Cash ratio

What it means

The cash ratio is cash in hand, at bank and short-term securities divided by current liabilities. It shows what part of its short-term debts a company could pay immediately, without waiting for customers to pay or selling inventory.

It is the strictest of the three liquidity ratios. The current ratio compares all current assets, including inventory and receivables, with liabilities; the quick ratio excludes inventory; the cash ratio counts only short-term financial assets.

A value of roughly 0.2 to 0.5 is often considered reasonable. A lower value may indicate a risk of payment problems if customer payments are delayed, while a much higher value may mean the company is holding too much idle cash.

How it works in practice

The ratio is calculated from the balance sheet at the reporting date or from interim figures. In financial analysis, its trend over time is followed and compared with industry peers. Banks and suppliers use it to judge whether the company can pay on time.

The cash ratio is only a snapshot of a single day. For managing money, a cash flow plan showing when receipts arrive and when payments fall due is more useful. A company with a low cash ratio but reliable regular income may be perfectly sound.

Faster collection of receivables, longer payment terms with suppliers or a credit line as a buffer can improve the ratio. What matters, though, is managing overall working capital, not just adjusting the figure at the reporting date.

What to watch out for

The ratio is easy to influence at the reporting date, for example by delaying supplier payments or drawing a loan just before year end. When assessing a company, it is therefore worth looking at average values over the year and the structure of liabilities.

A very high cash ratio is not necessarily good news. Money sitting in an account without interest loses value to inflation and could be invested in growth or paid out to owners. The optimal level depends on the industry and the stability of income.