A:

The relationship between the cash ratio and liquidity is that the cash ratio is one of three liquidity ratios used to compare a company's most liquid assets to its total current liabilities.

The cash ratio is used to determine whether a company has the cash and cash equivalents on hand to meet all of its short-term debt obligations. It is the most conservative of the liquidity ratios and is, therefore, the best measure of true liquidity. Unlike the other two liquidity ratios that take into account current assets that aren't highly liquid, such as inventory, the cash ratio only uses its most liquid assets when determining a company's ability to pay all of its current liabilities.

The formula for the cash ratio is as follows:

Cash ratio = (cash + cash equivalents) / total current liabilities

A cash ratio of 1 means that a company has the exact amount of cash on hand to pay off all of its current liabilities as they come due. A cash ratio greater than 1 means that a company has an excess of cash above what is needed to pay off all of its current liabilities. A cash ratio less than 1 means that a company needs to find other sources of cash to pay off all of its current liabilities as they come due.

A cash ratio greater than 1 signals that a company's current assets are highly liquid, while a cash ratio less than 1 signals that a company may have illiquid current assets. If a company's cash ratio is less than 1, it can use its accounts receivable or inventory to pay off all of its current assets.

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