Cash Ratio

What is the Cash Ratio?

Cash ratio is the ratio which measures the ability of the company to repay the short term debts with the cash or cash equivalents and it is calculated by dividing the total cash and the cash equivalents of the company with its total current liabilities.

If we look at the graph below, we note that Starbucks has the highest cash ratio (0.468x in FY2016) as compared to Colgate and Procter & Gamble. But what does it mean by this ratio? Does it matter if this ratio of a company is more than 1? We will find out in this article.


Cash Ratio Formula

The formula is as simple as it can be. Just divide cash & cash equivalents by current liabilities, and you would have your ratio.

Cash Ratio Formula = Cash + Cash Equivalents / Total Current Liabilities

Cash Ratio

Most of the firms show cash & cash equivalent together in the balance sheet. But few firms show the cash and the cash equivalent separately.

But what cash equivalent really means?

According to GAAP, cash equivalents are investments and other assets which can be converted into cash within 90 days or less. Thus, they get included in the cash coverage ratio.

Current Liabilities are liabilities that are due in the next 12 months or less.

Let’s have a look at the cash & cash equivalents and current liabilities that any firm considers to include in their balance sheet.

Cash & Cash Equivalent: Under Cash, the firms include coins & paper money, undeposited receipts, checking accountsChecking AccountsChecking Account, also known as a transactional account, can be defined as a kind of deposits account held by a financial institution or non-banking financial institution which allows the holder of the account to deposit and withdraw money. This is one of the most liquid forms of money. It differs from a normal bank savings account since it allows multiple deposits and withdrawal in a particular more, and money order.  And under cash equivalent, the organizations take into account money market mutual funds, treasury securities, preferred stocks which have a maturity of 90 days or less, bank certificates of deposits, and commercial paper.

Current liabilities: Under current liabilities, the firms would include accounts payableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting more, sales taxes payableSales Taxes PayableSales taxes payable refers to the liability account created when an entity collects sales taxes on behalf of the government and stores the aggregate amount of taxes before paying the concerned taxes more, income taxes payable, interest payable, bank overdrafts, payroll taxes payable, customer deposits in advance, accrued expenses, short-term loans, current maturities of long-term debt, etc.

Interpretation of Cash Ratio

  • Let’s say that the Cash & Cash Equivalent > Current Liabilities; that means the organization has more cash (more than 1 in terms of ratio) than they need to pay off the current liabilities. It’s not always a good situation to be in as it denotes that the firm has not utilized assets to its fullest extent
  • If Cash & Cash Equivalent = Current Liabilities, that means the firm has enough cash to pay off the current liabilities.
  • If Cash & Cash Equivalent < Current Liabilities, then this is the right situation to be in, in terms of the firm’s perspective. Because this means the firm has utilized its assets well to earn profits.

Even if it’s a useful ratio as it strips away all the uncertainties (receivables, inventories, etc. to turn into cash to pay off current liabilities) from current assets and focuses on only cash & cash equivalent, most of the financial analysts don’t use cash ratio to come to a conclusion about the firm’s liquidity position.

Cash Ratio Example

Example 1

Let’s take an example to illustrate this. In the example below, our primary concern would be to see the liquidity position of the firm from two perspectives. First, we will look at which company is in a better situation to pay off short-term debt, and second, we will look at which company has better utilized its short-term assets.

X (in US $)Y (in US $)
Cash Equivalent1000500
Accounts Receivable10005000
Accounts Payable40003000
Current Taxes Payable50006000
Current Long-term Liabilities110009000
cash coverage ratio0.550.19
Current Ratio0.630.81

Now from the above example, we will be able to make some conclusions.

First, which company is in a better position to pay off short-term debt for sure (not having any uncertainty)? It’s surely Company X because the cash & cash equivalent of the Company X is much more than Company Y compared to their respective current liabilities. And if we look at the ratio of both the companies, we would see that the ratio of Company X is 0.55, whereas the cash coverage ratio of Company Y is just 0.19.

