| The
cash asset ratio is used to measures the corporations
ability to quickly liquidate assets and cover
short-term liabilities. The cash asset ratio
is typically of interest to short-term creditors.
The
cash ratio can be calculated as follows:
Cash
ratio = (Cash equivalents + Cash) / Current
liabilities
The
cash ratio excludes both inventory and accounts
receivable in comparison to the current ratio
and it is important to note that the cash ratio
does not take into account the timing of cash
received and paid.
When
using any liquidity ratio, generally accepted
cash asset ratio values will vary by industry
and should only be compared to other companies
in the same industry.
Generally,
a value of at least 1 is required, and the higher
the number, the better. (A ratio of less than
one means the company cannot meet it's current
liabilities and a value of 2 would mean the
company could cover the liabilities twice.)
Generally, higher numbers are a favorable indicator
of the ability to pay short-term debts and very
high ratio values can indicate poor receivables
or excess cash reserves.
- Lower values
show that the company may experience problems
paying short-term debts. Companies with
lower values should consider liquidating
some inventory, refinancing short-term debt
with long-term debt and/or consider a sale/leaseback
of fixed assets.
- Extremely high
ratio's can indicate unnecessary accumulation
of funds (too much inventory) or bad financial
management.
Out
of the three main liquidity ratio's, typically
the cash ratio will tend to understate the short
term liquidity and the current ratio will tend
to overstate the short term liquidity while
somewhere in the middle is the acid test/quick
ratio.
Note:
Ratios should not be used as the only valuation
method since ratios are only as reliable as
the data on which they are based. Ratio's should
therefore be supplemented with other complementary
methods to achieve a reasonable opinion.
Also
see:
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