are no assurances that these two accounts can be converted to cash in a timely matter to meet current liabilities.
Very few companies will have enough cash and cash equivalents to fully cover current liabilities, which isn't necessarily a bad thing, so don't focus on this ratio being above 1:1.
The cash ratio is seldom used in financial reporting or by analysts in the fundamental analysis of a company. It is not realistic for a company to purposefully maintain high levels of cash assets to cover current liabilities. The reason being that it's often seen as poor asset utilization for a company to hold large amounts of cash on its balance sheet, as this money could be returned to shareholders or used elsewhere to generate higher returns. While providing an interesting liquidity perspective, the usefulness of this ratio is limited.
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