Cash ratio

Definition

The cash ratio measures a company's ability to pay off its short-term liabilities with its most liquid assets, specifically cash and cash equivalents. It is calculated by dividing cash and cash equivalents by current liabilities.

5 Must Know Facts For Your Next Test

1. The formula for the cash ratio is Cash + Cash Equivalents / Current Liabilities.
2. A higher cash ratio indicates a more liquid position, meaning the company can easily cover its short-term debts.
3. The cash ratio is considered more conservative than other liquidity ratios like the current ratio or quick ratio.
4. A very high cash ratio might indicate inefficient use of resources, as excessive cash could be invested elsewhere for better returns.
5. Unlike other liquidity ratios, the cash ratio excludes inventories and accounts receivables because they are not as easily converted to cash.

Review Questions

• What does a high cash ratio indicate about a company's financial health?
• How is the cash ratio different from the current and quick ratios?
• Why might a very high cash ratio be considered inefficient?

Related terms

currentRatio: Measures a company's ability to pay off short-term liabilities with all current assets.

quickRatio: Assesses a company’s capacity to meet short-term obligations using its most liquid assets excluding inventory.

workingCapital: Represents the difference between a company's current assets and current liabilities, indicating overall liquidity.