Current Ratio – Formula, Meaning, Assumptions and Interpretations
The current ratio is the most popularly used metric to gauge the short term solvency of a company. This article provides the details about this ratio. Formula Current Ratio = Current Assets / Current Liabilities Meaning Current ratio measures the current assets of the company in comparison to its current liabilities. This means that the…
What are Common Size Statements ?
Common size statements are not financial ratios. Rather they are a way of presenting financial statements that makes them more suitable for analysis. However, analysts always use them in conjunction with ratio analysis. In fact, financial analysts use common size statements as the starting point to help them dig deeper. Common size statements tell them…
Cash Ratio – Meaning, Formula and Assumptions
The cash ratio is limited in its usefulness to investors and financial analysts. It is the least popular of the liquidity ratios and is used only when the company under question is under absolute duress. Only in desperate circumstances do situations arise where the company is not able to meet its short term obligations by…
Once upon a time, investors and analysts used to believe in ratios that have been calculated based on the earnings that the company has stated in the Income Statement. Alas! That was once upon a time. Of late, there have been a huge number of frauds and malpractices that have come to the fore. All these malpractices have taught the investors one lesson only.
The lesson is that fact that corporate income statements and balance sheets are susceptible to fraud. This is because the numbers in these statements are based on the policies that management sets. Thus, in the seas of fraud, they have found truth in cash flow ratios. Here is why cash flow ratios are so important and form the backbone of any financial analysis conducted today.
Cash flow is fact, all else is error, or at least susceptible to error. The company cannot fudge how much cash it has in the bank. The auditors are supposed to confirm with the bank the amount of cash that they have in the company’s accounts and verify the same with what the company has stated. How the company received this cash is also made clear by the cash flow statement. Hence, it is the least susceptible to fraud and provides the truest picture of the state of affairs.
The company cannot pay its employees in earnings. Neither can it pay its creditors or suppliers in earnings.
The fact of the matter is that the company needs cash like humans need oxygen to stay alive. A few days without adequate cash and the company may not survive. This is the reason investors want to ensure that they have enough cash on hand to meet forthcoming obligations.
To many investors it seems insane that expenses like interest be compared with earnings since if earnings are not converted to cash, they cannot pay expenses. Therefore cash is what matters!
The company invests cash when it makes capital expenditures. These capital expenditures are what makes the company’s profits and cash flow grow in the future. Therefore, it makes more sense to consider cash flow rather than earnings while trying to gauge the rate at which the company will grow in the future.
There is a slight problem with cash flow ratios though. There has been no consensus on what constitutes cash flow. Hence there are many measures of cash flow instead of one. This leads to there being multiple ratios.
Article Written by
Himanshu Juneja, the founder of Management Study Guide (MSG), is a commerce graduate from Delhi University and an MBA holder from the esteemed Institute of Management Technology (IMT). He has always been someone deeply rooted in academic excellence and driven by a relentless desire to create value. Recently, he was honored with the “Most Aspiring Entrepreneur and Management Coach of 2025 (Blindwink Awards 2025)” award, a testament to his hard work, vision, and the value MSG continues to deliver to the global community.
Article Written by
Himanshu Juneja, the founder of Management Study Guide (MSG), is a commerce graduate from Delhi University and an MBA holder from the esteemed Institute of Management Technology (IMT). He has always been someone deeply rooted in academic excellence and driven by a relentless desire to create value. Recently, he was honored with the “Most Aspiring Entrepreneur and Management Coach of 2025 (Blindwink Awards 2025)” award, a testament to his hard work, vision, and the value MSG continues to deliver to the global community.
Your email address will not be published. Required fields are marked *
