Financial ratios are a series of basic calculations that use financial data to reveal fundamental information about how a business operates or its current financial position. Investors, internal analysts and market analysts all use ratios to learn about businesses. The ratio of cash assets is one such financial ratio that focuses on a business' degree of liquidity.
A ratio of cash assets, also known as a cash-asset ratio, a liquidity ratio or simply a cash ratio, measures a business' assets against its current liabilities. In particular, it takes into account the value of a business' marketable assets and cash. Cash is money the business holds as savings. Marketable securities are property and investments that the business could sell quickly if needed. For example, stock market investments are marketable securities and would count in a cash-asset ratio. However, patents, which are extremely valuable assets to businesses, would not count because they are not marketable or readily convertible into cash.
The formula for a cash-asset ratio consists of adding the value of a business' cash and marketable assets, and dividing this sum by the value of its total current liabilities. Marketable assets are also known as cash equivalents and have clear prices based on what they sell for on an open market, such as a stock exchange, at a given time. Current liabilities include all of a business' short-term spending requirements, such as accounts payable, accruals and notes payable.
A business' ratio of cash assets indicates several important things. While ratios vary between sectors of the economy and different types of businesses, a high cash-asset ratio indicates that a business has the ability to pay its debts, while a low ratio indicates that it may have difficulty doing so. A rising cash-asset ratio over time shows that a business' growth comes from revenue and retained earnings rather than borrowing. Likewise, a diminishing cash-asset ratio shows that a business' liabilities are growing disproportionately to its ability to pay for them.
Several other financial ratios and accounting metrics share certain features with the ratio of cash assets. One example is the current ratio, which uses the same formula as the cash-asset ratio but adds the value of a business' accounts receivable and its current inventory. Analysts may also look at the proportion of cash to cash equivalents in a business' cash-asset ratio to determine how much of its money is invested and subject to growth or losses, and how much is secure but earning relatively low returns as cash savings.
- Value Based Management: Cash Ratio Formula -- Measuring Liquidity
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