Cash to Net Working Capital Ratio

Cash to Net Working Capital Ratio = Cash / Net Working Capital

Where:

• Cash includes both cash as well as short-term marketable securities.

• Net working capital is calculated as current assets minus current liabilities.

Cash flow measures allow the investor-analyst to understand if the company is able to meet its short-term financial obligations using cash and highly liquid marketable securities. One of the ways to understand the ability of a company to pay these short-term financial obligations is by calculating its cash to net working capital ratio.

By calculating a company's cash to net working capital ratio, the investor-analyst can understand the proportion of its current liabilities that can be paid using only cash and short-term marketable securities. Stated another way, the metric allows the analyst to understand how important the collection of accounts receivable and the sale of inventory is to meeting their current liabilities obligation. If the ratio is much lower than 1.0, then the company must be extremely careful when spending cash.

As is the case with any metric utilizing short-term assets or liabilities, the investor-analyst must be wary of one-time, near-term events that might have affected the balances in these accounts.

Company ABC's CFO would like to understand how much the company relies on the collection of accounts receivable to pay the company's current liabilities. She asked her analytical team to calculate the company's cash to net working capital ratio and report their findings to the finance team. The analysts determined the company's current liabilities were $2,693,000, while current assets were $3,017,000. Current assets included inventory of $2,132,000, accounts receivable of $625,000, cash of $185,000, and marketable securities of $75,000.

Calculating the cash to net working capital ratio:

= ($185,000 + $75,000) / ($3,017,000 - $2,693,000)= ($260,000 / $324,000), or 0.80

Since the ratio is very close to 1.0, the CFO concluded the company did not rely heavily on cash and short-term marketable securities to meet its current liabilities and the focus of the company should be on the collection of accounts receivable and sales of existing inventory.