Cash ratio is a financial ratio that measures a company's ability to pay off its short-term liabilities using its available cash and cash equivalents. It is calculated by dividing a company's cash and cash equivalents by its current liabilities.
Cash and cash equivalents include cash in hand, checking and savings accounts, and short-term investments that can be easily converted into cash. Current liabilities include any debts or obligations that a company must pay within one year.
The resulting ratio shows how many times a company's available cash and cash equivalents can cover its current liabilities. A higher ratio indicates that the company has a stronger ability to meet its short-term obligations, while a lower ratio suggests that the company may struggle to pay off its debts.
Company has $500,000 in cash and cash equivalents and $250,000 in current liabilities. The cash ratio would be calculated as follows:
Cash Ratio = Cash and Cash Equivalents / Current Liabilities
Cash Ratio = $500,000 / $250,000
Cash Ratio = 2
In this example, the company's cash ratio is 2, which means that its available cash and cash equivalents can cover its current liabilities twice over. This suggests that the company has a strong ability to meet its short-term obligations and manage its cash flow effectively.