## How to Perform a Cash Ratio Analysis in Excel

The Cash Ratio represents a measurement of the liquidity of a company. It evaluates the ability of the business to cover short-term obligations with cash and cash equivalents alone.

It is particularly useful to creditors when deciding how much money they are willing to loan to a company. Suppliers also consider the ratio when assessing the optimal credit terms to provide to a client.

The Cash Ratio indicates a business’s value in a worst-case scenario when it’s about to go out of business. The metric shows the amount of cash and assets that we can quickly convert to money and what portion of current liabilities these can settle.

## What is the Cash Ratio?

The ratio shows us the company’s ability to cover short-term obligations using only cash and cash equivalents. It is more conservative than other liquidity ratios because it considers only the most liquid assets of the business.

Cash equivalents are generally short-term assets that we can convert to cash in less than 30 to 90 days.

We present the ratio as a number.

If it’s below 1.0, this means cash on hand is insufficient to cover current liabilities. This is rarely an issue, specifically if the company has extended credit terms with its suppliers and efficiently manages inventory.

If the Cash Ratio is above 1.0, the business can cover all its current liabilities and still have some cash left. A high ratio may not always be a good thing. If it’s way above the industry average, management does not utilize cash efficiently, and they let it stagnate instead of investing in profitable projects. The reason for this can also be that the company is accumulating a cash cushion, as it expects drops in profitability. An example of such a case will be a business that experiences significant seasonality fluctuations in its operations.

## Cash Ratio and Other Liquidity Ratios

As with other ratios, like the Current Ratio and the Quick Ratio, the Cash Ratio uses current liabilities for the denominator.

Current liabilities include obligations due in less than one year, such as short-term debt, accrued liabilities, and accounts payable. The critical difference between those ratios is the numerator they are using.

The difference between the three ratios is the extent to which we include current assets in the calculation. While the Cash Ratio only considers the business’s most liquid assets, the quick ratio also includes receivables in the numerator. At the same time, the current ratio goes further and also considers inventory.

Short-term assets, like inventory and accounts receivable, may require substantial time and effort to find a buyer and be converted to cash. Also, it may be impossible to forecast the amount such assets can yield if sold hastily.

If a company faces the necessity to pay all current liabilities at once, this metric shows if that’s possible without having to liquidate other assets.

As the Cash Ratio excludes receivables and inventory, this makes it a preferred choice for creditors than other liquidity ratios.

Inventory can take months to even years to realize, and receivables can take anywhere from weeks to months to collect, so these may not be available for current debt settlement.

### Comparison to Quick Ratio

The significant difference between the Cash and Quick ratios is in the assets in the numerator. The Quick ratio also considers trade receivables as part of the calculation. Whether we should consider these as truly short-term depends on the particular company.

Some companies may work with stable customers and be able to collect their receivables quickly. Such good collection history means there’s a limited risk if we add receivables to the short-term assets, even though the firm is yet to convert them to cash.

### Comparison to Current Ratio

The current ratio builds on top of the quick ratio by introducing inventory to the equation. Again, depending on the company and industry, the stock may be fast to realize, or it may be a part of a constant flow ‘supplier -> firm -> client.’ We can assume that inventory inclusion in the ratio will not add significant additional risks in such circumstances.

In industries where inventory is more volatile, it is a bad idea to include in a liquidity measure.

## Cash Ratio Analysis

We usually combine the Cash Ratio with the other two liquidity ratios (quick ratio and current ratio).

The metric is particularly useful when a company is entering bankruptcy. It makes no assumptions for the collectability of receivables or the business’s ability to sell inventory fast. Therefore, we often use the Cash Ratio to evaluate a worst-case scenario.

Generally, most analysts often don’t use the measure, as it shows an unrealistic degree of risk. It also places too much importance on cash, which is not applicable in most well-managed businesses.

If current liabilities include accrued expenses, we may consider subtracting these. The company has incurred and accrued the expense, but it’s not billed yet, and it may become due later in time. If these are significant, we might decide to adjust the formula.

It is important to note that we rarely use this variant of the formula when we need higher precision.

When we evaluate the Cash Ratio, we may consider some of the following factors.

The industry is an essential aspect of the analysis. A reselling company continually buys and sells inventory, which can bring its Cash Ratio close to zero. On the other hand, construction companies usually keep a cash buffer to pay out salaries and purchase materials, so their metric can go much closer to one.

Risk-averse business owners tend to keep more cash in the company, just in case something unexpected happens. At the same time, risk-prone investors tend to operate at a lower Cash Ratio, utilizing available cash to grow the business.

A company in a rapid growth stage would keep more money on hand to support the fast expansion.

Economic conditions are another factor for analysis. If the business operates in an unstable political or economic environment, it tends to follow the principle that ‘cash is king’ and keep more liquid assets on the balance sheet.

## Limitations

Analysts seldomly use the Cash Ratio in financial reporting or analysis, as for big companies, keeping excessive cash enough to cover current liabilities is not realistic. In most cases, we will consider supporting large amounts of money on hand as poor asset utilization.

The metric is most useful when we benchmark it against competitors’ and industry averages. Another helpful way to analyze the Cash Ratio is to look at its development over time.

## Improving the Cash Ratio

A company that wishes to improve its Cash Ratio may do one of the following:

• Increase the ratio by keeping net profits in cash and cash equivalents;
• Repay obligations to reduce current liabilities and cut non-essential expenses;
• Take a loan for fast cash in-flow.

And if the metric is too high, the company can invest a portion of its cash balances into longer-term projects.

## Example Analysis in Excel

Calculating and analyzing the Cash Ratio of the company starts with a look at the balance sheet. This is where we get the cash and cash equivalents balances. If we opt to compare the measures to the quick and current ratios, this is also where we would get the balances of receivables and inventory.

And looking a bit further down, we can also find the Current Liabilities balance.

Using the above-mention values, we can easily calculate the Cash Ratio, as per the formula we discussed.

There is some volatility to the metric’s development in the observed periods. However, as soon as we plot the ratio, we can see it has a declining trend. Generally, this is a red flag for creditors.

We can extend our analysis by looking at the other two liquidity ratios. We can see that these improve over the period, indicating that the company’s overall performance is better.

But the significant improvement in the current ratio is mainly due to the addition of inventory on top of the assets we use in the quick ratio calculation. This may also mean the company is piling up stock that it cannot realize. A potential result of this would be higher allowances for slow-moving and obsolete inventory in the future.

## Conclusion

The Cash Ratio shows us the portion of current liabilities that the company can settle immediately. Generally, we would aim at a value between 0.1 and 0.2.

However, it is essential to remember that we need to benchmark the ratio against our industry’s average and compare it to our competitors. Another way to analyze the metric is to look at its development over time.

## FCCA, FMVA

Hi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with.

In my spare time, I am into skiing, hiking and running. I am also active on Instagram and YouTube, where I try different ways to express my creative side.

## You might also like one of the following articles:

Financial Analysis

### The Purpose of Budget vs. Actuals Analysis

Introduction Running a business comes with many responsibilities. One of the more challenging aspects is being able to forecast future performance and being able to

Excel and VBA

### Unlocking Success: The Importance of Continuous Learning in FP&A

In the ever-evolving landscape of financial planning and analysis (FP&A), we succeed by mastering existing skills and continuously learning and improving. FP&A professionals play a