If we include current ratio to the perspective (current ratio = current assets / current liabilities), Company Y is in a better position to pay off short-term debt (if we consider that account receivables and inventories could be turned into cash within a short period of time) as its current ratio is 0.81.

Even if Company X has more cash, they have lesser accounts receivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance more & inventories. From one perspective, it is a good position to be in as nothing is locked up, and the major part has been liquidated. But at the same time, more the cash ratio and less current ratio means (compared to Company Y); Company X could have better utilized the cash lying for asset generation. From this perspective, Company Y has better utilized its cash.

Example 2 – Nestle

In this section, we will take an example from the industry so that you can understand how this ratio works.

Here we will take into account the raw data and will calculate this ratio for two consecutive years.

First, we will take into account the balance sheet data of Nestle.


source: Nestle Annual Report

If you look at the balance sheet, you would see that there are two sets of information that are important to us in terms of determining the cash ratio.

The first is the two-year data of cash & cash equivalent (see the highlighted yellow in the balance sheet above), and the second data, which is useful to us, is the total current liabilities for the year 2014 and 2015.

Now, we would determine this ratio by using the simple formula we have mentioned above.

In 2014, Nestlé’s ratio was = (7448/32895) = 0.23.

In 2015, Nestlé’s was = (4884/33321) = 0.15.

If we compare the cash coverage ratio of these two years, we would see that in 2015, the ratio is lesser compared to 2014. The reason may be better utilization of cash in the generation of profits.

On the other hand, we note that in 2014, Nestle had more cash to pay off short-term debt than it had in 2015.

Let us now compare how Nestle’s cash coverage ratio is compared to its competitors – Hershey’s and Danone.


source: ycharts

  • We note that Nestle’s ratio has been fairly stable, ranging between 0.14x – 0.25x over the past 10 years
  • Danone’s ratio is the lowest among its competitors at 0.056x
  • Hershey’s ratio has been variable in the past 10 years. The cash coverage ratio was between 0.45-0.80x between 2011 – 2015. However, most recently, Hershey’s ratio has dipped to around 0.156x

Example 3 – Colgate

Let us now take another example of Colgate

Cash Ratio - Colgate

source: ycharts

Colgate has been maintaining a healthy ratio of 0.1x to 0.28x in the past 10 years. With this higher cash ratio, the company is in a better position to pay off its current liabilities.
Below is a quick comparison of the cash coverage ratio of Colgate’s vs. P&G vs. Unilever.


source: ycharts

  • Colgate’s ratio, as compared to its peers, seems to be much superior.
  • Unilever’s ratio has been declining in the past 5-6 years.
  • P&G ratio has steadily improved over the past 3-4 years period.

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 receivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance more 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 that 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. It is not able to use it for profitable activities. 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 acquisitions, research, and development process to generate better returns. Due to this reason, a cash ratio in the range of 0.5-1 is considered good.
  • Although the cash ratio is a stringent liquidity measure, the investors do not look at the ratio very frequently during a 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.


From the above discussion, it’s clear that the cash coverage ratio could be one of the best-measuring grids of liquidity for a firm. But there are few limitations of this ratio, which may become the reason for its infamous nature.

  • First of all, most companies think that the usefulness of the cash coverage ratio is limited. Even a company that has portrayed a lower ratio may portray a much higher current and quick ratio at the end of the year.
  • In some countries, the ratio of less than 0.2 is healthy.
  • As the cash coverage ratio portrays two perspectives, it isn’t easy to understand which perspective to look at. If this ratio of a company is lesser than 1, what would you understand? Has it utilized its cash well? Or it has more capacity to pay off short term debt? That’s the reason, in most of the financial analyses, the cash coverage ratio is used along with other ratios like Quick Ratio and Current Ratio.

Cash Coverage Ratio Video


Having talked about the limitations, the cash ratio could be less useful than other liquidity ratios. But if you still want to check how much cash is lying around in your company, it’s good to use this guide to find out cash ratio on your own.