How is the cash ratio calculated?

The cash ratio is calculated by dividing cash and cash equivalents by current liabilities. This ratio is a liquidity metric that helps assess a company's ability to pay off its short-term obligations using its most liquid assets, which are cash and cash equivalents. It is a conservative measure of liquidity because it only considers cash and does not include receivables or inventory, providing a clear view of the company's immediate cash position relative to its current liabilities.

In financial analysis, the cash ratio is particularly useful for understanding the liquidity position in situations where a firm may face immediate cash outflows. A higher cash ratio indicates a stronger liquidity position, indicating that the company has enough cash to cover its current liabilities. Thus, the correct approach to calculating the cash ratio highlights the importance of cash management in sustaining adequate liquidity for operational needs and financial stability.