Cash ratio = (cash + marketable securities) ÷ current liabilities. No inventory, no receivables, no prepayments. It is the only liquidity measure a bad debt cannot flatter.
The liquidity ladder
Current, quick and cash are not three different measurements. They are one division — short-term assets over short-term liabilities — run three times, each with a stricter idea of what counts as an asset.
Current counts everything, including stock that may take months to shift. Quick removes inventory and prepayments: it assumes you sell nothing more. Cash removes receivables too: it assumes you collect nothing either.
Read as a sequence, the drops are the interesting part. A company falling from 2.2 to 1.32 to 0.60 is telling you that a chunk of its coverage is stock and another chunk is customer promises. The larger of the two drops names the asset class the balance sheet is leaning on.
A retailer typically falls hard at the first step and gently at the second — its liquidity is inventory. A construction firm barely moves at the first step and falls hard at the second — its liquidity is receivables, and its real risk is how long those take to collect. A software business barely moves at either, because there is nothing to remove.
That is a genuinely different diagnostic from any single ratio, and it costs nothing to read once all three are on screen.
What actually counts as cash
The cash ratio is the only liquidity test whose numerator is a definition rather than a subtotal, and the definition is narrower than most people assume.
The rule is three months. A cash equivalent is an investment that was already within three months of maturity when it was acquired, and that carries no meaningful risk of a change in value. A money market fund qualifies. A treasury bill bought at six months and now four months from maturity does not — the test is maturity at purchase, not the time left today.
Restricted cash is not cash. A balance pledged against a letter of credit, held in escrow, or fenced by a covenant sits in the cash line on many balance sheets and cannot be used to pay a supplier. It belongs outside the numerator, and leaving it in is the commonest reason a reported cash ratio overstates the position.
An undrawn credit facility is not cash either — but it is often the reason a low ratio does not matter. It appears nowhere on the balance sheet, so a company with a committed revolver and a company with none can report the same cash ratio from entirely different positions. That is the largest thing this ratio leaves out, and it is why the number should not be read without knowing what the company can draw.
Why a cash ratio below 1 is normal
Almost every healthy trading business has a cash ratio well below 1, and treating that as a warning sign is the commonest misreading of this particular number.
Holding cash equal to all current liabilities would mean keeping months of supplier payments idle in a bank account. That capital earns little, and the whole point of receivables and committed credit facilities is that you do not need to.
A ratio of 0.2 to 0.5 is unremarkable for most sectors. Utilities run lower still, because their cash inflows are predictable enough to plan against almost exactly, and because they can draw on facilities at short notice.
What matters far more than the level is the direction and the context: a cash ratio falling steadily while payables lengthen is a different story from one sitting flat at 0.3 for five years. And a low cash ratio alongside a fast cash conversion cycle is not a risk at all, because cash is arriving continuously.
Why a high cash ratio is not better
The mirror-image mistake is reading a high cash ratio as strength. Above 1 means the business could settle every short-term obligation today out of the bank — which raises the question of why it is holding that much.
Sometimes the answer is good: a deliberate war chest before an acquisition, a regulated entity with capital requirements, or a business whose revenue is genuinely volatile. Sometimes it is that nobody has decided what to do with the money.
Cash earns very little. Capital sitting in current accounts is capital not funding growth, not reducing debt, and not returned to owners. A persistently high cash ratio with no stated reason is a capital-allocation question, not a liquidity comfort.
The honest reading is that this ratio is informative at the bottom and ambiguous at the top. Very low tells you something specific and worth investigating. Very high tells you to ask a question.
What the cash ratio cannot tell you
Three limits.
It ignores committed facilities. An undrawn revolving credit line is real liquidity and appears nowhere in this ratio. A company with 0.1 and a large committed facility is in a stronger position than one with 0.4 and nothing, and the ratio cannot see the difference.
“Cash equivalents” is a judgement. What counts as a marketable security you could sell this week is a classification decision, and it is exactly the line that moves when a business wants the number to look better.
It is still a period-end snapshot. Cash balances swing more within a month than almost any other line on the balance sheet, so this ratio is the one most sensitive to which date you happen to measure.
Read it as the strictest of three readings rather than as the true one, and read the ladder rather than any single rung.
Sources and methodology
The classification rules the numerator depends on.
Method. The three rungs are computed by three separate engine functions rather than by subtracting one from another, and the ordering between them — current ≥ quick ≥ cash — is then asserted as a property over five thousand generated balance sheets rather than assumed from the construction. That is deliberate: an ordering that falls out of the code by accident would still be reported even if a function were wrong. The engine is verified on every change against 72 assertions shared with the rest of the liquidity cluster. The count and the per-case breakdown are published on the formula verification page.