What Is the Cash Ratio?

What Is the Cash Ratio?

Let me explain the cash ratio directly: it's a measure of how easily a company can cover its short-term liabilities using just its most liquid assets, which are cash and cash equivalents.

You calculate it by dividing the company's total cash and cash equivalents by its current liabilities. Cash equivalents include things like marketable securities that you can quickly turn into cash if needed.

If the ratio is acceptable, it means the company can handle all its current debt payments. This varies by industry, but typically it's between 0.5 and 1.0.

Key Takeaways

Lenders look at a company's cash ratio when deciding on loans, and investors use it to gauge stability. Remember, this ratio is more conservative than others because it only counts the most liquid resources.

A ratio over one shows cash exceeds debts, while under one means more short-term debt than cash.

Cash Ratio Formula

The cash ratio gives a conservative view of a company's debt-covering ability compared to other liquidity ratios, as it excludes assets like accounts receivable and focuses solely on cash or cash equivalents.

Here's the formula: Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities.

What the Cash Ratio Can Tell You

This ratio shows if a company can pay all current liabilities right away without selling other assets. It's expressed as a number above or below one—if it's one, cash matches liabilities exactly.

Think of it as a worst-case scenario indicator: if the company is failing, it tells creditors what percentage of debts the cash assets would cover.

The U.S. Small Business Administration recommends using this and other liquidity ratios to track liquidity, capacity, and collateral, especially when seeking loans.

Calculations Less Than 1

When the cash ratio is less than one, the company has more liabilities than cash and equivalents, meaning not enough cash to pay off short-term debt immediately.

But this isn't always a red flag—factors like long supplier credit terms, efficient inventory, or minimal customer credit can explain it.

Calculations Greater Than 1

A ratio greater than one means more cash than liabilities, so the company can cover debts and have money left over.

Generally, higher is better, but it might indicate inefficient cash use, like not leveraging low-interest loans for growth. It could also signal worries about future profitability, prompting a cash buildup.

Example of the Cash Ratio

Take Apple, Inc. at the end of 2024: it had $30.2 billion in cash and $23.5 billion in marketable securities, totaling $53.7 billion for short-term debt payment.

With about $123 billion in current liabilities like accounts payable, the ratio is $53.7 billion / $123 billion = roughly 0.43.

This reflects Apple's strategy of using debt, favorable credit, and prioritizing cash for growth.

Important Comparison

The current ratio is similar but includes more assets in the numerator, making the cash ratio a stricter measure of liquidity.

Limitations of the Cash Ratio

You won't see the cash ratio much in financial reports or analyses because holding excessive cash to cover liabilities is often viewed as poor asset use—better to return it to shareholders or invest for returns.

It's most useful when compared to industry or competitor averages, or tracked over time in the same company. Some industries naturally have higher liabilities and lower cash.

Analyzing it over time accounts for improvements or seasonality, but a low ratio might overstate risk if it's part of a strategy like low reserves for expansion.

What Is a Good Cash Ratio?

A good ratio varies by industry, especially those with quick inventory turnover relying on short-term debt.

Generally, equal to or greater than one means enough cash to pay all short-term debts. Below 0.5 is risky, as debt is twice the cash.

What Does the Cash Ratio Measure?

It measures liquidity—how well a company can pay current liabilities. High liquidity eases bill payments; low makes it harder.

Is It Better to Have a High or Low Cash Ratio?

Usually, high is better, indicating more cash, fewer liabilities, and easier debt payoff.

But too high might mean inefficiency in cash management or credit use, so reducing it could be advantageous.

The Bottom Line

Calculate the cash ratio by dividing cash and equivalents by short-term liabilities. To improve it, build more cash reserves through faster inventory turnover, less inventory, or avoiding prepayments.

You can also cut liabilities by paying with cash if credit terms worsen, or reduce overall spending to lower obligations.