Working capital ratios allow companies and stakeholders to gauge how liquid a company is. Usually, it uses figures from the income statement and balance sheet to show how long it takes to convert a company's resources to cash. One of the working capital ratios is the days cash on hand. Before understanding how to calculate it, it is crucial to discuss what it is.
What is Days Cash on Hand?
Days cash in hand is a financial ratio that measures the number of days a company can continue to operate using only its current cash balance. Essentially, it gauges how long a company can survive without additional cash inflows. It is a crucial ratio in determining how often a company needs cash inflows to run its operations smoothly.
The days cash on hand can provide an absolute ratio to users. However, it is crucial to use it comparatively instead to analyze it better. The situation in which a company operates significantly impacts this ratio. When users use this ratio comparatively, they can better understand how a company fairs based on its circumstances.
How to calculate the Days Cash on Hand ratio?
The days cash on hand is the ratio between cash on hand and average daily cash expenditure. Based on the above, the formula for the days cash on hand ratio is as below.
Days cash on hand = Cash on hand / Average daily cash expenditures
However, users outside a company may not have the information to calculate the average daily cash expenditures for a company. It is crucial to understand that it only includes expenses a company pays for in cash. Alternatively, users can calculate it by adding non-cash expenditures to operating expenses and averaging it over a year. The other days cash on hand formula based on the above becomes as follows.
Days cash on hand = Cash on hand / [(Operating expenses - Non-cash expenditures) / 365]
What does the Days Cash on Hand ratio mean?
The days cash on hand ratio differs for different companies. Usually, a high days cash on hand ratio indicates that a company has a significant cash reserve that can sustain its operations for a longer period. It provides a sense of security to investors, as it suggests that the company is financially healthy and has enough cash on hand to cover its short-term expenses and obligations.
On the other hand, a low days cash on hand ratio suggests that a company may have limited cash reserves and struggle to meet its short-term financial obligations. It may also imply that the company may need external funding sources. It can be a warning sign for investors, as it indicates that the company may be at risk of financial distress if it doesn't generate sufficient cash inflows in the short term.
Example
A company, Red Co., has cash on hand of $100,000. Its operating expenses for the period are $500,000, including non-cash expenditures of $100,000. Based on the above information, Red Co.'s days cash on hand is below.
Days cash on hand = Cash on hand / [(Operating expenses - Non-cash expenditures) / 365]
Days cash on hand = $100,000 / [(500,000 - $100,000) / 365]
Days cash on had = 91 days
Conclusion
Days cash in hand is a ratio that calculates how long a company can survive without cash inflows. It considers the relationship between cash on hand and average daily cash expenditure. Usually, companies strive to achieve a high days cash in hand. A low ratio means that the company may not be able to meet its financial obligations in the short term.
Post Source Here: Days Cash on Hand: Definition, Formula, Calculation, Example, Equation, Ratio, Meaning
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