Cash Ratio, Research Paper Example

The Financial Ratio that I would select in order to be most useful for business today, is that of the Cash Ratio. The illustration to the right shows the computation algorithm in order to determine the result of the Cash Ratio.  It is essentially the Cash Equivalents + Cash divided by the current liabilities i.e. Accruals + Accounts Payable + Notes payable. It is essentially a mathematical formula for measuring the liquidity of a Company, calculating the ration between its cash and current liabilities.  The ratio has also been termed the Liquidity Ratio and Cash Asset Ratio.  It provides an indicator or guide to the extent which a Company can pay its liabilities, this without have to adopt sale of inventory or inventory reduction and without reliance upon receipt of accounts receivables. “The cash asset ratio formula is relatively straightforward, and is derived by adding together all available cash on hand and market securities available for sale and then dividing that figure by the total short-term financial liabilities and obligations the company has incurred” (mysmp.com, 2010).

Example:

Any Manufacturing Company

Has the following financial profile:

$20,000 in liquid market securities

$30,000 Cash in Hand

= Total Current Assets = $50,000

$30,000 = Short Term Liabilities

($20,000 in securities + $30,000 cash in hand) / $30,000 (Short term debt)

= ($20,000+$30,000) / $30,000

= $50,000/$30,000

= Cash Ratio of  1.66

Those ratios that are over 1.0 are considered as positive indicators and as such show that a company or business is able to meet current obligations and as such continue business operations. Those that are under 1.0 are viewed as negative indicators and are often frowned upon by investors or banks’ lending the company money.  Equally if the indicator goes a long way above 1.0 it might prove indicative of a high positive indicator and this may illustrate a lack of investment in core business and therefore indicate a business with less ability to expand and develop. “The cash ratio is the most stringent and conservative of the three short-term liquidity ratios (current, quick and cash). It only looks at the most liquid short-term assets of the company, which are those that can be most easily used to pay off current obligations. It also ignores inventory and receivables, as there are no assurances that these two accounts can be converted to cash in a timely matter to meet current liabilities.” (Investopeadia, 2010).

Financial Ratios are classified in accordance with the type of financial information that they provide. Examples of other useful ratios include:

• Liquidity Ratios
• Asset Turnover Ratios
• Financial Ratios
• Profitability & Leverage Ratios (NetMBA, 2010)

Works Cited

Investopeadia. (2010). Cash Ratio. Retrieved 11 9, 2010, from Investopeadia: http://www.investopedia.com/university/ratios/liquidity-measurement/ratio3.asp

mysmp.com. (2010). Cash Asset Ratio. Retrieved 11 9, 2010, from mysmp.com: http://www.mysmp.com/fundamental-analysis/cash-asset-ratio.html

NetMBA. (2010). Financial Ratios. Retrieved 11 9, 2010, from NetMBA: http://www.netmba.com/finance/financial/ratios/