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Cash Ratio

The cash ratio is a financial metric that measures a company's ability to pay off its short-term liabilities using only its most liquid assets: cash and cash equivalents. The ratio is calculated by dividing cash and cash equivalents by current liabilities. A high cash ratio indicates that a company has a strong liquidity position and can easily cover its short-term obligations without relying on other assets. However, an excessively high ratio may suggest that the company is not using its cash efficiently to invest in growth.

Example

A company has $500,000 in cash and cash equivalents and $300,000 in current liabilities. Its cash ratio would be 1.67, indicating that it has more than enough cash to cover its short-term debts.

Key points

• The cash ratio measures a company’s ability to pay short-term liabilities using cash and cash equivalents.

• A ratio greater than 1 indicates strong liquidity; less than 1 suggests a potential liquidity risk.

• It helps assess whether a company can meet short-term obligations without selling other assets.

Quick Answers to Curious Questions

The cash ratio is calculated by dividing cash and cash equivalents by current liabilities.

A high cash ratio indicates that a company has strong liquidity and can easily cover its short-term debts.

While a high cash ratio indicates liquidity, it may also suggest that the company is not effectively using its cash for investment or growth opportunities.