Cash ratio is a liquidity ratio that measures the company ability to pay its current liabilities with readily available funds. It’s a ratio of the company cash and cash equivalents in relationship to its current liabilities. Its similar to the current and quick ratio but a more strict measurement as it only uses the most liquid current assets.
The cash ratio is calculated by dividing the most liquid part of the current assets - the cash and cash equivalents by the total current liabilities.
Cash ratio = Cash and cash equivalents / Current Liabilities
Current liabilities are liabilities that the company need to repay in the next 12 months. Both numbers that are needed to calculate this ratio can be found on the company’s balance sheet.
When the cash ratio is equal to 1, it indicates that the company has exactly the amount of cash and cash equivalents to pay all of its current liabilities. When the number is lower than 1 it indicate that the company does not have a cash at hand to immediately payout all of its short term liabilities. If, for some reason, the company is forced to pay all of its current liabilities immediately, the cash ration will show the ability of the company to do so without having to sell or liquidate other assets.
The cash coverage ratio tells investors and analysts the value of current assets that can be quickly turned into cash. In a way is a measurement that shows the company ability to handle a worst case scenario (if for some reason is forced to pay out all of its current debts). This information is also useful to potential creditors when they decide if they would be willing to loan to a company.