# Cash Ratio Definition Formula and Example

## Cash Ratio Definition, Formula, and Example

The cash ratio is calculated by dividing the company’s cash and cash equivalents by its current liabilities. The formula for cash ratio is:

Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities

The cash and cash equivalents include cash on hand, demand deposits, and short-term investments that can be easily converted into cash. Current liabilities are the company’s obligations that are due within one year.

For example, let’s say Company ABC has \$100,000 in cash and cash equivalents and \$50,000 in current liabilities. The cash ratio would be calculated as:

Cash Ratio = (\$100,000) / (\$50,000) = 2

This means that Company ABC has a cash ratio of 2, indicating that it has twice the amount of cash needed to cover its current liabilities.

## What is Cash Ratio?

Cash ratio is a financial ratio that measures a company’s ability to pay off its current liabilities using only its cash and cash equivalents. It is a measure of a company’s liquidity and indicates how easily it can cover its short-term obligations without relying on other sources of funds.

The cash ratio is calculated by dividing a company’s cash and cash equivalents by its current liabilities. Cash and cash equivalents include cash on hand, demand deposits, and short-term investments that can be easily converted into cash.

A high cash ratio indicates that a company has a strong ability to meet its short-term obligations, while a low cash ratio suggests that a company may struggle to pay off its debts in the near future.

Overall, the cash ratio provides insight into a company’s liquidity position and its ability to handle short-term financial obligations. It is a useful tool for investors and analysts to evaluate a company’s financial health and make informed investment decisions.

## How to Calculate Cash Ratio?

The cash ratio is a financial ratio that measures a company’s ability to pay off its short-term liabilities with its cash and cash equivalents. It is an important indicator of a company’s liquidity and financial health. The cash ratio is calculated by dividing a company’s cash and cash equivalents by its current liabilities.

### Formula:

The formula for calculating the cash ratio is as follows:

Cash Ratio = (Cash and Cash Equivalents) / Current Liabilities

Where:

• Cash and Cash Equivalents refers to the total amount of cash on hand and cash equivalents that a company has.
• Current Liabilities refers to the total amount of short-term liabilities that a company owes and is expected to pay within one year.

The cash ratio is expressed as a decimal or a percentage. A higher cash ratio indicates that a company has a greater ability to cover its short-term liabilities with its cash reserves, which is generally seen as a positive sign of financial health.

### Example:

Let’s say Company XYZ has \$100,000 in cash and cash equivalents and \$50,000 in current liabilities. To calculate the cash ratio, we can use the formula:

Cash Ratio = \$100,000 / \$50,000 = 2

This means that Company XYZ has a cash ratio of 2, indicating that it has twice the amount of cash and cash equivalents compared to its current liabilities. This suggests that the company is in a strong financial position and has sufficient liquidity to meet its short-term obligations.

It is important to note that the cash ratio should be interpreted in the context of the industry and company’s specific circumstances. A high cash ratio may not always be desirable, as it could indicate that the company is not effectively utilizing its cash resources.

## Example of Cash Ratio Calculation

Assets Amount
Cash \$50,000
Accounts Receivable \$20,000
Inventory \$30,000
Current Liabilities \$40,000

Using the formula:

Cash Ratio = Total Cash / Current Liabilities

Substituting the values:

Cash Ratio = \$50,000 / \$40,000

Cash Ratio = 1.25

The cash ratio for Company XYZ is 1.25. This means that for every dollar of current liabilities, the company has \$1.25 of cash available to cover those liabilities.

The cash ratio is an important financial ratio as it indicates the company’s ability to meet its short-term obligations using its available cash. A higher cash ratio is generally considered favorable as it shows a stronger liquidity position.