Definition

Cash ratio is the ratio of total cash and cash equivalents to its current liabilities of a company. It is commonly used as a measure of liquidity of a company. It reflects how quickly a company can pay its short term liabilities.

Explanation of Cash Ratio

It is a more conservative look at the ability of a company to settle its liabilities than many other liquidity ratios. Cash ratio should not be used for the determination of company value, but simply as a factor to determine the company’s liquidity. Cash ratio is an effective indicator of a liquidity of a company that is used to refine the quick and the current ratio by measuring the amount of cash equivalents, cash, and other invested funds.

This ratio also ignores account receivables and inventories, as it is not sure that these two accounts can be converted into cash if conversion is required on an urgent basis to meet the current liabilities. Few companies have this ability to keep their business liquid and cover the short term liabilities.