The cash coverage ratio is a financial ratio that measures a company’s ability to pay off its current liabilities with its available cash and cash equivalents. The cash coverage ratio is also known as the cash ratio or the liquidity ratio.
The cash coverage ratio is calculated by dividing a company’s cash and cash equivalents by its current liabilities. The ratio shows how many times a company can pay off its current liabilities with its available cash.
The formula for calculating the cash coverage ratio is as follows:
Cash Coverage Ratio = Cash and Cash Equivalents / Current Liabilities
For example, if a company has cash and cash equivalents of $500,000 and current liabilities of $250,000, the cash coverage ratio would be:
Cash Coverage Ratio = $500,000 / $250,000 Cash Coverage Ratio = 2
This means that the company can cover its current liabilities twice over with its available cash and cash equivalents.
A high cash coverage ratio indicates that a company is in a strong financial position and has sufficient cash to cover its short-term obligations. However, a very high ratio may also suggest that a company is not investing its cash effectively or may be overly conservative in its financial management. On the other hand, a low cash coverage ratio may indicate that a company has limited cash reserves and may struggle to meet its short-term obligations.