Cash Ratio (Liquidity) – Meaning, Formula and Example

The Cash Ratio (CR) is an important liquidity ratio in financial analysis. This ratio measures a company’s ability to immediately cover its short-term liabilities. Very low values may indicate potential repayment risks, while very high values could point to inefficient cash management. The cash ratio can also serve as a financial covenant and is an important parameter monitored during due diligence in M&A transactions.

Cash Ratio – Definition and Formula

The cash ratio is calculated as the ratio of cash and cash equivalents to current liabilities. The source for this calculation is the company’s financial statements, specifically the balance sheet.^{1 2}

Where:

• Cash and cash equivalents = cash + highly liquid assets
• Current liabilities

Formula description:

• The numerator includes all the most liquid assets – see the section on how to calculate cash and equivalents.
• The denominator contains liabilities due within one year (current liabilities) – see the section on how to calculate current liabilities.
• The resulting ratio indicates to what extent the company can immediately cover short-term liabilities (for example, if they were suddenly called in by a bank or similar scenario).

How to Calculate Cash and Cash Equivalents

Cash and equivalents include all cash and near-cash instruments. Therefore:

Cash and cash equivalents = cash + highly liquid assets

a) Cash:

• Current accounts
• Cash on hand
• Cash in transit – money sent between accounts but not yet received.

b) Cash Equivalents:

These are instruments very close to cash in terms of liquidity and risk. They are quickly convertible to cash and carry minimal market risk. Examples include:

• Government treasury bills
• Marketable securities (maturing within 1 year)
• Money market funds

How to Calculate Current Liabilities

Current liabilities are obligations due within one year. They may vary slightly by company, but typically include:³

• Accounts payable
• Short-term loans
• Employee-related liabilities
• Tax liabilities
• Accrued expenses
• Advance payments received
• Accrued interest on long-term loans due within the period

Cash Ratio – Interpretation and Recommended Values

By applying the formula, we can assess how well a company can cover its short-term liabilities. The higher the ratio, the better the company can manage its operations and respond to unexpected financial demands (e.g., a loan is called in, or an unplanned expense arises).

The cash ratio can be evaluated as a single point in time, but it is more insightful to analyze it over a longer period (trend analysis). When interpreting the ratio, consider company characteristics – size, life cycle stage (startup vs. established company), industry, economic environment, collection management, and client diversification. Different types of businesses may require different cash reserves. Each company has its own working capital strategy and money management approach. Drawing conclusions based solely on the ratio without context is not recommended.

Regarding recommended values, there are slight differences between Czech and international sources. There is no single “correct” value range, but generally:

• Czech sources suggest a range of 0.3 – 0.5; Czech Wikipedia notes 0.2 as a critical threshold (link).
• International sources are more conservative, preferring values between 0.5 – 1.

During my university studies (about 10 years ago), recommended values were around 0.3 – 0.5. However, the global economy has evolved since then, with unprecedented monetary expansion, geopolitical risks, disrupted supply chains due to COVID, and other challenges. Regardless, the purpose of the cash ratio is to quantify the ability to cover short-term liabilities and manage financial risk. Optimal values vary by company, industry, and economic context. Lower values near the critical threshold may still be acceptable and could indicate good financial management, or they might not. ⁴

1. Investopedia, Cash ratio [online]. [cit. 2025-10-29]. Available at: https://www.investopedia.com/terms/c/cash-ratio.asp
2. Corporate Finance Institute, Cash ratio formula [online]. [cit. 2025-10-29]. Available at: https://corporatefinanceinstitute.com/resources/accounting/cash-ratio-formula
3. Indeed, Current liabilities formula [online]. [cit. 2025-10-29]. Available at: https://www.indeed.com/career-advice/career-development/current-liabilities-formula
4. Master Class, Cash ratio explained [online]. [cit. 2025-10-29]. Available at: https://www.masterclass.com/articles/cash-ratio-explained