What is the 'Cash Ratio'

The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities. The metric calculates a company's ability to repay its short-term debt; this information is useful to creditors when deciding how much debt, if any, they would be willing to extend to the asking party. The cash ratio is generally a more conservative look at a company's ability to cover its liabilities than many other liquidity ratios because other assets, including accounts receivable, are left out of the equation.

Next Up

BREAKING DOWN 'Cash Ratio'

The cash ratio is most commonly used as a measure of company's liquidity. The metric calculates a company's ability to pay current liabilities using only cash and cash equivalents on hand. If the company is forced to pay all current liabilities immediately, this metric shows the company's ability to do so without having to sell or liquidate other assets.

Items Omitted From the Cash Ratio

Accounts receivable, inventory, prepaid assets and certain investments are not included in the cash ratio. These items may require time and effort to find a buyer in the market. In addition, the amount of money received from the sale of any of these items may be indeterminable. The cash ratio restricts the asset portion of the equation to only the most liquid of assets.

Cash Ratio Results

If a company's cash ratio is equal to 1, the company has exactly the same amount of current liabilities as it does cash and cash equivalents to pay off those debts.

If a company's cash ratio is less than 1, there are more current liabilities than cash and cash equivalents. In this situation, there is insufficient cash on hand to pay off short-term debt.

If a company's cash ratio is greater than 1, the company has more cash and cash equivalents than current liabilities. In this situation, the company has the ability to cover all short-term debt and still have cash remaining.

Usefulness of the Cash Ratio

The cash ratio is more useful when it is compared to industry averages and competitor averages. A cash ratio lower than 1 does indicate a company is having financial difficulty. A low cash ratio may be an indicator of a company's strategy to have low cash reserves. However, certain industries operate with higher current liabilities and lower cash reserves. In addition, a higher cash ratio does not necessarily reflect a company's strong performance. High cash ratios may indicate that a company is inefficient in the utilization of cash or not maximizing the potential benefit of low-cost loans.

RELATED TERMS
1. Current Ratio

The current ratio is a liquidity ratio that measures a company's ...
2. Cash Flow-to-Debt Ratio

The cash flow-to-debt ratio is a measure that compares a companyâ€™s ...
3. Overall Liquidity Ratio

Overall liquidity ratio is the measurement of a companyâ€™s capacity ...
4. Ratio Analysis

A ratio analysis is a quantitative analysis of information contained ...
5. Cash Per Share

Cash flow per share is the broadest measure of available cash ...
6. Cash And Cash Equivalents - CCE

An item on the balance sheet that reports the value of a company's ...
Related Articles
1. Investing

Debt Ratios

Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
2. Investing

Why Cash Management Is Key To Business Success

Businesses need to generate a healthy cash flow to survive, but not hold too much so that inventory suffers or investment opportunities are missed.
3. Investing

Key Financial Ratios to Analyze Tech Companies

Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
4. Investing

5. Investing

Useful Balance Sheet Metrics

These metrics can help you better understand the information found on balance sheets.
6. Investing

Corporate cash flow: Understanding the essentials

Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
7. Investing

Analyze cash flow the easy way

Learn the key components of the cash flow statement, how to analyze and interpret changes in cash, and what improved free cash flow means to shareholders.
RELATED FAQS
1. What are some alternative liquidity ratios to the cash ratio?

Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >>
2. What is the formula for calculating the current ratio?

Find out what makes up the current ratio, how to calculate it, and what the result can tell you about a potential investment. Read Answer >>
3. How do the current ratio and quick ratio differ?

The current ratio and the quick ratio are both liquidity ratios that measure how a company's ability to pay off its short-liabilities ... Read Answer >>
4. To what extent should you take a company's liquidity ratio into account before investing ...

Find out how important it is for an investor to know a company's liquidity ratio before deciding to invest, and why relying ... Read Answer >>
5. What is the proper ratio between working capital, current assets and current liabilities?

Explore the working capital ratio, a basic liquidity measurement intended to represent the current relationship between a ... Read Answer >>
6. Why do shareholders need financial statements?

Discover the importance of a company's financial statements for stock shareholders in evaluating their equity investment ... Read Answer >>
Hot Definitions
1. Leverage

Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
2. Financial Risk

Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
3. Enterprise Value (EV)

Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
4. Relative Strength Index - RSI

Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
5. Dividend

A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
6. Inventory Turnover

Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.