The cash ratio formula contains two parts, cash and cash equivalents, and current liabilities. Cash and cash equivalents are either cash itself or assets that are so easily converted into cash that they are considered cash-like, and current liabilities are obligations due within a year’s time. Simply divide the former into that latter to calculate the cash ratio.
Let’s look at a simple example based on a company. Usually, you’ll be calculating cash ratios on companies, as in the example, but just keep in mind that you could even calculate a cash ratio on your personal balance sheet.
Suppose a company has a balance sheet that looks like the one below.
|Cash and Cash Equivalents||$||13573||$||12925|
|Total Current Assets||15989||15560|
|Property, Plant, and Equipment||40334||40129|
|Other Current Liabilities||47||55|
|Total Current Liabilities||14723||20631|
|TOTAL LIABILITIES AND EQUITY||$||33057||$||25459|
Say you’re looking to invest in this company, but you want to look at how liquid this company is compared to its competitors, and you are going to use the cash ratio to do just that. So how do you do it? All you have to do is take the “Cash and Cash Equivalents” line from the assets side (the most recent year) and divide it by the line on the liabilities side of the balance sheet titled “Total Current Liabilities” (again, the most recent year). The calculation is shown below:
And there we have it, a cash ratio of 0.92. This means that the company can cover 92.2% of its liabilities due within a year with cash and cash-like items.