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Cash Ratio

 

Cash ratio is a financial ratio that measures company’s financial liquidity over short term. It compares company’s cash reserves to short-term liabilities. If ‘cash ratio’ is high, it may indicate few things:

  • Company is safe in case of funding shortage over short period.
  • Company accumulates cash for some acquisition or other large investment.
  • Company manages cash not very efficiently.

 

Cash accumulation allows to company’s management feel safer. Some conservative managers like to keep large cash amounts and earn low interest. However, cash accumulation for long period is not the most efficient way to use shareholders’ capital. Normally, free funds have to be invested in some projects or have to be paid out for shareholders as dividends or stock buybacks. Cash accumulation without particular reason could be justifiable only for cyclical companies that are affected by economic cycles very strongly.

 

Cash ratio formula 


Cash ratio = (Cash + Cash equivalents) / Current liabilities

 

* Basically, nominator should include cash and other short-term financial assets with high liquidity that easily can be converted in cash. For example, deposits in bank’s account, safe short-term bonds or similar financial instruments could also be included in this ratio. All these data are available in company’s balance sheet

 

Cash ratio’ can be used together with ‘current ratio’ and ‘quick ratio’. All these ratios measure company’s financial liquidity but other two ratios include more types of current assets in calculation. 

 






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