What Is the Cash Ratio?

A company's cash ratio is an indicator of its liquidity. That is, it estimates the company's ability to meet its short-term obligatꦫions.

The formula for cash ratio is the company's total cash and cash equivalents on hand divided by its outstanding liabilities. Cash equivalents are assets like 澳洲幸运5官方开奖结果体彩网:marketable securities, which could quickly be converted to cash if ne꧙eded.

An acceptable cash ratio suggests that the company can meet all current payments due on debt. This numbeꦫr varies by sector but generally falls between 0.5 and 1.0.

Cash Ratio Formula

The cash ratio is a relatively conservative look at a company's ability to cover its debts and obligations compared to other 澳洲幸运5官方开奖结果体彩网:liquidity ratios. The cash ratio considers only cash or cash-equivalent assets, leaving other assets such as 澳洲幸运5官方开奖结果体彩网:accounts receivable out of the equation.

The formula for a company's cash ratio is:

Cash Ratio: Cash + Cash Equivalents / Current Liabilities

What Cash Ratio Can Tell You

The cash ratio indicates the company's ability to pay all of its current liabilities immediately without having to sell or liquidate other assets.

A ca❀sh ratio is expressed as a numeral greater or less than one. If the result is equal to one, the company has the same amount of current liabilities as it does cash and cash equivalents🥃 to pay off those debts.

The cash ratio could be considered an indicator of a firm’s value under the worst-case scenario. If a company is about to go out of business, it informs its creditors of the value of its 澳洲幸运5官方开奖结果体彩网:current assets in cash and cash equivalents and what percentage of its 澳洲幸运5官方开奖结果体彩网:current liabilities those assets would cover.

The U.S. Small Business Administration advises companies to use the cash ratio and other liquidity ratios to monitor their levels of liquidity, capacity, and collateral. Lend🍒ers analyze these numbers when companies pursue loans🔜.

Calculations Less Than 1

If a company's cash ratio is less than one, it has more current liabilities than cash and cash equivalents. In short, it has 澳洲幸运5官方开奖结果体彩网:insufficient cash on hand to pay off its short-term debt.

This may not spell trouble. There may be factors that skew the company's 澳洲幸运5官方开奖结果体彩网:balance sheets, such as long credit terms with it﷽s suppliers, efficiently managed inventory, or very little credit ex𓆏tended to customers.

Calculations Greater Than 1

The company has more cash and cash equival🍌ents than current liabilities w🦄hen its cash ratio is greater than one. It can cover all short-term debt and still have cash remaining.

A higher cash ratio is generally better, but it may also reflect an inefficient use of cash. The company may🎃 not be maximizing the potential benefit of using low-interest loans to invest in company growth.

A high cash ratio may also suggest that a company has concerns about its future profitability and i🌃s accu🐷mulating a protective cash cushion.

Example of the Cash Ratio

Apple,🌺 Inc. held $30.2 billion in cash and $23.5 billion worth of marketable securities at the end of 2024. So, it had $53.7 billion available🐈 for the immediate payment of short-term debt.

Between accounts payable and other current liabilities, Apple was responsible for roughly $123 billion of short-term debt.

Short-Term Ratio = $53.7 billion / $123 billion = Roughly 0.43

Apple's operating structure shows the company leverages debt, takes advantage of favorable credit terms, and prioritizes cash for company growth.

Limitations of the Cash Ratio

A company's cash ratio is seldom used in financial reporting or by analysts in the fundamental analysis of a company.

It's not considered ideal for a company to maintain excessive levels of cash and near-cash assets to cover its current liabilities. It's seen rather as poor asset utilization for a company to hold large amounts of cash on its balance sheet that could be returned to shareholders or used elsewhere to generate higher returns.

The cash ratio is more useful when it's compared with industry averages and competitor averages or when looking at changes in the same company over time. Certain industries tend to operate with higher current liabilities and lower cash reserves.

The cash ratio may be most useful when it's analyzed over time. A company's metric may be low but it may have been directionally improving over the last year. The metric also fails to incorporate seasonality or the timing of large future cash inflows. This may overstate a company in a single good month or understate a company during the offseason.

A cash ratio lower than one could indicate that a company is at risk of having financial difficulty. However, a low cash ratio may also be an indicator of a company's specific strategy that calls for maintaining low cash reserves, such as dedicating that money to expansion.

The Bottom Line

A company's cash ratio is calculated by dividing its cash and cash equivalents by its short-term liabilities. A company can strive to improve its cash ratio by having more cash on hand in case of short-term liquidation or demand for payments. This includes turning over inventory more quickly, holding less inventory, or not prepaying expenses.

Alternatively, a company can reduce its sh☂ort-term liabilities. The company can begin paying expenses with cash if credit terms are no longer favorable. The company can also evaluate spending and strive to reduce its overall expenses, thereby reducing payment obligations.