The cash ratio is a company's cash and cash equivalents divided by its current liabilities. Cash equivalents are very safe holdings that can be turned into cash almost at once, such as bank deposits and short-term government bills. Current liabilities are the bills and debts that fall due within a year. It is the strictest of the three liquidity ratios: unlike the quick ratio and the current ratio, it ignores money owed by customers and inventory, and asks whether the company could pay what it owes this year using only the cash it holds today. In German-speaking countries it is called Liquidität 1. Grades.
Worked example
Company A holds $100,000 in cash and cash equivalents, is owed $200,000 by customers and has $200,000 of inventory. It owes suppliers and lenders $400,000 within the year. Cash ratio = $100,000 ÷ $400,000 = 0.25. For comparison, the quick ratio = ($100,000 + $200,000) ÷ $400,000 = 0.75 and the current ratio = ($100,000 + $200,000 + $200,000) ÷ $400,000 = 1.25. Read together, the three numbers show a company that looks comfortable on paper but could cover only a quarter of its bills from cash today, so it depends on customers paying and on selling its stock.
Why it matters
The cash ratio is the harshest way to ask whether a company could pay its short-term bills if nothing else came in. The figures come from the balance sheet in the annual report. A low number is common and not alarming by itself, because most healthy companies keep little idle cash and expect customers to pay and stock to sell. A very high number can also be a question: the company may be holding cash it has not put to work, or may be preparing for a large bill. Typical levels differ by industry, and a cash balance on the reporting date can be unusually high or low because of timing. A reading is a question to look into, not a verdict, so compare it with companies in the same industry, with the company's own past years, and alongside the quick and current ratios.
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Frequently asked questions
There is no single good level, because it depends on the industry. A figure of 1 or more means cash alone covers every bill due within a year, but few healthy companies hold that much idle cash, so a lower number is normal and not alarming by itself. Compare it with similar companies and with the same company's earlier years.
All three divide by current liabilities. The cash ratio counts only cash and cash equivalents. The quick ratio adds money owed by customers. The current ratio adds inventory as well. So the cash ratio is the strictest and the current ratio the most generous.
Both numbers are on the balance sheet in the company's annual report, under cash and cash equivalents and under current liabilities. Use the same reporting date for both.
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