In This Article

Profit margins are key performance indicators (KPIs) for business executives. Determining a company’s liquidity is an essential part of providing the necessary information for decision-makers who must develop strategies to maintain profitability and potentially pay off debts. Calculating your business’s cash ratio is an efficient step toward keeping your company well-informed for the future.

## The Cash Ratio Explained

What is the cash ratio? This number is a reading of a business’s liquidity. A formula can be used to specify the ratio of an organization’s total cash to its liabilities. Higher-ups should pay attention to the cash ratio because it communicates how capable a company is of repaying short-term debts using cash and securities.

A high cash ratio often benefits companies by increasing the likelihood that creditors will allow a business to borrow money. The better your cash ratio, the more financing your company may be able to secure from a lender.

### Different Types of Cash Flow Ratios

All cash flow ratios are used to determine the state of a company’s finances and different types can provide different insights. Consider the differences between quick and current cash ratios:

**Quick ratio:**This ratio refers to how capable a business is of covering current liabilities using only its assets. The quick ratio is sometimes referred to as the acid-test ratio. When calculating the quick ratio, you should only include assets that could be converted to cash in 90 days or less.**Current ratio:**Determine the current ratio to measure a company’s capacity to cover short-term debts using short-term assets such as cash, merchandise or receivables.

### About the Quick Ratio

The most significant difference between the quick and current ratios is that the acid-test ratio incorporates accounts receivable in the equation. This category can be understood as the money customers must pay back to your company in a given amount of time. The number and value of receivables you include in the calculation have the potential to make an impact based on the financial status of your company.

For example, your business may work with a client for years and issue receivables with a quick turnaround. This ongoing relationship creates a documented history of on-time payment collection — lowering the risks surrounding the receivables.

### About the Current Ratio

The current ratio is also known as the working capital ratio. This measurement represents the value of the assets that your company can convert into cash in 12 months or less.

Businesses might bring marketable securities, inventory items or prepaid expenses into the calculation. These short-term assets will be evaluated against liabilities like accounts payable.

## What Is a Good Cash Ratio?

A business’s cash ratio will change according to its industry and sector. Some industries depend on short-term debts and funding to keep operations moving. This scenario applies to manufacturing, distribution and technology fields where a high inventory turnover is required.

If you are unfamiliar with the cash ratio concept, the best approach is to strive for a ratio equal to or greater than one. A cash ratio close to one indicates that your business has sufficient funds and cash equivalents to cover all short-term debts.

If your company’s cash ratio is 0.5 or below, you should evaluate business plans and find potential areas for improvement. Ratios at 0.5 or less tell decision-makers that a business currently owes double its funds in short-term debt.

### One Piece of the Financial Puzzle

Understand that a cash ratio measurement of 0.5 to one does not paint an entire picture of a company’s financial standing. Businesses rarely keep cash sitting around. Money on a balance sheet is likely missing investments made to create a more substantial return.

## How to Find the Cash Ratio

The formula for finding your cash ratio is straightforward. Using this measurement allows you to evaluate your company’s cash or cash-equivalent holdings without considering accounts receivable. Find your organization’s cash ratio using the formula below:

- (Cash + Cash Equivalents) / Current Liabilities

Applying the cash ratio formula to your own business can be done in seconds. Consider these examples to see how the equation works in practice before using it to determine your company’s cash ratio.

### Cash Ratio Example 1

We will map out a cash ratio example for Company A. For the 2021 calendar year, Company A held $700,000 in cash and equivalents. The business’s liabilities totaled $550,000 of short-term debt. Placing these numbers into the cash ratio formula, we can calculate the measurement for Company A:

- $700,000 / $550,000 = 1.27

With a ratio of 1.27, Company A is in a great financial position according to the cash ratio formula.

### Cash Ratio Example 2

The next example will review data from Company B. The organization secured $650,000 between cash and equivalents. The liabilities for the business add up to $980,000 of short-term debt. Using the same formula, we can find the cash ratio for Company B:

- $650,000 / $980,000 = 0.66

While the cash ratio for Company B is above 0.5, there is still room for improvement.

## Calculating the Quick Cash Ratio

The process for finding the q