Calculation / Formula

The calculation of cash ratio involves cash and cash equivalent current assets and current liabilities. The formula of cash ratio is as follows:

Cash Ratio = Cash and Cash Equivalents / Current Liabilities payable within 12 months or Operating Cycle

Piggybank Surrounded In Coins Showing European SavingsCash & Cash Equivalents

Cash includes only the balances lying as cash in hand and in bank accounts. Cash equivalents are those short-term assets which are readily convertible to cash and are highly liquid in nature. For example stocks, bonds, government securities, treasury bills, bank deposits, money market instruments etc. The primary purpose is to include only those assets whose encashment is readily possible within a very short span of time say 3 months or so. Here, closing stock, debtors, and miscellaneous expenses are not considered because they are not the cash equivalent.

While calculating the ratio, the value of cash equivalents should be the net realizable value (NRV). NRV is the value or amount which can be realized if sold immediately. NRV is taken to avoid the risk of change of the market value of the investments.

Current Liabilities Repayable within Operating Cycle

Cash ratio intends to find out the capacity of the company to meet its short-term debts using its most liquid items. The short-term debts are debts repayable within 12 months or within the operating cycle. Major items being sundry creditors, outstanding expenses, short-term loans & advances, bank overdraft/cash credit, provision for taxation, proposed dividend, unclaimed expenses etc. The more the cash ratio, the more efficient the company is in paying off its short-term dues.


Let’s assume balance sheet of a company as on 31.03.2013 as follows:

Liabilities Amount Assets Amount
Equity share capital 5,00,000 Fixed Assets 5,00,000
Reserves & Surplus 1,50,000 Investments 1,00,000
Unsecured Loans 70,000
Current Liabilities-Sundry Creditors-outstanding  Expenses

-Provision for Tax



Current Assets-Closing Stock-Debtors

-Cash in hand

-Cash at Bank

-Bank Deposit

-Treasury Bills

-Prepaid Expenses







8,00,000 8,00,000

Cash Ratio = cash in hand+ cash at bank + bank deposit + treasury bills
sundry creditors +o/s expenses + provision for tax
= 15,000+35,000+55,000+15,000
= 1,20,000 / 80,000
= 1.5

Here, the cash ratio is 1.5, which signifies that there is excess cash after paying off current liabilities.


The interpretation of cash ratio will vary from business to business. There is no such ideal cash ratio. Following is an indicative understanding of the ratio.

Cash Ratio equals to 1

It means cash and cash equivalents are equal to the short-term liabilities.

Cash Ratio greater than 1

It means more cash in the system than required for payment of short-term liabilities. A creditor of the company will be happy with such ratio as higher as possible because that will reduce the chances of any delay in paying his dues. But, on the other hand, the company would like to keep it low or optimized to suit its requirements because idle cash means unwanted loss of interest cost.

Cash Ratio lower than 1

It means cash in the system is insufficient to pay for short-term liabilities. A creditor of the company will assume more risk while extending credit to the company. In this case, they will rely on the previous track record of the company. Lowest possible cash levels with no delays in creditor’s payments in the company make the management happy because they see the savings in terms of interest cost on idle cash and effective cash management.

Various Other Interpretations of the High Levels of Cash in the Industry

Companies with large cash in the balance sheet indicate that there are limited growth opportunities available to the company otherwise such idle cash could have been used for expansion. From mergers and acquisition point of view, these companies are the potential target for the acquirers. Last but not the least, idle cash does not return anything and hence opportunity cost of interest on the idle cash is a direct dent in the profits of the company.


Last updated on : February 21st, 2018
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About The Author

Sanjay Bulaki Borad
Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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