Definition
A financial metric that is used to measure a company's ability to repay its short term debt obligations is called a liquidity ratio. The three most common liquidity ratios include the current, quick, and the cash ratio.
Calculation
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
Cash Ratio = (Cash + Marketable Securities) / Current Liabilities
Explanation
Of the financial ratios that utilize the balance sheet, the cash ratio is the most rigorous test of a company's ability to satisfy short term debt. While the current ratio allows for all current assets in its calculation, the cash ratio limits the liquid assets to cash and marketable securities.
Generally, a cash ratio value that approaches 1.0 is considered satisfactory. With a ratio greater than 1.0, the company can satisfy current liabilities using just their cash and marketable securities and does not have to rely on the collection or payment of accounts receivable.
Liquidity ratios allow analysts, investors and creditors to quickly identify if a company may have trouble meeting its debt coming due in the next twelve months. When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Company A's balance sheet indicates cash and cash equivalents of $2,219,000, short term investments of $1,461,000, and current liabilities of $5,441,000. The cash ratio of Company A would be:
= ($2,219,000 + $1,461,000) / $5,441,000 = $3,680,000 / $5,441,000, or 0.68
Related Terms
The current ratio is a measure of liquidity. The calculation only requires two inputs from the balance sheet: current assets and current liabilities. The current ratio measures a company's ability to pay debt coming due in the next 12 months.
Moneyzine EditorJanuary 12th, 2024- Also known as the acid test, the quick ratio is a measure of liquidity, which is the ability of a company to pay its short term debt obligations using a subset of current assets known as quick assets. The calculation of the quick ratio requires information found on a company's balance sheet.Moneyzine EditorSeptember 21st, 2023
The financial accounting term current assets is generally defined as cash and other assets that can be converted into cash within one year or one operating cycle, whichever is longer. Current assets are a subcategory of assets, which appear on a company's balance sheet.Moneyzine EditorJanuary 12th, 2024
The financial accounting term current liabilities are generally defined as any debts that must be paid within one year or one operating cycle, whichever is longer. Current liabilities are a subcategory of liabilities, which appear on a company's balance sheet.Moneyzine EditorJanuary 12th, 2024
The cash ratio is a measure of liquidity. The calculation only requires three inputs from the balance sheet: cash, marketable securities, and current liabilities. The cash ratio is one of several measures used by investors to understand a company's ability to pay debt coming due in the next 12 months.Moneyzine EditorJanuary 10th, 2024.png)
The term liquidity is used to describe the relative time it takes until an asset is converted into cash, or the payment of a liability is due. Liquidity is a comparative term, meaning it may be easier to convert one asset into cash than another.Moneyzine EditorJanuary 23rd, 2024
The term liquidity risk typically refers to the inability of an investor to buy or sell an asset to minimize or avoid a financial loss. Liquidity risk can also refer to a company's inability to meet a debt obligation without incurring a loss.Moneyzine EditorJanuary 23rd, 2024- The term defensive-interval ratio refers to a measure of the number of days a company can operate using only its current assets. The defensive-interval ratio is considered a measure of liquidity, since it evaluates a company's ability to meet its financial obligations.Moneyzine EditorSeptember 19th, 2023
- The term total debt to total assets ratio refers to a measure of the leverage a company has used in the past to acquire assets. The total debt to total assets ratio is considered a coverage metric, and it's one that provides a relatively broad measure of a company's ability to meet its financial obligations as they come due.Moneyzine EditorSeptember 21st, 2023
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