Understanding Cash Ratio

The Cash Ratio measures the liquidity position of the company. This metric indicates how much the company can cover its current liabilities with its cash and cash equivalents. In other words, it shows the company's ability to pay its short-term debts by cash or items that are similar to cash, such as commercial papers, marketable securities, treasury bills, etc., that can easily convert into cash. It is calculated by dividing cash and cash equivalent by current liabilities. The Cash Ratio is also known as the Cash Asset Ratio.

The formula to derive Cash Ratio



Cash and Cash Equivalents - These are liquid assets that are found in a company's Balance Sheet. Cash equivalents are short-term commitments such as commercial papers, marketable securities, treasury bills, etc., which are easy to convert into cash.

Current Liabilities - These are a company's debt obligations that are due to be paid within one year. Some current liabilities are accounts payables, short-term debts, outstanding expenses, etc. Current liabilities are found in the liabilities section of the company's Balance Sheet.

Example of Cash Ratio: For the financial year, Container Corporation of India reported cash and cash equivalents as Rs.2625.94 Cr., and Current Liabilities as Rs.1329.51 Cr.
The value as per the formula (Cash and cash equivalents / Current Liabilities) is calculated as (2625.94 / 1329.51) = 1.98.

---

Key Highlights

The Cash Ratio measures the short-term liquidity position of the company. And it is calculated as cash and cash equivalent divided by current liabilities.

The cash ratio of one or above one indicates that the company can meet its current short-term liabilities using cash and cash equivalents.

This metric is considered more conservative than the current ratio and quick ratio.

---

While looking at the Cash Ratio, the following points should also take into consideration:

The ideal cash ratio is 1. A high ratio indicates that the company can meet its current short-term liabilities using cash and cash equivalents.

Generally, a high ratio is considered good, but investors should look at other factors too. A high cash ratio does not indicate a strong liquidity position of the company. If the company's cash ratio is higher than the industry average, it may also mean it is not efficiently utilizing its cash and cash equivalents or has fewer investment opportunities.

A low cash ratio indicates that the company's liabilities are more than its cash and cash equivalents and inefficient to meet its current short-term liabilities.

It shows the ability of the company to pay its current liabilities without selling other assets if it is required to pay immediately.

If there are large amounts of cash on the company's balance sheet it is often seen as poor utilization of assets or not utilizing its cash effectively to generate more returns or revenue.

---

How to use Cash Ratio effectively

Investors should look for a higher cash ratio. It indicates that the company has efficient cash and cash equivalents to cover its current liabilities.

It is considered more conservative than the current ratio and quick ratio. It only considers cash-related assets that are easily converted into cash if the company needs to pay immediate current liabilities. But cash ratio only takes cash and cash equivalents into account, so it better go along with the current and quick ratio to understand the company's liquid position.

To get a more accurate analysis of the company, also use other financial metrics relative to Cash Ratio such as Current Ratio, Quick Ratio, Cash Turnover Ratio, Operating Cycle, etc.,

---