As a businessman, you must understand and know about cash ratios, which are part of financial ratios. So, what is meant by financial ratios? This financial ratio is a technique for analyzing financial statements and explaining a relationship between a certain amount and another amount in the financial statements. One of the elements used in financial ratios is the cash ratio or what is often referred to as the cash ratio.
Understanding Cash Ratio
The cash ratio or what we know better as the cash ratio is the ratio used to make a comparison between the total cash and cash equivalents of a company and its current liabilities.
Cash ratio is a refinement of the quick ratio which is used to identify the extent to which funds are prepared to pay off current liabilities or short-term debt. Usually prospective creditors use this ratio as a measure of the company’s liquidity and how easy it is for the company to cover its short-term debt.
Cash ratio is the tightest and most conservative liquidity ratio in the company’s ability to cover its short-term debt compared to other ratios.
This is all because the cash ratio only calculates the most liquid short-term assets or current assets, namely cash and cash equivalents. The way to measure whether a company is liquid or not is by comparing the components on the balance sheet, such as total current assets with total current liabilities (short-term debt).
Cash Ratio Calculation
The way to calculate cash ratio is to distribute very current assets (cash and cash equivalents) with current liabilities. The following is the formula for the cash ratio:
Cash Ratio = (Cash + Cash Equivalent): Current Debt
Cash is all means of payment that are used immediately.
Cash Equivalents are investments that are very liquid, short term and can be converted into cash (cash) in a certain amount of time without the risk of significant changes in value.
Current debt is a company debt that must be paid in cash within a predetermined time with a maximum time of one year or in the company’s operational cycle.
The following is an example of calculating the cash ratio
PT. Indonesian Bulat Biscuits have current assets of Rp. 300 million of which Rp. 80 million is in cash and Rp. 70 million is a checking account at a bank. Meanwhile, the current debt is Rp. 200 million. What is the Company Cash Ratio of PT. Biskuit Bulat Indonesia?
Cash and Cash Equivalents = Rp. 150 million (Rp. 80 million + Rp. 70 million)
Current debt = Rp. 200 million
Cash Ratio =?
Cash Ratio = (Cash + Cash Equivalents): Current Accounts Payable
Cash Ratio = Rp. 150 million / Rp. 200 million
Cash Ratio = 0.75 times
So the cash ratio at the company PT. Indonesian Round Biscuits is 0.75 times
From the example above we can find out that PT. Indonesian Bulat Biscuits have a cash ratio of 0.75 times, which means that PT. Biscuits Bulat Indonesia only has cash and cash equivalents of 75% to pay its short-term debt. Cash ratio of PT. Indonesian Round Biscuits are considered quite high because they have a high cash balance throughout the year.
Basically, a cash ratio that is too high can also indicate the use of assets that is not optimal, because the company holds too much cash on its balance sheet.