A low cash ratio is not good. It means there are not enough cash reserves to cover current liabilities. This is typically brought on when a business uses the day’s cash collections from A/R (Peter) to pay off old A/P (Paul) because a vendor has put you on COD until you pay down your past-due invoices. It also leads to maxed-out credit cards.
A low cash ratio is a function of insufficient Cash Quality to pay down financial obligations from profits.
Overview
The Cash Ratio is a Liquidity Ratio that shows the company’s readiness to immediately cover current liabilities by measuring a company’s ability to pay off its current liabilities with only cash and cash equivalents as a percentage of current liabilities.
The Cash Ratio is used to confirm that a company maintains adequate cash balances to pay off all of its current debts as they come due, given that inventory could take months or years to sell, and that receivables could take weeks to collect. A healthy Cash Ratio shows cash is available to repay creditors.
The formula for calculating the Cash Ratio is as follows:
(Cash + Cash Equivalents) / Current Liabilities
A Cash Ratio of 1 means that the company has the same amount of cash and equivalents as its current debt.
Above 1: means that all the current liabilities can be paid with cash and equivalents.
Less than 1: means that not all of the current liabilities can be paid with cash and equivalents.
