Smith Electronics reported the following figures in its 2017 and 2016 financial statements
2017 2016
Cash $ 38,500 $ 25,000
Cash Equivalents 3,000 2,000
Total Current Liabilities 33,200 30,000
Compute the cash ratio for 2017 and 2016. What does the cash ratio measure? Use this information to discuss the business performance of Smith Electronics.
What will be an ideal response
2017 Cash ratio = (Cash + Cash equivalents) / Total current liabilities
= ($38,500 + $3,000 ) / $33,200 = 1.25
2016 Cash ratio = (Cash + Cash equivalents) / Total current liabilities
= ($25,000 + $2,000 ) / $30,000 = 0.90
The cash ratio measures the company's ability to pay current liabilities from cash and cash equivalents. The cash ratio for Smith has increased from 0.90 in 2016 to 1.25 in 2017. A cash ratio of 0.90 is good because this measure is the most conservative valuation of liquidity since it only looks at cash and cash equivalents. A cash ratio of 1.25 indicates that the company may have an unnecessarily large amount of cash supply. Both the cash supply (cash and cash equivalents) and total current liabilities increased from 2016 to 2017. The management of Smith Electronics should determine if the cash supply is too high. Could excess cash be invested or used to pay current liabilities or dividends?
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