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One metric used by analysts and lenders to determine a company’s financial strength is its cash ratio. The cash ratio is an accounting measurement of a company’s liquidity. The higher the cash ratio, the more liquid the company is, and the better able it is to pay off short-term obligations under duress.

Liquidity refers to the state of having enough cash or near cash on hand to pay off short-term debts or emergencies. Being “illiquid” or “not sufficiently liquid” means having too much money tied up in assets that cannot be turned immediately into cash. Thus, a company can have a lot of money, yet still be illiquid.

Analysts calculate cash ratio by dividing the total of a company’s cash and cash equivalents by its current liabilities. Current liabilities are near-term debts and accounts payable that are due within the year.

The cash ratio is a conservative view of a company’s liquidity because it does not include inventory or accounts receivable as cash or near cash. Other measurements of liquidity, such as the current ratio, do count these assets because they can be sold to meet short-term debts. However, it’s not always possible to sell such assets quickly. Therefore, the cash ratio measures only money a company can access immediately for emergency needs or debts.

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