Definition of 'Cash Ratio'
The cash ratio is a more stringent measure of liquidity than the current ratio because it only includes cash and cash equivalents, which are the most liquid assets. The current ratio, on the other hand, includes all current assets, which can include less liquid assets such as accounts receivable and inventory.
A high cash ratio is generally considered to be a good sign, as it indicates that a company has the ability to meet its short-term obligations. However, a very high cash ratio can also be a sign that a company is not investing its cash in profitable ways.
The cash ratio is one of several liquidity ratios that can be used to assess a company's financial health. Other liquidity ratios include the current ratio, the quick ratio, and the acid-test ratio.
Here is a more detailed explanation of how the cash ratio is calculated:
* Cash and cash equivalents are defined as cash, cash equivalents, and short-term investments.
* Current liabilities are defined as accounts payable, accrued expenses, and short-term debt.
* The cash ratio is calculated by dividing cash and cash equivalents by current liabilities.
Here is an example of how the cash ratio is calculated:
* A company has $100,000 in cash and cash equivalents and $50,000 in current liabilities.
* The company's cash ratio is 2.0, which means that it has $2 of cash and cash equivalents for every $1 of current liabilities.
The cash ratio is a useful tool for assessing a company's liquidity. However, it is important to note that the cash ratio does not take into account a company's long-term debt obligations. For a more comprehensive assessment of a company's financial health, it is important to consider other financial ratios, such as the debt-to-equity ratio and the interest coverage ratio.
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