Cash Ratio is a type of Liquidity Ratio that determines a company’s capacity to meet its short-term liabilities/debts only with Cash and Cash Equivalent. It measures the extent to which cash and cash equivalents cover the current liability of the company.
$$Cash\quad Ratio=\frac { Cash\quad and\quad Cash\quad Equivalent }{ Current\quad liabilities } $$
$$Cash\quad Ratio=\frac { Cash\quad and\quad Cash\quad Equivalent }{ Current\quad liabilities } $$
- Significance and InterpretationCash and Cash Equivalents are those assets which in the form of cash or can be converted to liquid cash immediately. For Example, Tradable Security and Short-Term Deposits are considered as Cash Equivalents as they can be converted to cash immediately.
- Current Liabilities are the liabilities or debts that are due for payment within a year.
- Cash Ratio = 1: This implies that the company can meet its current liabilities only with cash and cash equivalents itself.
- Cash Ratio < 1: This implies that the company does not have enough cash and cash equivalent to meet its current liabilities.
- Cash Ratio > 1: This implies that the company has surplus cash and cash equivalents over its current liability.
- Ideally, Cash Ratio =1, a higher value of Cash Ratio indicates that the funds of the company are not utilized efficiently.
- However, it should be noted that Cash Ratio < 1 does not indicate that the company is in bad shape as it might be possible that the company has a variety of investments placed that may be converted to cash at the time of need.
- Cash Ratio is the best measure of Liquidity as it indicates only liquid cash and cash equivalents. However, it must be noted that this limit may shift depending upon the regulatory reforms and/or type of business.
- Cash Ratio = Cash and Cash Equivalents / Current Liabilities
- Current Ratio = Current Asset / Current Liability
- Cash Ratio / Current ratio = Cash and cash Equivalents / Current Assets
Examples
Example 1:
M/S ABC Ltd. has Current Assets worth ₹ 520 Cr out of which Cash and Cash Equivalents are ₹ 300 Cr. and Current Liabilities of ₹ 500 Cr. Calculate the Cash Ratio for the companySolution:
Cash and Cash Equivalents = 300 Cr and Current Liabilities = 500 Cr.
Cash Ratio = Cash and Cash Equivalents / Current Liabilities
Cash Ratio = Cash and Cash Equivalents / Current Liabilities
⇨ 300 /500
⇨ 3/5
Hence, Cash Ratio = 3/5 or 0.6
Hence, Cash Ratio = 3/5 or 0.6
Example 2:
The following information is available about M/S XYZ Ltd, find a cash ratio of the firm.| Sr. No | Particulars | Amount (in ₹ Cr) |
|---|---|---|
| 1 | Accounts Receivable | 400.00 |
| 2 | Bills Payable | 150.00 |
| 3 | Inventories | 125.00 |
| 4 | Cash Balance | 150.00 |
| 5 | Tax Payable | 50.00 |
| 6 | Marketable Securities | 100.00 |
Solution:
Cash and Cash Equivalents = (Cash Balance + Marketable Securities)
⇨ (150 +100)
Hence, Cash and Cash Equivalents = 250 Cr.
Current Liabilities = Bills Payable + Tax Payable
Hence, Cash and Cash Equivalents = 250 Cr.
Current Liabilities = Bills Payable + Tax Payable
⇨ (150 + 50)
⇨ 200 Cr
Cash Ratio = Cash and cash Equivalents / Current Liability
Cash Ratio = Cash and cash Equivalents / Current Liability
⇨ 250 / 200
⇨ 1.25
