Cash Equivalent is an investment which can be converted into cash within 90 days.
A high ratio indicates that business enterprise is not using its resource cash to best advantage. A low cash ratio reflects an immediate problem with repaying its liability.
Let us see an example to understand cash flow formula in a better manner.
A company named K&G Pvt. Ltd with cash of $50,000 and cash equivalent of $20,000 and total liabilities of $100,000 wants to know cash ratio. Now let us calculate cash ratio.
Cash Ratio is calculated using below formula.
So, the cash ratio is 0.7. That means the company has enough cash and cash equivalent to pay 70% of current liabilities.
Let us see an example to understand the above cash ratio formula.
A company has cash and cash equivalent of $50,000, accruals of $15,000, account payable of $45,000 and notes payable of $5,000. And the company wants to know the cash ratio.
So, the cash ratio is 0.77. That means a company has enough cash and cash equivalent to pay 77% of current liabilities.
If Cash ratio = 1: It means that cash & cash equivalent is equal to current liabilities that means the company has enough cash to pay off current liabilities.
If Cash ratio > 1: It means that cash & cash equivalent is greater than current liabilities that means the company has more cash than they need to pay off current liabilities.
If Cash ratio < 1: It means that cash & cash equivalent is less than current liabilities that means the company has used its asset well to earn profits but low cash ratio reflects an immediate problem with repaying its liability.
The cash ratio liquidity that measures the ability of a company to pay its short term liabilities with high liquid assets.
It is the most conservative measure of a company’s liquidity as compared to other ratios like quick ratio or current ratio.
The cash ratio should be between 0.5 and 1.
Cash ratio does not provide good analysis as a company does not hold cash much.
Let us see another example to calculate cash ratio.
Below is the balance sheet of a printing company for the year 2019, now let us calculate cash ratio for same.
Put values in the formula.
As cash ratio is 1.78 which means the company has more cash than they need to pay off current liabilities.
Below is balance sheet of the company for the year 2019.
As cash ratio is $1.53 which means the company has more cash than they need to pay off current liabilities.
The cash ratio measures the liquidity of the company.
It helps lender or creditor to take a decision of giving a loan to a company.
Cash Ratio formula used in the financial reporting of the company.
You can use the following Cash Ratio Calculator.
Cash ratio is used in the fundamental analysis of a company and it is also used by a company for financial reporting but it does not provide good analysis details about financial management or financial position of a company. If cash ratio is high it is good for the lender as the risk for him is less but practically companies do not keep large cash and if it keeps it will be not a good sign as a company does not use its resources properly.