Examples of Cash Ration Formula Calculations for Financial Affairs

Examples of Cash Ration Formula Calculations for Financial Affairs

In the financial sector, a solid understanding of the cash ratio formula is essential as it can be the key to making informed decisions. This step plays an important role in evaluating the financial condition of a business entity.

Broadly speaking, the cash ratio is a formula that provides an overview of a company’s ability to pay its short-term obligations using cash and cash equivalents. To better understand it, let’s read the definition, formula, functions, and strategies of cash ratio in this article!

What is Cash Ratio?

The cash ratio is one of the financial ratios that describe the company’s ability to pay its short-term obligations by comparing cash and current liabilities. Simply put, the cash ratio provides a concrete picture of how flexible the company is in meeting its financial obligations.

The main purpose of using the cash ratio formula is to evaluate the company’s liquidity level, especially in terms of the ability to repay short-term debt. By understanding how much current assets can be used immediately to pay debts, financial managers can make better decisions in managing company cash.

Read Also: Credit Restructuring: Definition, Types, Conditions, and Examples

Formulas and How to Count the Ratio

The following are formulas and how to calculate the cash ratio and an analysis related to the results of the cash ratio calculation.

1. Cash Ratio Formula

The cash ratio formula is calculated by dividing total cash and cash equivalents by total current liabilities. The following is the cash ratio mathematical formula.

Cash Ratio = Total Cash and Cash Equivalents: Total Current Liabilities

Through the proper calculation of the cash ratio, the company will gain further insight into its financial condition. It should be noted that a high cash ratio indicates the company’s ability to pay off its short-term obligations easily.

2. Calculation Example

After knowing the cash ratio formula, now it’s time to comprehend the cash ratio calculation example. To understand it better, let’s look at the example of cash ratio calculation in the following description.

For example, here is the data information in the balance sheet of PT Mitra Solusindo.

  • Cash: Rp. 25,000,000
  • Receivables: Rp. 60,000,000
  • Securities: Rp. 35,000,000
  • Tax Payable: Rp. 4,000,000
  • Employee Salary Payable: Rp. 45,000,000
  • Other short-term debts: Rp. 20,000,000

Cash ratio = (Total Cash + Cash Equivalents): Total Current Liabilities

Cash ratio = (Cash + Receivables + Securities) : (Tax Payable + Employee Salary Payable + Other Short Term Debt)

Cash ratio = (Rp25,000,000 + Rp60,000,000 + Rp35,000,000) : (Rp 4,000,000 + Rp45,000,000 + Rp20,000,000)

Cash ratio = 1.739

Thus, the cash ratio of PT Mitra Solusindo is 1.739.

3. Calculation Analysis

Through the results of the cash ratio calculation in the previous sections, PT Mitra Solusindo has a cash ratio of 1.739. The cash ratio value that exceeds 1 makes PT Mitra Solusindo considered to have a very strong financial position. The company is considered to be able to pay short-term debt with significant excess cash and has lower short-term liabilities.

In general, the ideal ratio value is 1, which means that the company is considered capable of paying its short-term debt. If the cash ratio is below 1, this indicates that the company cannot pay off its debts properly. This is because the cash owned by the company is lower than the amount of debt.

Function of Cash Ratio in Financial Management

The cash ratio has a seemingly negligible yet real impact on the company’s financial management. Let’s examine some important functions of the cash ratio in financial management!

1. Reduce Overhead Cost

A healthy cash ratio can help companies to reduce overhead costs. Overhead costs are costs that are not directly related to the production process also known as other costs, such as rent, stationery costs, or security costs. Companies with adequate liquidity tend to be able to manage financial needs without having to rely on expensive sources of funds.

2. Increase Sales

Trust from external parties, such as customers and business partners, can increase when they know that your company has a good financial ability to run operations. Therefore, a high cash ratio can provide additional trust to related parties.

3. Ability to Pay Debt

Apart from reducing overhead costs and increasing sales, a healthy cash ratio also reflects a company’s ability to pay its debts on time. This helps a company build a positive reputation among creditors and other related parties.

Read Also: Essential Elements of Credit for Granting Credit Loans

4. Managing Company Receivables

In general, companies can more effectively manage receivables with an appropriate cash ratio value. Sufficient liquidity allows the company to settle receivables more efficiently and avoid liquidity risks that could be detrimental in the future.

5. Paying for Assets

A high cash ratio also provides flexibility in paying for company assets or investments. This helps the company to expand or make long-term investments without being overburdened by short-term liabilities.

Strategy for Optimizing Cash Ratio Value

To maintain an effective cash ratio, proper strategic planning is required. This involves careful monitoring and management of cash flow and financial obligations. Here are some strategies to maintain the cash ratio that you can do in the office.

1. Plan and Monitor Cash Flow Carefully

Planning your cash flow and monitoring its movement carefully is the first step to maintaining your cash ratio. This step allows the company to identify potential liquidity problems and take the necessary preventive measures.

2. Evaluate Expenditure Needs

Every company expense needs to be evaluated carefully. In practice, you can prioritize expenses that support growth and generate profits. This can be done in conjunction with efforts to reduce expenses that do not support the company’s strategic goals.

3. Manage Inventory Wisely

Managing inventory wisely is an important step in maintaining the company’s cash flow balance. Effective management of inventory can help in optimizing the use of financial resources. Therefore, it is important to optimize excessive inventory as it affects the liquidity of the company.

4. Effective Management of Receivables

Companies can maintain a steady cash flow and avoid unwanted shortages of funds by ensuring that bills are paid on time. Through careful management of receivables, you can speed up the receipt of funds from customers and reduce the risk of uncollectible accounts.

5. Payment Cycle Optimization

In addition to receipts from customers, an efficient payment cycle also includes payments to suppliers. From a revenue perspective, shortening the billing period can increase the amount of available cash. Meanwhile, extending the payment period to suppliers can give the company more time to use its cash before having to pay it back.

After taking cues from the explanation above, an understanding of the cash ratio formula that divides cash by current liabilities is very important for analyzing company finances. This formula allows companies to evaluate liquidity and take action to improve financial conditions. A high cash ratio value indicates that the company has a good ability to pay off its short-term debt.

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Cash Ration Formula, Examples of Cash Ration Formula Calculations for Financial Affairs, Advance Innovations

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Published date :

15 March 2024