Cash ratio

Cash ratio

This ratio is slightly more conservative than the current ratio and the quick ratio. It is used to check the liquidity position of a company from 1 day to 2 weeks.

This ratio is types of liquidity ratio that measure the immediate liquidity of a company between 1 day to 2 weeks

Remark

A question must be arising in your mind that what are the liabilities which need to be repaid immediately, we are giving you an example of this.

Sometimes what happens is that a company takes payment in advance to make a product from the customer, but due to the company not delivering the product to the customer at the right time, the customer demands his money immediately, then the company to deal with such incidents It is very important to have a cash
Through this ratio, we test the liquidity of liabilities of the company from 1 day to 2 weeks.

Formula

cash ratio formula
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Cash ratio is the ratio of cash & cash equipments and current liabilities

Cash ratio = Cash & Cash equivalents / Current liabilities

Seeing this formula, this question must have arisen in your mind that what are the cash and cash Equivalents? So let us know a little bit about it so that you can understand the cash ratio easily

Cash & cash equivalents

Assets of the company that can be converted between 1 day to 2 weeks between cash are kept in the category of cash and cash equivalents. Example- Reserve cash, Bank deposits, Short-term investment (mutual funds and stock market investments), etc.

So we can write the formula in another form of cash ratio

Cash ratio = (Cash + Short-term investments) / Current liabilities

If you do not know about the current assets, inventory, account receivable, and current liability, then you can read the post containing part 1 of the liquidity ratio, whose link we have given, please read now

You can find the data of current assets, reserve cash, short-term investment and current liability on the balance sheet of any Indian company on the website https://www.moneycontrol.com/

Example

  1. If you are considering Company TCS as a potential investment, one of the many pieces of information you examine is the liquidity position (between 1 day to 2 weeks) of the company.
Current AssetsAmount in cr. (March 2020)
1. Current investment25,686.00
2. Inventories5.00
3. Trade Receivables28,660.00
4. Cash & Cash Equivalents4,824.00
5. Short Term Loans And Advances7,270.00
6. Other Current Assets12,749.00

These current assets have only two such assets which can be converted into cash flows, one is a current investment and the other is cash and cash equivalent.

Cash & cash equivalent + current investment = 4,824.00 + 25,686.00 = 30510.00 cr.

Current liabilities = 27,060.00 cr.

When we plug the relevant data into the above formula, we get the Cash ratio of the TCS company.

Cash ratio = 30510.00 / 27060.00 = 1.12

2. We take an example of BHEL (Bharat Heavy Electricals Ltd.) date- 26/07/2020

First of all, you have to go to the https://www.moneycotrol.com website, after that you will have to search by entering the name of the company and you will have to click on the option of financial data upwards. you will get an option of a balance sheet as soon as you click. On which you can find current assets and current liability by clicking.

Current assetsAmount in cr. (March 2020)
1. Current Investments0.00
2. Inventories8,905.46
3. Trade Receivables7,107.62
4. Cash & Cash Equivalents6,418.56
5. Short Term Loans And Advances134.99
6. Other Current Assets10,136.90

These current assets have only two such assets which can be converted into cash flows, one is current investment and the other is cash and cash equivalent.

Cash & cash equivalent + current investment = 0.00 + 6418.56 = 6418.56

Current liabilities = 22,676.84 cr.

Cash ratio = 6418.56 / 22676.84 = 0.2830 = 28%

Therefore, BHEL’s cash ratio is 0.28, which means that the company can pay off only 28% of its current liabilities from Cash & Cash Equivalent.

Important points

  • Cash ratio tells about the immediate liquidity position of the company.
  • No ideal cash ratio, Lender should prefer minimum cash ratio of 0.5 to 1.
  • A high cash cash ratio also means that companybis not utilising its cash efficient.

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