Operating Cash Ratio – Formula and Understanding
Far and above the most valuable liquidity ratio is the operating cash ratio. Unlike the other liquidity ratios that are balance sheet derived, the operating cash ratio is more closely connected to activity (income statement based) ratios than the balance sheet. Its primary element, the numerator in this formula is based on the income statement’s results on the cash basis method of accounting. This cash income is then divided by all current liabilities. The concept is simple; can the cash income over a period of time pay the current liabilities over the same period of time.
Of the 21 different core business ratios used in business analysis, this one is one of the top three most complicated. For one thing, the user must understand how cash flow from operations is calculated. Secondly, the perceptive user will want to know how is it that the very result of operating cash flows which is calculated from the change in current liabilities is then used to determine the ability to pay those current liabilities. It is like saying that you depend on ‘A’ to pay ‘A’. It borders on circular reasoning. Finally,
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