Cash Ratio: Calculations, Examples, and Meaning

The Cash Ratio is defined as a company’s Cash & Cash-Equivalents / Current Liabilities, and it captures a company’s ability to repay its short-term obligations using only its Cash, without selling assets, borrowing more, or collecting owed customer payments.

The Cash Ratio is an example Liquidity Ratio; like the others, it’s a measure of the company’s operational and credit risk.

It is the strictest Liquidity Ratio because it includes only the company’s Cash in the numerator – unlike the Current Ratio and Quick Ratio, which both include additional short-term assets, such as Inventory and Accounts Receivable.

Files & Resources:

Liquidity Ratios – Slides (PDF)

Liquidity Ratios – Extracts from Illinois Tool Works Filings (PDF)

Illinois Tool Works – Liquidity Ratio Analysis (XL)

Video Table of Contents:

1:39: Part 1: The Top 3 “OG” Liquidity Ratios
4:00: Part 2: Unofficial Liquidity Ratios
8:25: Part 3: Liquidity Ratios in Real Life for Illinois Tool Works
10:44: Recap and Summary

What is the Cash Ratio?

Cash Ratio Definition: The Cash Ratio equals a company’s Cash & Cash-Equivalents divided by its Current Liabilities. It indicates whether the company can immediately repay its short-term obligations using only its Cash on hand, without selling assets, raising more capital, or collecting owed payments. Higher Cash Ratios indicate less credit and liquidity risk, but if a company’s ratio is too high, it could indicate mismanagement or misallocated capital.

As with the other Liquidity Ratios, context is king for understanding the Cash Ratio.

By itself, it doesn’t mean much; you want to look at trends and changes over time, such as how it has changed in the past few quarters and how it compares to the historical levels and the ratios of comparable companies.

Some sources online say that a “good” Cash Ratio is between 0.5x and 1.0x, but this is a meaningless statement that doesn’t necessarily apply to all industries.

For example, if a company converts its Receivables and Inventory into Cash very quickly, the Cash Ratio might not matter all that much; the Quick Ratio or Current Ratio might suffice in these cases.

Also, if the company’s Current Liabilities consist mostly of items like Deferred Revenue rather than Debt or Accounts Payable, a higher Current Liabilities balance isn’t necessarily “bad.”

High Deferred Revenue is often viewed as a positive sign because it means the company is collecting more Cash upfront from customers!

You can see an example of the Cash Ratio calculation for Illinois Tool Works [ITW] below (see the Excel file and filing PDF above):

The Cash Ratio here is 0.16x, which means that ITW has $0.16 of Cash for each $1.00 in current liabilities.

This means that ITW could not afford to repay all its short-term obligations using its Cash and taking no other actions.

Many people would call this a “negative sign,” but, again, context is essential.

If the company never has any trouble collecting Cash from customers or selling its Inventory as finished products, this point might be irrelevant because it will never be in a position where it needs to use its Cash like this.

On the other hand, it is concerning that the company’s liquidity has fallen over the past few years:

The key driver is that ITW’s Cash balance has fallen, while its Short-Term Debt has risen.

We should look into this and do a deeper dive on the company’s Cash and Debt to see why this is happening, but it could be something innocuous.

For example, maybe some of the company’s Long-Term Debt is maturing soon, so the company has reclassified a portion as Short-Term Debt.

If the company plans to “refinance” by issuing new Debt to replace this older Debt that needs to be repaid soon, this low Cash Ratio means very little.

It would mean something negative only if the company had trouble refinancing its existing Debt due to a poor credit profile (for example).

What is a Good Cash Ratio?

The “magic number” from random copy/pasted online articles written by monkeys at keyboards seems to be “between 0.5x and 1.0x,” but we would argue this is a meaningless range.

The Cash Ratio is like a blood pressure reading at the doctor’s office: It doesn’t necessarily tell you what is wrong if your reading is too high or too low, but it does tell you that you may need to do additional tests to figure out the problem and its root causes.

Continuing with the example above, if we dig in and find that the Cash Ratio has fallen just because some Debt is close to maturity, we’d ignore it and move on (unless there are signs the company could not refinance its Debt).

On the other hand, if we dig in and find that the Cash Ratio has fallen because it’s getting harder to collect Cash from customers, while the company’s Payables are piling up (i.e., there are more and more owed bills to suppliers), that would be a cause for concern – especially if the industry is also declining.

Cash Ratio vs. Quick Ratio

These ratios are both stricter than the Current Ratio, but they have some distinct differences in meaning and calculations:

1) Scope of Assets Considered: The Quick Ratio focuses on the most-liquid assets — specifically, Cash, Cash-Equivalents, and Accounts Receivable. It is based on the idea that certain assets, such as Inventory, may not be as easily convertible into Cash, especially in a crisis or downturn.

But the Cash Ratio is even stricter since it includes only the Cash and Cash-Equivalents, implicitly assuming that the company cannot collect its Receivables to increase its Cash balance.

2) Conservatism: The Cash Ratio is more conservative than the Quick Ratio because of this difference above. It’s especially pronounced for companies with high Accounts Receivable, or companies that take a long time to collect these owed payments, such as 90 days or more.

3) Lender Perspective: From a creditor’s standpoint, the Cash Ratio is a better test of the company’s “worst case liquidity.” The Quick Ratio is more forgiving, but many lenders like to focus on these worst-case outcomes since their upside is limited, but their downside is high if the company defaults or goes bankrupt (see our debt vs. equity tutorial).