Cash Ratio - Explained in Hindi | #35 Master Investor - YouTube

This video is a part of a series in which we're discussing liquidity ratios

In the first two videos, we saw what are current ratio and quick ratio

With the current ratio, we can check the short term financial condition, i.e 1 year financial position of a company

The quick ratio is a bit more conservative in which we see

what are those assets that we can sell quickly or convert into cash quickly

so that we can quickly pay off our current liabilities

The cash ratio is even more conservative. In this, we only take cash and cash equivalents

So that we can check how much liabilities we can pay off with the current cash available

So in this video, we'll understand the cash ratio and will see how its calculation is done

Stay tuned with this video till the end

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In the first two liquidity ratios, we saw the current ratio

Current ratio = current assets/current liabilities

In the second video, we saw quick ratio = quick assets/current liabilities

Current assets are the assets that can be converted into cash or can be consumed within 1 year

We have already discussed the current liabilities

These are your account payables, short term loans, cash credit and overdraft

advance from customers, outstanding expenses

I have already explained these in detail in the current ratio and quick ratio videos so do watch those videos

We already discussed the current assets which is for 1 year

That means the current ratio is telling the short term liquidity position of a company

How short it is?

This is for 1 year

After that, the quick ratio is even more conservative.

In this, we consider only those current assets

that can be sold immediately or can be sold within 2-3 months

So in the last video, we discussed that the quick assets are cash and deposits

Short term investments are also quick assets because these can be converted into cash immediately

We get receivables within 2-3 months so these are also quick assets

You can recall short term loans and advances. You receive it within 2-3 months

So these are also the quick assets

Inventory is not considered a quick asset

because it may take time.

Raw material, work in progress inventory or finished goods can not be sold immediately

Then there are prepaid expenses. If you gave money to someone in advance

Let's say you paid the insurance premium in advance

You paid some of your bills in advance or gave a salary to the employees in advance

And you cannot take it back immediately

So you dont include this in the quick assets

Now let's talk about the cash ratio

The cash ratio becomes a bit more conservative

We already discussed about the quick assets

There are your cash and deposits which are already in the cash form

So the cash in the company is in the form of cash

You can also withdraw the deposits from the bank immediately

So in cash ratio, instead of quick assets, cash and cash equivalents are discussed

That can immediately be converted into cash

There we were talking about 2-3 months but here we're talking immediate

If a company faces a problem and they have to pay for all the current liabilities immediately in today's date

Let's say all the banks ask to pay all the short term loans on today's date

Or if you took advance from your customers then the customer asks for the product or money back

So we can check the needs of a company through the cash ratio

So what are cash and cash equivalents?

We already discussed that cash and deposits come in cash equivalent

Let me remove quick assets from here

Obviously, you cannot take inventory and prepaid expenses in cash and cash equivalents

Because those cannot be converted immediately into cash

Short term investments are the investments done in mutual funds and shares

so you can immediately sell it and convert it into cash

You'll not get accounts receivables immediately because

Because you cannot get the money back immediately that you've lent to the customers

So you'll not take this in cash and cash equivalents

You cannot get short term loans and advances so we'll not consider this as well

So you can only consider cash and deposits and short term investments in the cash ratio

So if I write the cash ratio formula again, I can write

Cash ratio = cash (Immediate cash available) + short term investments

that is done by the company in the marketable securities

like mutual funds and shares to which the company can sell and recover immediately

you'll add that and when you divide the total by the current liabilities, you get the cash ratio

Let's take an example

Let's say these are the current assets of a company

Cash and deposits of Rs 40 Cr, Marketable securities of Rs 60 Cr

Account receivables of Rs 35 Cr

the short term loan and advances of Rs 20 Cr and inventory of Rs 35 Cr

and the total current liabilities are Rs 150 Cr

So how we'll calculate the cash ratio? What all things we'll include in this?

Cash and deposits that can be converted into cash immediately

So we'll add Rs 40 Cr here + short term investments

We are talking about the marketable securities, so we'll add this also

so we'll take Rs 60 Cr here

We don't have to add receivables, short term loans and advances, and inventory also

Divided by the total current liabilities, i.e Rs 150 Cr

So divide by Rs 150 Cr

So this becomes Rs 100/Rs 150 Cr

This is 0.67

So what does the cash ratio equals 0.67 mean?

The liabilities of Rs 150 Cr can be covered by the 67% of current assets that are in the form of cash equivalents

So 67% cash equivalents are there in comparision with the current liabilities

So this is a very comfortable position

So what should be the ideal ratio of the cash ratio?

So we already discussed that the cash ratio tells us about the immediate liquidity position of a company

But there is no ideal cash ratio. As we discussed the current ratio that it should be more than 1.33

then we discussed that the quick ratio should be more than 1

The cash ratio doesn't matter much for an analyst but it matters very much for a bank

So generally, the lenders calculate it and they prefer the cash ratio minimum between 0.5 to 1

if at least this much is there then the company is stable

and the company can easily pay the loans

If the cash ratio will be high, it can impact negatively also

If the cash ratio is very high, that means the company is not using the cash efficiently

That means more cash is there in the bank and that could be a sign of worry

So if there is more cash in the company's account then it's better to distribute dividends

if they are not able to utilise it

or deploy the cash in the investments that will give good returns

So as I say for all ratios, the cash ratio does not tell the whole story but

But it helps us to understand the total financial health of a company

But if the cash ratio is very low, i.e the company don't have cash. Then that is also a sign of worry

So let me write it again here so that you don't get confused by the current ratio

If the cash ratio is 0.1 then that is a sign of worry

Cash equivalents should not be this low with a company that they are unable to fulfil the immediate short term liabilities

So I hope you understood the concept of cash ratio

and since the cash ratio is a very conservative form

So if you analyse a company, the current ratio and the quick ratio are sufficient according to me

But from a bank's point, the cash ratio definitely matters

Thats why you should maintain a good cash ratio if you own a company

So that's it in this video

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