Ratios: Cash to Monthly Cash Expenses: Videos & Practice Problems

The cash to monthly cash expenses ratio helps businesses, especially in healthcare, assess how long they can operate without incoming cash. This ratio is calculated by dividing the cash balance at year-end by monthly cash expenses, indicating the number of months the business can sustain operations. Monthly cash expenses can be derived from the operating section of the cash flow statement. Understanding this ratio is crucial for managing liquidity and ensuring financial stability in uncertain situations.

Ratios: Cash to Monthly Cash Expense

The cash to monthly cash expenses ratio is a crucial internal metric for managing a company's liquidity, particularly in industries like healthcare where cash flow can be heavily dependent on external sources such as government payments or insurance reimbursements. This ratio helps determine how long a company can continue to operate if it suddenly stops receiving cash inflows. Essentially, it answers the question: if all cash inflows ceased today, how many months could the company sustain its operations before running out of cash?

To calculate this ratio, you need two key figures: the cash balance at year-end and the monthly cash expenses, often referred to as cash burn. The formula can be expressed as:

Cash to Monthly Cash Expenses Ratio = \(\frac{\text{Cash Balance at Year-End}}{\text{Monthly Cash Expenses}}\)

This calculation yields the number of months the company can operate before depleting its cash reserves. Monthly cash expenses can typically be derived from the operating activities section of the statement of cash flows, which outlines all cash outflows related to the company's operations. The statement of cash flows is divided into three sections: operating, investing, and financing. For this ratio, focus on the operating section, which details the cash spent on operational expenses.

When analyzing the statement of cash flows, it is important to note that it usually covers a full year. Therefore, if the total cash outflows are provided, you can simply divide that figure by 12 to find the average monthly cash expenses. While this ratio is not commonly used, understanding its calculation and implications can be beneficial, especially in financial discussions or assessments. If your coursework includes this ratio, mastering it can provide an easy advantage in your studies.

The Liquid Company had a cash balance at the end of the current year of $14,511. If the monthly cash expenses total $3,495, how long could Liquid stay in business before going bankrupt, assuming no cash inflows?

• A. 4.15 months
• B. 3.12 months
• C. 6.33 months
• D. Not enough information

Answer: (A)

Tougher Company's had the following data for 2018 and 2017:
What was the increase or decrease in the ratio of cash to monthly cash expenses in 2018?

• A. Increase 5.3 months
• B. Decrease 5.3 months
• C. Increase 8.1 months
• D. Decrease 8.1 months

Answer: (A)

Here’s what students ask on this topic:

What is the cash to monthly cash expenses ratio and why is it important?

The cash to monthly cash expenses ratio measures how long a business can continue operating without receiving any additional cash inflows. It is calculated by dividing the cash balance at year-end by the monthly cash expenses. This ratio is crucial for assessing a company's liquidity and financial stability, especially in uncertain situations. For example, in the healthcare industry, where cash inflows often come from government programs like Medicare, understanding this ratio helps in planning and ensuring that the business can sustain operations even if these payments are delayed or stopped.

How do you calculate the cash to monthly cash expenses ratio?

To calculate the cash to monthly cash expenses ratio, you need two pieces of information: the cash balance at year-end and the monthly cash expenses. The formula is:

$\frac{\mathrm{Cash} \mathrm{Balance} \mathrm{at} \mathrm{Year} \mathrm{End}}{\mathrm{Monthly} \mathrm{Cash} \mathrm{Expenses}}$

This ratio tells you the number of months the business can operate without additional cash inflows. Monthly cash expenses can be derived from the operating section of the cash flow statement by dividing the annual cash outflows by 12.

Why is the cash to monthly cash expenses ratio particularly relevant in the healthcare industry?

The cash to monthly cash expenses ratio is particularly relevant in the healthcare industry because a significant portion of cash inflows comes from government programs like Medicare and Medicaid, as well as third-party insurers. If these payments are delayed or stopped, healthcare providers need to know how long they can continue to operate with their existing cash reserves. This ratio helps healthcare organizations manage liquidity and plan for financial stability in case of disruptions in cash inflows.

Where can you find the data needed to calculate the cash to monthly cash expenses ratio?

The data needed to calculate the cash to monthly cash expenses ratio can be found in the company's financial statements. The cash balance at year-end is listed on the balance sheet, while the monthly cash expenses can be derived from the operating section of the statement of cash flows. The operating section shows the cash outflows related to the company's core business activities. To find the monthly cash expenses, you can divide the annual cash outflows by 12.

What are the limitations of the cash to monthly cash expenses ratio?

While the cash to monthly cash expenses ratio is useful for assessing liquidity, it has limitations. It assumes that cash outflows remain constant, which may not be realistic as expenses can fluctuate. Additionally, it does not account for other sources of liquidity, such as lines of credit or the ability to quickly liquidate assets. This ratio also does not consider the timing of cash inflows and outflows, which can impact a company's actual cash position. Therefore, it should be used in conjunction with other financial metrics for a comprehensive analysis.