In this article, we explain to you what the cash flow ratio is, how it is calculated, why it is key for investors and public funding, and how to optimize it strategically.
What exactly is the cash flow ratio?
The cash flow ratio, also known as Cash Ratio or “acid test”, is an accounting metric that measures a company's ability to meet their short-term liabilities using only their most liquid assets: the money available in cash or in bank accounts. Unlike other liquidity indicators such as the current ratio, this ratio excludes inventories, accounts receivable and other assets that, although they have value, cannot always be converted quickly into cash.
This ratio is especially important for startups, since in their early stages it is common for them to not yet generate recurring revenues or to have unpredictable cash cycles. In this context, having immediate liquidity is a survival factor.
The formula is simple:
Treasury Ratio = (Cash + Banks)/Current Liabilities
When the result is equal to or greater than 1, it means that the company can cover its most immediate debts without depending on future sales or outstanding collections.
Why is it critical for startups?
For many startups, the difference between moving forward and stopping doesn't depend so much on profitability, but on liquidity. You can have a validated business model, a promising business pipeline and a brilliant team, but if you can't pay the payroll for the next month, the company comes to a standstill. This is where the treasury ratio comes into play as a reliable thermometer of operational financial health.
Having clear visibility over available liquidity makes it possible to make better strategic decisions. For example, if a startup knows that its cash ratio is below 0.5, it must urgently prioritize cash inflow (via billing, investment or grants) before making new commitments.
In addition, this indicator has become an almost implicit requirement in the risk assessment processes of any external agent: from private investors to banks and public bodies.
What is considered a healthy ratio?
Although there is no single rule, there are useful guidelines, especially for startups in the early stages or those with accelerated growth:
- Below 0.5: The company does not have enough cash to cover even half of its short-term debts. It's a serious warning sign.
- Between 0.5 and 1: It's a precautionary zone. It can cover part of its commitments, but it is exposed to any unforeseen event or delay in collections.
- Above 1: Good financial health. The company can handle all of its immediate payments stress-free.
However, this ratio should always be read in conjunction with other metrics, such as Burn Rate (monthly spending rate), the Cash Runway (how many months to live with the current cash) or the gross margin. A low ratio is not the same in a company with a closed or ongoing round as in another without expected revenues or cash in sight.
Why do investors and public bodies review it?
The cash ratio is not a fact that remains within the financial team. In fact, it is increasingly common for it to appear in investor analyses during funding rounds or in evaluation reports of public support programs.
Private investors, especially venture capital funds, use it to gauge short-term operational risk. A startup with a weakened bottom line may need funding urgently, reducing its bargaining power and raising questions about its ability to survive until the next round.
As for the public funding, programs such as ENISA, CDTI or Horizon Europe analyze the solvency and liquidity of startups to ensure that they will be able to execute the project and co-finance its corresponding part. A company without liquidity or with ratios below certain thresholds can be discarded directly from the process, regardless of the quality of the project presented.
Even banking institutions use this ratio when studying credit policy renewals, granting loans or renegotiating debt. The level of available cash is often a key criterion for defining conditions, deadlines or required guarantees.
How to improve the treasury ratio strategically
Improving this ratio is not just about increasing cash flow, but about better managing the relationship between income, expenses and maturities. Here are some specific strategies:
1. Reorganize collection and payment cycles. It tries to reduce the time it takes to charge customers (for example, by offering discounts for prompt payment) and, at the same time, it negotiates longer terms with suppliers. This creates a time margin that alleviates cash tension.
2. Control the pace of spending. Adjust the Burn Rate It is one of the most effective mechanisms to extend the Runway and strengthen the treasury. Delaying non-strategic hiring or renegotiating fixed costs can have an immediate impact.
3. Get early liquidity. Some public grants allow advances of 60% or more, and there are bridge instruments that can inject liquidity without dilution. You can also evaluate short-term lines of credit as an operating cushion.
4. Avoid excessive short-term debt. Although it is common to finance certain operating expenses through debt, an excess of current liabilities directly worsens this ratio. Whenever possible, restructure in the medium term or accompany capital increases.
5. Build treasury scenarios. An essential tool is to project real cash flow on a monthly basis and to simulate different stress scenarios. This allows you to anticipate problems before they materialize and make decisions in advance.
Liquidity as a competitive advantage
In the context of startups, where uncertainty is part of everyday life, having good visibility over the treasury is not only a guarantee of survival, but also a competitive advantage. Companies with sufficient cash can better negotiate with suppliers, invest in stress-free growth and approach financing processes from a position of strength.
In Intelectium, we help startups and scaleups to structure their financial planning with a strategic vision, optimizing their liquidity and preparing their structure to successfully face investment rounds, grants and sustained growth.
Do you want to evaluate your cash position and define a solid financial plan? Get in touch with us through the following Link. We're here to help.
