CASH RATIO OR ABSOLUTE LIQUID RATIO
Cash Ratio is a type of liquidity ratio that is calculated to analyze the short term solvency or financial position of the firm. It is calculated to exclude the receivables from the current and liquid assets and to know about the Cash assets. Although receivables, debtors and bills receivables are generally more liquid than inventories, yet there may be doubts regarding their realization into cash immediately or on time as there are the chances of bad debts. To exclude this possibility, absolute ratio is calculated. The Cash ratio is also known as Cash ratio. The Cash ratio formula is:
Cash Ratio= Cash Assets/ Current Liabilities
CASH ASSETS: The assets included in Cash assets are as follows:
- Cash in
Hand: Cash in hand means the cash available with the business house at a
point of time. - Cash at
Bank: Cash at bank means the cash that is with the business by the way of
deposits in the bank accounts may it be saving account, current account or any
kind of other account. - Marketable
Securities: Marketable Securities are those securities that can be readily
converted in to the cash by sale. These are generally traded in the money
market. These securities are also known as temporary investments.
CURRENT LIABILITIES: Current liabilities are the liabilities payable within 12 months from the date of balance sheet or within the period of operating cycle. Current liabilities include the following liabilities:
- Short
term borrowings: Short term borrowings are those borrowings that the
business house has to repay within 12 months or a year. These borrowings may be
secured or unsecured. - Trade
payables i.e. creditors and bills payable: Trade Payables includes the
creditors or bills payable. Creditors are the persons from whom the business
purchases the goods on credit and make guarantee to repay their payment on some
future date. - Short
term provisions: The provisions like
provision for doubtful debts, provisions for repairs, provision for taxation
are short term provisions. These made to meet any short term liability that
might arise in the future. - Outstanding
expenses: The expenses which have become due but are not paid yet are
Outstanding Expenses. Example of these expenses is: Salary due but not paid,
Electricity bill due but not paid, etc. - Incomes
received in advance: The incomes received in advance makes the business
house liable to perform the contract.
IDEAL CASH RATIO
The ideal standard for this ratio is 0.5:1 i.e. 50%. This means Rs. 1 worth Cash assets are considered adequate to pay Rs. 2 worth current liabilities in time as all the creditors are not expected to demand cash at the same time and then cash may also be realized from debtors and inventories.
EXAMPLE: Suppose the firm has following assets and liabilities:
| Goodwill | 50,000 | Cash at bank | 30,000 |
| Plant and machinery | 4,00,000 | Inventories | 75,000 |
| Trade investments | 2,00,000 | Bank overdraft | 70,000 |
| Marketable securities | 1,50,000 | Sundry creditors | 60,000 |
| Bills receivables | 40,000 | Bills payable | 90,000 |
| Cash in hand | 45,000 | Outstanding expenses | 30,000 |
Cash Ratio= Cash Assets/ Current Liabilities
Cash assets= marketable securities+ cash in hand+ cash at bank
=1,50,000+ 45,000+ 30,000
=2,25,000
Current Liabilities= Bank Overdraft+ Sundry Creditors + Bills payable+ Outstanding expenses
= 70,000+ 60,000+ 90,000+30,000
= 2,50,000
Cash ratio= 2,25,000/ 2,50,000
= 0.9.