What is Cash Ratio Formula?
Cash Ratio formula is the most conservative form of company’s liquidity ratio and is calculated by dividing the cash and cash equivalents of the company by the current liabilities and signifies the company’s ability to pay short term liabilities with its highest liquid assets.
The formula for Cash Coverage Ratio can be represented as:
Cash ratio is a liquidity ratio that measures the ability of the Company to repay the current liabilities only using its cash and cash equivalents. It is an extreme liquidity ratio than the other liquidity ratios i.e. current ratio and quick ratio as it requires the current liability to be settled using only the cash and cash equivalents.
Examples of Cash Coverage Ratio Formula (with Excel Template)
Let’s see some simple to advanced example to understand it better.
A Company XYZ Inc. has following items on its balance sheet. Calculate the cash ratio for the same.
For the calculation of cash ratio, we will need to calculate Cash and Cash Equivalents and Current Liabilities
Cash and Cash Equivalents
Thus, Cash and Cash Equivalents = 15000 + 12000 = $ 27000
Therefore, Current Liabilities = Accounts Payable + Short term debt = 20000 + 5000 = $ 25000
So, the calculation of cash ratio equation can be done as –
i.e. Cash Ratio = 27000/25000
So, Cash Ratio will be –
Therefore, Cash Ratio =1.08
The value of cash ratio = 1.08 shows that the Company has enough cash and cash equivalents to cover its company’s current liabilities. Thus, the Company is considered liquid and can service its debt easily.
Let us look at this industry example to understand Cash Ratio better:
The following snapshot shows a consolidated balance sheet of Apple Inc. for the year ended 2018 and 2017.
Source: Apple SEC Filings
With the help of the above balance sheet, we have gathered the following information.
Calculation of Cash Ratio for the year 2018
Cash ratio for year 2018 = 25913/116858 = 0.22
Calculation of Cash Ratio for the year 2017
Cash ratio for year 2017 = 20289/100814 = 0.20
The cash ratio of the Company increased from 0.20 to 0.22 from the year 2017 to 2018. This shows that the liquidity position of the Company bettered from the year 2017 to 2018.
A Company XYZ Inc. has cash bank balance as $ 50000 and cash equivalents of $ 60000. The Company has current liabilities of $ 200000. The cash ratio of Company XYZ Inc. is as below.
The Cash ratio can be found by adding both cash and cash equivalents and dividing them by the current liabilities. The calculation of Cash Ratio will be –
Cash Ratio will be –
Cash Ratio of Company XYZ Inc. is 0.55
Cash Ratio Calculator
You can use the following Cash Ratio calculator.
|Cash Ratio Formula =||
Relevance and Use
- Creditors are more likely to look at the cash ratio of the Company than the investors as it guarantees whether the Company can service its debt or not. Since the ratio does not use inventory and accounts receivables, the creditors are assured that their debt is serviceable if the ratio is greater than 1.
- Accounts receivables can take weeks or months to be converted to cash and inventory may take months to be sold, however, cash is the best form of an asset which is used to pay off the liabilities. Hence, creditors take solace and provide loans to Companies with better cash ratios.
- Although a higher cash ratio is preferred by the creditors the Company does not keep it too high, Cash ratio of more than 1 suggests that the Company has too high cash assets and it is not able to use it for profitable activities. The Companies do not maintain high cash assets because idle cash in bank accounts do not generate good returns hence, they try to use it for projects, acquiring new businesses, mergers, and acquisition, research, and development process so as to generate better returns. Due to this reason, a cash ratio in the range 0.5-1 is considered good.
- Although cash ratio is a stringent liquidity measure, the investors do not look at the ratio very frequently during fundamental analysis of the Company. Investors would like the company to utilize its idle cash to generate more profit and income.
- The investors are better off if the company pays off its debt in time and uses idle cash to reinvest in the business activities and generating better returns.
Cash ratio formula is Cash and Cash equivalents/Current Liabilities. It is a liquidity ratio that measures the ability of the company to pay its current liabilities utilizing its cash assets only. It is the most stringent liquidity ratio and highly restrictive as compared to the current ratio and quick ratio. It is most helpful to the creditors of the company as they would like the company to have more assets in the form of cash and cash equivalents.
The investors would like to have less cash on the balance sheet as they would prefer the company to invest in business activities to generate higher returns. Cash ratio of 0.5 – 1 is most preferred. Cash ratio may not be a good measure of fundamental analysis of the company; it only provides the ability of the company to remain solvent in short term.
This has been a guide to Cash Ratio Formula. Here we discuss how to calculate cash coverage ratio using its formula along with practical examples and excel downloadable template. You can learn more about financial analysis from the following articles –