Cash Ratio Formula (Table of Contents)
Cash Ratio Formula
The cash ratio is liquidity ratio that measures the ability of a company to pay its liabilities with cash. It is a fundamental financial management tool. Cash ratio is not given much importance unless a firm is in deep financial trouble but cash availability provides a guarantee for payment of debt. The cash ratio relates to cash and marketable securities to current liabilities. Cash ratio is also known as a cash asset ratio. The cash ratio formula can be written as the sum of cash and cash equivalent divided by total current liabilities
Where,
Cash Equivalent is an investment that can be converted into cash within 90 days.
A high ratio indicates that a business enterprise is not using its resource cash to best advantage. A low cash ratio reflects an immediate problem with repaying its liability.
Examples of Cash Ratio Formula (With Excel Template)
Let us see an example to understand cash flow formula in a better manner.
Cash Ratio Formula – Example #1
A company named K&G Pvt. Ltd with cash of $50,000 and cash equivalent of $20,000 and total liabilities of $100,000 wants to know cash ratio. Now let us calculate cash ratio.
Cash Ratio is calculated using below formula.
Cash Ratio = (Cash + Cash Equivalent) / Total Current Liabilities
Put a value in the formula.
- Cash Ratio = ($50,000 + $20,000) / $100,000
- Cash Ratio = $0.7
So, the cash ratio is 0.7. That means the company has enough cash and cash equivalent to pay 70% of current liabilities.
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Cash ratio excludes inventory and accounts receivable. Cash ratio formula is written as the sum of cash and cash equivalent upon the sum of accruals, accounts payable and notes payable. The formula for Cash Ratio can be expressed as:-
Let us see an example to understand the above cash ratio formula.
Cash Ratio Formula – Example #2
A company has cash and cash equivalent of $50,000, accruals of $15,000, account payable of $45,000 and notes payable of $5,000. And the company wants to know the cash ratio.
Cash Ratio is calculated using below formula
Cash Ratio = (Cash + Cash Equivalent) / (Accruals + Account Payable + Notes Payable)
Put a value in the formula.
- Cash Ratio = $50,000 / ($15,000 + $45,000 + $5,000)
- Cash Ratio = $50,000 /$65,000
- Cash Ratio = $0.77
So, the cash ratio is 0.77. That means a company has enough cash and cash equivalent to pay 77% of current liabilities.
Interpretation of Cash Ratio Formula
Cash ratios vary from business to business, but cash ratio gives an idea about whether the company will be able to pay current liabilities of the company. Let us see the interpretation of cash flow which are as follows:-
- If Cash ratio = 1: It means that cash & cash equivalent is equal to current liabilities that means the company has enough cash to pay off current liabilities.
- If Cash ratio > 1: It means that cash & cash equivalent is greater than current liabilities that means the company has more cash than they need to pay off current liabilities.
- If Cash ratio < 1: It means that cash & cash equivalent is less than current liabilities that means the company has used its asset well to earn profits but low cash ratio reflects an immediate problem with repaying its liability.
Below are the key points
- The cash ratio liquidity that measures the ability of a company to pay its short term liabilities with high liquid assets.
- It is the most conservative measure of a company’s liquidity as compared to other ratios like quick ratio or current ratio.
- The cash ratio should be between 0.5 and 1.
- Cash ratio does not provide good analysis as a company does not hold cash much.
Let us see another example to calculate cash ratio.
Cash Ratio Formula – Example #3
Below is the balance sheet of a printing company for the year 2019, now let us calculate cash ratio for same.
Cash Ratio is calculated using below formula
Cash Ratio = (Cash + Cash Equivalent) / Total Current Liabilities
Put values in the formula.
- Cash Ratio = ($15,000 + $10,000 + $86,000 + $1,200) / ($50,000 + $12,000 + $1,200)
- Cash Ratio = $112,200 / $63,200
- Cash Ratio = $1.78
As cash ratio is 1.78 which means the company has more cash than they need to pay off current liabilities.
Now, let us see another example.
Cash Ratio Formula – Example #4
A company named Active Pvt. Ltd has below balance sheet for the year 2019 and company wants to calculate cash ratio
Below is balance sheet of the company for the year 2019.
Cash Ratio is calculated using below formula
Cash Ratio = (Cash + Cash Equivalent) / Total Current Liabilities
Put a value in the formula.
- Cash Ratio = ($25,000 + $21,000) / ($15,000 + $15,000)
- Cash Ratio = $1.53
As cash ratio is $1.53 which means the company has more cash than they need to pay off current liabilities.
Relevance and Uses
There are multiple uses of cash ratio which are as follows:-
- The cash ratio measures the liquidity of the company.
- It helps lender or creditor to take a decision of giving a loan to a company.
- Cash Ratio formula used in the financial reporting of the company.
Cash Ratio Calculator
You can use the following Cash Ratio Calculator.
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Conclusion
Cash ratio is used in the fundamental analysis of a company and it is also used by a company for financial reporting but it does not provide good analysis details about financial management or financial position of a company. If cash ratio is high it is good for the lender as the risk for him is less but practically companies do not keep large cash and if it keeps it will be not a good sign as a company does not use its resources properly.
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