Cash Ratio Explained: How to Calculate Cash Ratio

The cash ratio is a financial ratio that compares a company’s cash and cash equivalents (such as marketable securities that are sold to create cash flow) to its current [liabilities](https://www.masterclass.com/articles/assets-vs-liabilities), such as short-term debt. Cash ratios are a type of [liquidity ratio](https://www.masterclass.com/articles/liquidity-ratio-explained), which measures a company’s working capital and its ability to pay the bills it faces in the regular course of business. The cash ratio on a financial statement focuses exclusively on short-term liabilities (such as accounts payable and regular employee salaries) rather than total liabilities. Long-term debt is designed to be paid back over many years, and in some cases, a business may make more money by not paying off its long-term debt all at once. This is particularly true in times of low interest rates. The simplest way to calculate a company's cash ratio is to divide its cash assets by its current liabilities. The cash ratio formula is: __Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities__ When performing a cash ratio analysis, financial analysts focus squarely on a company’s ability to fulfill short-term obligations. - __Cash ratio of one__: If a company's current cash assets equal its current liabilities, then it will have a cash ratio of one. In other words, using only cash and cash equivalents, its current assets could pay for one hundred percent of its current debt. - __Cash ratio of less than one__: If the cash ratio is less than one, the company does not have enough cash (or cash equivalents) to meet its short-term debt obligations. For instance, a liquidity ratio of 0.75 means that the company only has enough cash on hand to pay 75 percent of its short-term liabilities. This could foretell a liquidity crisis. - __Cash ratio over one__: If a business's current ratio measures greater than one, it is considered a high cash ratio. A high cash ratio indicates a business has more than enough cash to cover the short-term debts on its balance sheet. For instance, a financial statement that shows a cash ratio of two suggests that the company has enough cash assets to pay its liabilities two times over. The cash ratio on a company’s balance sheet can reveal numerous insights. 1. __Billing__: Some companies struggle to maintain a reasonable amount of cash on hand because their customers don't pay their bills on time. A more efficient accounts receivable department may improve a business’s cash ratio. This fact is particularly relevant to accounting managers. 2. __Solvency__: Cash ratios function as basic solvency ratios. If a company does not have enough liquid assets to quickly pay off short-term debt and liabilities, it may teeter on the edge of bankruptcy. Cash is the ultimate liquid asset, which means a cash ratio can come close to representing overall liquidity. 3. __Profitability__: While some startups may endure heavy debt as part of their early existence, a well-established business needs to be profitable to survive. If a company cannot manage to have a steady cash flow many years into its existence, it may not be designed for profitability. In addition to the cash ratio, there are three other methods to calculate a company’s liquidity. 1. __Current ratio__: Calculating the current ratio of a company or individual is the simplest and most common way of measuring liquidity. The current ratio looks at a company's total current assets (cash assets and otherwise) against their total current liabilities like debt obligations. The current ratio formula is: __Current Ratio = Current Assets / Current Liabilities__. 2. __Quick ratio__: The quick ratio considers a company's cash and cash equivalents, short-term investments, and accounts payable against its current liabilities. Use this formula to calculate a company’s quick ratio: __Quick Ratio = (Cash and Cash Equivalents, Accounts Payable, Short-Term Investments) / Current Liabilities__. 3. __Acid-test ratio__: The acid-test ratio is a variation on the quick ratio that subtracts inventories and prepaid costs from current assets to determine short-term assets. Use this formula to calculate the acid-test ratio: __Acid-Test Ratio = (Current Assets - Inventories - Pre-paid costs) / Current Liabilities__. All investments and investment strategies entail inherent risks and introduce the potential for financial loss or the depreciation of assets. The information presented in this article is for educational, informational, and referential purposes only. Consult a professional investment advisor before making any financial commitments. Get the [MasterClass Annual Membership](https://www.masterclass.com/) for exclusive access to video lessons taught by business luminaries, including Sara Blakely, Chris Voss, Robin Roberts, Bob Iger, Howard Schultz, Anna Wintour, and more. The cash ratio compares a company’s most liquid asset—cash—to its current liabilities. Learn more about how the cash ratio is used and how to calculate cash ratio.