Here’s another calculator you may want to use. We’ve created this tool to allow businesses to calculate their cash ratio when they analyze their liquidity. As you may already know, the cash ratio is frequently utilized in company analysis. This liquidity ratio is very helpful for many companies.
Continue scrolling to learn how to use the cash ratio calculator. You can also get a better understanding of the cash ratio in this article. We will take a look at the cash ratio formula and give a few examples to let you know how this equation is applied in real life.
What Is the Cash Ratio?
Cash ratio is a financial term that is used to assess the company’s liquidity. It is calculated by dividing the cash, cash equivalents, and short-term investments by the current liabilities. This liquidity ratio is meant to estimate the ability of companies to pay off their liabilities and debts using liquid assets such as cash equivalents and cash.
Creditors often use this ratio in their credit analyses when they want to measure the liquidity of a company. It is worth noting that the cash ratio is not the same as other liquidity ratios that use less liquid assets. The current ratio, for instance, reckons with current assets like account receivables. However, account receivables don’t allow companies to quickly repay their debt as is the case with cash equivalents. This makes a difference.
What Does It Indicate?
As you can see, the cash ratio is aimed at measuring liquidity. There are two possible situations:
- The cash ratio < 1: This means the company will not be able to completely pay off current liabilities with cash in case.
- The cash ratio > 1: This tells us that the company can pay off short-term debt or liabilities using cash reserves.
The higher the cash ratio, the more liquid a company’s assets are. This is a sign that the company has a good liquidity position. This isn’t always true, though. A too high cash ratio is not favorable because cash reserves are used to increase shareholder value instead of being invested in growth.
A low cash ratio, on the other hand, can indicate that a company has not been able to collect enough money from its customers or suppliers. It usually means that a business is aggressively investing in future expansion. If a company is not capable of paying off short-term debt with the most liquid assets, then it will have to liquidate other assets.
Whatever the case, it is important to know how to calculate the cash ratio. Along with other industry benchmarks, it can help you get a better idea of a company’s liquidity. When calculating the cash ratio, you should compare it against competitors. So let’s see what the cash ratio formula looks like.
Cash Ratio Formula: How to Calculate It
Cash ratio = cash and cash equivalents / current liabilities
This is the formula you need to use when calculating the cash ratio. So you will only need two inputs (current liabilities as well as cash and cash equivalents) for this calculation.
For example, if the current liabilities of a company are as high as $12,000,000 while their cash and cash equivalents are $14,400,000, then the cash ratio is 1.2.
While it may seem simple at first glance, you will have to go through three steps. Let’s check them out!
Step 1: Calculating CCE (Cash & Cash Equivalents)
First things first, you need to determine the cash and cash equivalents. To get this information easily, check the balance sheet of the company. It is usually displayed as the 1st line of the current assets. Alternatively, it can be calculated using this equation:
CCE = demand deposit + cash balance + money market fund + saving account + treasury bills
Step 2: Determining the Company’s Current Liabilities
The next thing you should know is the current liabilities. You can find it by getting insight into the balance sheet of the company. When talking about the current liabilities of the company, it usually means that they have debt and their assets are not as liquid. They may also have a high level of inventory and accounts receivable.
Step 3: Calculating the Cash Ratio
Finally, you will be able to calculate the cash ratio. You can either use the aforementioned formula or use our calculator. The cash ratio calculator will not only save you time, but it will also make sure your calculation is correct.
Cash Ratio FAQs
What Can the Cash Ratio Reveal?
The cash ratio is a measure of liquidity. It is the ratio of cash and cash equivalents to current liabilities. Actually, the cash ratio is a measure of the amount of cash that a company has on hand, divided by the company’s total current liabilities. The higher the ratio, the more liquid the company is.
It can be used to reveal how much money a business has available at any given time. This information can then be used to make decisions about the company’s financial stability and future prospects.
There are two types of cash ratios: current and quick. A current ratio measures how much money a company has in its bank account to cover its short-term debts, while a quick ratio measures how much money it has to cover both short-term and long-term debts.
A company with a high cash ratio may appear more stable than one with low liquidity, but it does not necessarily mean that the business will have enough money in the future.
What Is a Good Cash Ratio?
The cash ratio is a measure of how much cash a company has in relation to its total assets. A company with a higher cash ratio will have more money on hand to pay off creditors and investors, while a company with a lower cash ratio will be more at risk of going bankrupt.
A good cash ratio is between 1-2% for publicly traded companies and 5-10% for privately-held businesses. As a general rule of thumb, a cash asset ratio of about 1 (or slightly more) is considered to be ideal in the first case. It suggests that a company will be able to repay short-term debt and other obligations using the most liquid assets.