The cash ratio measures a company’s ability to pay its short-term debts using only cash and cash equivalents. It’s one of many financial ratios that investors and lenders use to measure the health of a business and the risk of lending it additional money. The cash ratio is calculated by taking the sum of a company’s cash and cash equivalents and then dividing that sum by the company’s total current short-term liabilities.
You can use our calculator below to determine your company’s cash ratio. A good cash ratio is usually more than 1 as it means a company has enough liquid assets to cover its short-term financial obligations.
The Cash Ratio Formula
The cash ratio formula is shown below:
| Cash Ratio | = | Cash + Cash Equivalents |
| Current Liabilities |
Cash
This is any legal tender the business owns and has possession of, such as coins and other paper currency. Although it will have no impact on the calculation of the cash ratio, this is sometimes confused and combined with cash equivalents, which we cover in the next section.
Petty cash is also included in this figure and describes the funds that are physically kept on premises to cover minor expenses or reimbursements. Tracking petty cash involves several steps—including the requirement to have an assigned custodian and a petty cash journal, something we detail in our guide differentiating cash vs petty cash.
Cash Equivalents
Cash equivalents are items that can quickly and easily be liquidated and turned into cash. This commonly includes demand deposits with banks, such as checking and savings accounts. Low-risk items can also be included, like treasury bills and certain marketable securities like certificates of deposit and money market accounts.
Current Liabilities
For the purposes of the cash ratio, current liabilities are financial obligations that are due and payable within one year. This can include things like business loans, accounts payables, income taxes, and payroll expenses.
Cash Ratio Calculation Example
Given a list of common business expenses and assets, below is an example of how the cash ratio can be calculated.
Cash & Cash Equivalents | |
Checking & savings account balance | $50,000 |
Petty cash | $2,000 |
Paper currency & coins | $3,500 |
Total Cash & Cash Equivalents | $55,500 |
Current Liabilities (total payable within 12 months) | |
Accounts payable | $10,000 |
Taxes | $7,000 |
Payroll Expenses | $2,000 monthly × 12 months = $24,000 |
Business loan payments | $800 × 12 months = $9,600 |
Total Current Liabilities | $50,600 |
Cash Ratio Calculation | |
(Cash + Cash Equivalents) ÷ Total Current Liabilities | $55,500 ÷ $50,600 = 1.097 |
Interpreting the Cash Ratio
The higher the cash ratio is, the more cash a company has to cover its short-term financial obligations. In general, it’s recommended to have a ratio greater than 1. You can multiply the cash ratio by 100 to get the percentage of cash available to cover those debts. For example, a cash ratio of 0.80 means that a company has 80% of the cash needed to cover its current liabilities.
- Less than 1.0 means that the business does not have enough cash or cash equivalents to cover its short-term obligations.
- Equal to 1.0 means the company has exactly the amount of cash needed to cover its current liabilities.
- Greater than 1.0 is an indicator that the business has more than sufficient cash to pay its obligations due within the next 12 months.
Significance of the Cash Ratio
Your company’s cash ratio can impact its ability to get approved for loans and other forms of credit.
- Lenders, landlords, and other types of creditors view high cash ratios more favorably because it is an indicator that your business can easily and quickly cover its financial obligations. This can result in a higher approval rate in addition to more competitive rates and terms.
- Investors may also use the cash ratio as a tool to measure your company’s financial health in determining whether to invest capital or extend credit.
Pros & Cons of the Cash Ratio
| PROS | CONS |
|---|---|
| Provides a snapshot of a company’s ability to quickly pay debts | Does not account for a company’s non-liquid assets |
| Offers insight on liquid assets that can be used to invest in other areas of the business | Only considers a company’s ability to pay short-term debts |
| Can serve as an early warning indicator if additional credit or liquid assets are needed to cover unexpected expenses | May not be as useful for certain industries that are not as cash-heavy due to the nature of the business |
How to Improve Your Cash Ratio
Lenders and creditors view businesses with higher cash ratios more favorably. If you want to improve your company’s cash ratio, you can do so by increasing the amount of cash and cash equivalents you have available and decreasing your company’s short-term liabilities.
✅Convert non-liquid assets into cash. Since the cash ratio only considers liquid assets, such as cash and cash equivalents, you can improve your ratio by converting non-liquid items into cash. This can involve the sale of business equipment and other assets. This may also involve transferring funds from a less-liquid account into a more liquid account, such as a checking or savings account.
✅Review your budget for savings opportunities. Evaluating your budget can help identify areas where you can cut back on expenses. This can increase your monthly cash flow and allow you to deposit excess funds into a checking or savings account.
✅Lower the amount of your current liabilities. Reducing your current liabilities can be done in several ways. You can consider a debt consolidation or refinance in order to lower your payments, something that can be done with a combination of getting a lower interest rate or longer repayment term. You can also try negotiating payment terms with your creditors or other suppliers.
Other Common Financial Ratios
The cash ratio is just one of many other financial ratios that lenders, creditors, and investors can use when evaluating the financial health of your company. Since it’s limited in the factors it takes into account, it’s common for other ratios, such as the current ratio and quick ratio, to be evaluated to obtain a better picture of your company’s overall financial health.
Current Ratio
The current ratio measures a company’s ability to pay its short-term obligations with current assets. Current assets are items that can be turned into cash or cash equivalents within one year. Common examples include accounts receivables and inventory. You can use our current ratio calculator to determine where you stand.
Quick Ratio
The quick ratio is nearly identical to the current ratio. However, the quick ratio only considers current assets that can be converted to cash within 90 days, whereas the current ratio considers items within one year. The quick ratio also specifically excludes inventory. Our guide on the quick ratio details how you can calculate it and how it’s evaluated by lenders.
Frequently Asked Questions (FAQs)
The cash ratio measures a company’s ability to pay its short-term debts using only its current amount of cash and cash equivalents.
A cash ratio greater than 1 is considered ideal. A ratio equal to 1 indicates a company has exactly enough cash and cash equivalents to cover its current liabilities, while a figure less than 1 indicates the company’s cash and cash equivalents are insufficient to cover its short-term obligations.
Yes. In most cases, the cash ratio is just one of many different aspects that lenders will evaluate. If you otherwise have strong credit and finances, you should have no problem getting approved at competitive rates.
Bottom Line
The cash ratio is one of many financial ratios that can be used to evaluate the health of your company, and can be a key determining factor in getting a small business loan. It considers your company’s most liquid assets to determine if they’re enough to cover short-term obligations. It’s ideal to have a cash ratio greater than 1, but failing to meet this threshold will rarely cause issues if you have other compensating factors to offset it.
