What Is the Cash Asset Ratio?
The cash asset ratio is the current value of marketable securities and cash, divided by the company's current liabilities. Also known as the cash ratio, the cash asset ratio compares the amount of highly liquid assets (such as cash and marketable securities) to the amount of short-term liabilities. This figure is used to measure a firm's liquidity or its ability to pay its short-term obligations.
- The cash asset ratio is a financial ratio that seeks to determine a company's liquidity by assessing its ability to pay off its short-term obligations with cash and cash equivalents.
- The cash asset ratio is calculated by dividing the sum of cash and cash equivalents by current liabilities.
- Cash equivalents include items such as treasury bills, bank certificates of deposit, commercial paper, and other money market instruments. Current liabilities include items such as accounts payable, short-term debt, dividends payable, notes payable, and current maturities of long-term debt.
- Investors and analysts use the cash asset ratio to determine a company's liquidity. A ratio of 1 and above indicates a company is able to pay off its short-term obligations with its most liquid assets, while a ratio of under 1 may indicate financial difficulty.
- Every company and every industry will have different cash requirements, so there is no one value that is considered strong or poor.
- The cash asset ratio is similar to the current ratio; however, the current ratio includes all current assets.
Formula and Calculation of the Cash Asset Ratio
The cash asset ratio is calculated by dividing the sum of cash and cash equivalents by current liabilities. The formula is as follows:
Cash Asset Ratio = (Cash + Cash Equivalents) / Current Liabilities
Cash equivalents include all assets that can quickly be turned into cash. These include treasury bills, bank certificates of deposit, commercial paper, and other money market instruments. Cash equivalents are highly liquid and have high credit quality.
Current liabilities include accounts payable, short-term debt, dividends payable, notes payable, and current maturities of long-term debt.
What the Cash Asset Ratio Can Tell You
The cash asset ratio is a financial indicator of a company's liquidity. It shows how well of a position a company is in to pay off its short-term obligations. It is a very conservative calculation in that it only includes cash and cash equivalents and no other assets, to determine how liquid a company is.
Investors and analysts can determine a company's ability to pay off its short-term obligations, such as accounts payable and short-term debt, with its most liquid assets by using the cash asset ratio. A cash asset ratio of 1 and above indicates a company that is in good financial standing with the ability to pay off obligations through liquid assets. A cash asset ratio below one may indicate a company in financial distress.
However, having a cash asset ratio below 1 does not necessarily indicate financial difficulty. As with all financial analyses, more than one data point needs to be assessed before making a judgment on a company's financial health.
The cash asset ratio is a prime example of this, as many companies do not keep on hand large portions of cash or cash equivalents, which is seen as a poor use of cash. Instead, many companies invest in a variety of ways or funnel the money back into the business.
The Difference Between the Cash Asset Ratio and the Current Ratio
The cash asset ratio is a liquidity ratio and is similar to another liquidity ratio, the current ratio. The current ratio, however, includes all current assets in addition to cash and marketable securities, such as inventories. Including all current assets, not just those that are immediately convertible into cash, makes the current ratio a less stringent measure than the cash asset ratio. The cash asset ratio is, therefore, a better measure of a firm's liquidity.
Example of the Cash Asset Ratio
For example, if a firm had $130,000 in marketable securities, $110,000 in cash, and $200,000 in current liabilities, the cash asset ratio would be (130,000+110,000)/200,000 = 1.20. The ratio being above 1 demonstrates that the firm has the ability to cover its current liabilities in the short term. Companies in different industries have different needs for liquidity, so acceptable ratios differ from one industry to another.
What Is a Good Cash Asset Ratio?
An ideal cash asset ratio would be 1. It indicates a company is able to pay off its short-term obligations with its most liquid assets but also does not have too much cash sitting around that is not being put to use. However, every company and industry will have different cash requirements, thus, there will always be different values that are considered good.