How to calculate & interpret cash ratio for your small business

When evaluating a company's ability to pay down short-term debt, liquidity ratios like the current and quick ratios often come to mind.

However, another means of calculating liquidity is your business’ cash ratio. Your cash ratio provides financial planning & analysis teams with the means to determine whether your company has enough cash to pay down current liabilities.

In this article, we'll explore the cash ratio, its formula, and the limitations of its use.

What is the cash ratio?

The cash ratio is a liquidity metric calculated from certain line items on your balance sheet. The calculation results indicate whether your company has enough cash to cover all its short-term liabilities.

The cash ratio differs from other liquidity measures like the quick ratio (also known as the acid-test ratio) or current ratio. When evaluating a company's liquidity, the quick and current ratios consider all existing current assets, including accounts receivable and inventory. However, the cash ratio considers only fully liquid assets, such as your company's cash and cash equivalents.

Cash ratio formula

Here’s how to calculate your cash ratio:

Cash ratio = cash and cash equivalents / current liabilities

In this formula, cash includes the balance of all checkings and savings accounts and any available cash on hand.

Cash equivalents include any readily convertible assets. Examples of cash equivalents include money market accounts, marketable securities, and T-bills.

Current liabilities encompass all short-term debts due in one year or less. Current accounts payable, accrued liabilities, and any short-term installment debts are examples of current liabilities.

Cash ratio example

Let’s say a small business owner wants to assess whether they can take on a short-term equipment lease without needing a loan. By calculating their cash ratio and finding it to be 1.3, they see that their cash and cash equivalents exceed current liabilities.

This gives them the confidence to proceed with the lease, knowing they have enough liquidity to cover existing short-term obligations—even in a slow sales month.

How to calculate your business’ cash ratio

Calculating your cash ratio is a relatively simple exercise. Consider Company XYZ. Company XYZ has the below total assets and liabilities on its year-end balance sheet.

• $8M Cash
• $1.5M Cash equivalents
• $7M Accounts receivable
• $1M Inventory
• $2.5M Property and equipment
• $4M Current accounts payable
• $2.5M Accrued liabilities
• $1.5M Installment debt
• $7M Long-term debt

Using the cash ratio formula, we find that Company XYZ has a cash ratio of 1.1875:

Cash ratio = ($8M cash + $1.5M cash equivalents) / ($4M accounts payable + $2.5M accrued liabilities + $1.5M installment debt)

According to the cash ratio formula, Company XYZ has enough cash and cash equivalents to pay for all of its short-term obligations without needing additional means of alternative funding.

Notice that we do not include the value of other assets and liabilities, such as inventory, accounts receivable, property and equipment, and long-term debt in the cash ratio calculation.

The cash ratio does not consider the value of inventory, accounts receivable, and property and equipment as easily convertible liquid assets. Accounts receivable usually take time to collect, and inventory, property, and equipment are not readily convertible to cash.

Companies classify long-term debt as due over a period longer than twelve months. Because of this, organizations do not consider long-term debt when using the cash ratio formula.

What the cash ratio tells you

The cash ratio helps evaluate your company's immediate liquidity position by showing how well it can cover short-term obligations using only cash and cash equivalents. Specifically, it provides insight into:

Availability of cash-on-hand to cover short-term debts

A cash ratio of 1 or more indicates that your company can cover all current liabilities without needing additional financing. A ratio below 1 suggests the business may need to dip into other assets or secure external funding to meet obligations.

Indication of potential growth prospects

Companies with strong cash reserves are typically better positioned to reinvest in the business, pursue acquisitions, or expand operations. Conversely, limited cash may restrict growth without additional capital.

Conservative measurement of liquidity

Because the cash ratio excludes accounts receivable and inventory, it gives a more conservative view of liquidity. This makes it a useful tool for analysts who want to focus on only the most liquid assets.

Helpful for creditors evaluating lending risk

Lenders often use the cash ratio when assessing a company's ability to repay loans. A ratio between 0.5 and 1.0 is generally considered healthy. Ratios below 0.5 may signal repayment concerns, while those above 1.0 could indicate that cash isn’t being actively deployed to generate returns.

What the cash ratio doesn’t tell you

While the cash ratio offers a snapshot of short-term liquidity, it presents an incomplete—and often overly conservative—view of a company’s financial health. Below are key limitations to consider:

It’s often too conservative for real-world decision-making

Most businesses don’t aim for a high cash ratio, as it can signal underutilized capital. In some cases, maintaining an excessively high ratio may even reflect poorly in performance reviews—indicating poor capital allocation rather than financial strength. Because it excludes assets like accounts receivable and inventory, the cash ratio should always be interpreted alongside broader liquidity metrics like the current or quick ratios.

A high ratio can reflect risk aversion—not strength

A strong cash position may look healthy on paper, but it could also indicate operational stagnation, risk-averse leadership, or a defensive posture ahead of anticipated liabilities (e.g., lawsuits, tax obligations). This is particularly true in industries like utilities or government contracting, where holding excess cash may be strategic—but not necessarily a sign of growth or efficiency.

It's highly sensitive to timing

Because the cash ratio reflects a single point in time, it can be skewed by temporary inflows (like a recent funding round) or outflows (such as an upcoming vendor payment). A more accurate picture emerges when businesses track the cash ratio over time or use rolling averages to smooth out volatility.

It doesn’t distinguish restricted cash

Not all cash on the balance sheet is freely available. Funds earmarked for payroll, loan repayments, or capital investments may be included in the calculation—falsely inflating the cash ratio. Accountants and financial analysts should adjust for restricted cash when evaluating liquidity.

It can affect creditworthiness assessments

A low cash ratio might raise red flags with lenders or trigger loan covenant concerns, especially in asset-light businesses. At the same time, a very high ratio could influence banks to reassess interest terms or availability of credit if it suggests the company is hoarding cash rather than using it for growth.

Common challenges of calculating and interpreting cash ratio

The cash ratio is relatively easy to calculate. As long as the company creates a balance sheet that classifies its general ledger accounts into the proper categories, financial analysts can quickly obtain the values necessary for calculating the cash ratio.

Problems arise when general ledger accounts do not properly segregate current liabilities. For instance, the cash ratio may be skewed if accounts payable or accrued liabilities include debts due in periods extending past one year.

Analysts must also be careful not to incorporate assets that are not considered cash equivalents, like inventory or accounts receivables.

Improve liquidity management with Ramp

Understanding your cash ratio is just one part of maintaining financial stability—acting on that insight is where the real impact happens. Ramp’s all-in-one finance automation platform gives small businesses greater control over spend, real-time visibility into cash balances, and tools to optimize working capital.

With Ramp, you can:

• Track cash and liabilities in real time to improve liquidity visibility
• Automate expense controls to prevent cash leakage
• Build more accurate forecasts with integrated accounting and analytics
• Make faster, smarter decisions around short-term obligations and growth planning

Whether you're managing day-to-day expenses or preparing for your next investment, Ramp helps you move with confidence.