comparable companies<\/a>.<\/p>\nSome sources online say that a “good” Cash Ratio is between 0.5x and 1.0x, but this is a meaningless statement that doesn’t necessarily apply to all industries.<\/p>\n
For example, if a company converts its Receivables and Inventory into Cash very quickly, the Cash Ratio might not matter all that much; the Quick Ratio or Current Ratio might suffice in these cases.<\/p>\n
Also, if the company’s Current Liabilities consist mostly of items like Deferred Revenue rather than Debt or Accounts Payable, a higher Current Liabilities balance isn’t necessarily “bad.”<\/p>\n
High Deferred Revenue is often viewed as a positive sign<\/em> because it means the company is collecting more Cash upfront from customers!<\/p>\nYou can see an example of the Cash Ratio calculation for Illinois Tool Works [ITW] below (see the Excel file and filing PDF above):<\/p>\n
![\"Liquidity](\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2023\/11\/19074649\/03-Liquidity-Ratios-Cash-Ratio.jpg\" "\\"Liquidity")
<\/p>\n
The Cash Ratio here is 0.16x, which means that ITW has $0.16 of Cash for each $1.00 in current liabilities.<\/p>\n
This means that ITW could\u00a0not<\/em> afford to repay all its short-term obligations using its Cash and taking no other actions.<\/p>\nMany people would call this a “negative sign,” but, again,\u00a0context<\/strong> is essential.<\/p>\nIf the company never has any trouble collecting Cash from customers or selling its Inventory as finished products, this point might be irrelevant because it will never be in a\u00a0position<\/em> where it needs to use its Cash like this.<\/p>\nOn the other hand, it is concerning that\u00a0the company’s liquidity has fallen over the past few years:<\/strong><\/p>\n![\"Liquidity](\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2023\/11\/19074649\/04-Liquidity-Ratios-ITW.jpg\" "\\"Liquidity")
<\/p>\n
The key driver is that ITW’s Cash balance has fallen, while its Short-Term Debt has risen.<\/p>\n
We should look into this and do a deeper dive on the company’s Cash and Debt to see why this is happening, but it could be something innocuous.<\/p>\n
For example, maybe some of the company’s Long-Term Debt is maturing soon, so the company has reclassified a portion as Short-Term Debt.<\/p>\n
If the company plans to “refinance” by issuing new Debt to replace this older Debt that needs to be repaid soon, this low Cash Ratio means very little.<\/p>\n
It would mean something negative only if the company had trouble<\/em> refinancing its existing Debt due to a poor credit profile (for example).<\/p>\n<\/span>What is a Good Cash Ratio?<\/strong><\/span><\/h2>\nThe “magic number” from random copy\/pasted online articles written by monkeys at keyboards seems to be “between 0.5x and 1.0x,” but we would argue\u00a0this is a meaningless range.<\/strong><\/p>\nThe Cash Ratio is like a blood pressure reading at the doctor’s office: It doesn’t necessarily tell you what<\/em> is wrong if your reading is too high or too low, but it does tell you that you\u00a0may need to do additional tests<\/em> to figure out the problem and its root causes.<\/p>\nContinuing with the example above, if we dig in and find that the Cash Ratio has fallen just because some Debt is close to maturity, we’d ignore it and move on (unless there are signs the company could not refinance its Debt).<\/p>\n
On the other hand, if we dig in and find that the Cash Ratio has fallen because it’s getting harder to collect Cash from customers, while the company’s Payables are piling up (i.e., there are more and more owed bills to suppliers), that would be a cause for concern – especially if the industry is also declining.<\/p>\n