|Used For:||Accounting, Financial Management, KPIs|
The Cash Ratio (CR), also known as the Liquidity Ratio or Cash Asset Ratio, is a measure of a company’s immediate liquidity, i.e. its ability to pay off all its liabilities immediately without having to sell off any of its inventory.
The cash ratio is considered the most conservative of all the three short-term liquidity ratios, i.e. quick, current and cash. This is because it only takes into account the most liquid of all the short-term assets of a company that can be used to pay off current liabilities while ignoring receivables and inventory. Inventory and receivables are ignored because there is no guarantee that these accounts could be converted in to cash immediately when and if the need arose.
Calculating the Cash Ratio
The CR is calculated by taking the ratio of a company’s complete cash and cash equivalent assets against its current liabilities, as follows:
Cash Ratio Limitations
The following issues should be considered when using the CR:
- CR ignores the timing the timing of both cash received and cash paid out.
- It must be kept in mind that very few companies out there, even the successful ones, actually have enough cash reserves to pay off all of their immediate liabilities. Thus if the CR ratio is not 1:1, it is not necessarily an indicator of bad health.
- CR is rarely used in financial reporting because it is unrealistic for companies to maintain large amounts of cash in order to cover their liabilities. Keeping large amounts of cash is considered poor asset utilization as this cash could be invested in order to generate greater returns, or returned to shareholders.
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