Thursday, July 21, 2011

Finance and Management - 15

In the last blog, we discussed quick ration. In today’s blog we discuss another measure of the liquidity of the company - the cash ratio.

Cash ratio could be defined as:

Cash Ratio = (Cash + Cash Equivalent + Invested Funds) / Current Liabilities

Cash Ratio from its definition is clearly the most stringent of the 3 liquidity ratio discussed this far - this is primarily because it relies only on the cash at hand! No inventory No Receivables. Cash is obviously the most liquid asset and thus this measure the company's current ability to pay off its financial obligations.

Given this understanding, should one expect this cash ratio to be 1:1? Really this wouldn’t be the best value for cash ratio - having it at 1:1 means that you are paying off the current liabilities with the present cash reserve and this couldn’t really be a good situation for a company. This surplus cash could be considered poor asset utilization for a company to hold large amounts of cash on its balance sheet, as this money could be returned to shareholders or used elsewhere to generate higher returns.

While this ratio give a good understanding of the company's liquidity status, its usefulness is rather limited.

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