Financial Management · Determining working capital needs and funding strategies

Working Capital Ratios and Liquidity Analysis for ACCA FM

Updated 11 October 2026 · Fact-checked

Working capital ratios test whether a business can pay its short-term debts and how efficiently it uses inventory, receivables and payables. The current ratio and quick ratio measure liquidity. Inventory, receivables and payables days measure efficiency. You calculate them, compare them with a benchmark, and explain what they mean.

Understand Working Capital Ratios and Liquidity Analysis

Working capital is current assets minus current liabilities. A business needs enough of it to pay suppliers, staff and lenders on time. Too little risks insolvency. Too much ties up cash that could earn a return.

Liquidity ratios look at the balance sheet at one date. The current ratio compares all current assets with current liabilities. The quick ratio (acid test) removes inventory, because inventory can be slow to sell and may not realise its book value.

Efficiency ratios (turnover ratios) show how long cash is tied up in each part of the cycle. Inventory days shows how long stock is held. Receivables days shows how long customers take to pay. Payables days shows how long the business takes to pay suppliers. Together they give the cash operating cycle.

A ratio alone means little. You must compare it with the prior year, a competitor, the industry average or a stated target. A supermarket sells for cash and holds fast-moving stock, so it can run a current ratio below 1 safely. A manufacturer selling on credit usually needs more.

High is not always good. A very high current ratio may mean idle cash, excess inventory or slow-paying customers. A low ratio with rising payables days may signal overtrading or reliance on suppliers as a free loan.

Key rules to remember

Current ratio: Current assets ÷ Current liabilities; Often expressed as x : 1. A common rule of thumb is around 1.5 to 2, but it varies by industry.
Quick ratio (acid test): (Current assets − Inventory) ÷ Current liabilities; Rule of thumb is around 1, but retailers with fast cash sales often sit lower.
Inventory days: Inventory ÷ Cost of sales × 365; Use cost of sales. For raw materials or WIP, use the matching cost base if given.
Receivables days: Trade receivables ÷ Credit sales × 365; Use revenue if credit sales are not given, and say so.
Payables days: Trade payables ÷ Credit purchases × 365; Use cost of sales if purchases are not given, and state the assumption.
Cash operating cycle: Inventory days + Receivables days − Payables days; A shorter cycle means less funding is needed for working capital.

How to solve Working Capital Ratios and Liquidity Analysis questions

Use this method for any working capital ratio question, whether objective or written.

1Identify exactly which ratios the question asks for and the year-end figures needed.
2Pick the correct denominator: cost of sales for inventory, credit sales for receivables, credit purchases for payables.
3Calculate each ratio, using 365 days unless told otherwise, and round sensibly.
4Write the formula on one line so a marker can award method marks.
5Compare with the benchmark: prior year, industry or target. State the direction and size of the change.
6Explain the cause, such as slower collection, higher inventory or reliance on supplier credit.
7Link to risk and action: liquidity pressure, overtrading, or idle funds, then recommend a step.
8 Note assumptions, for example using total revenue as credit sales.

Quickest way: Ratio, benchmark, reason in three lines

When to use it: Use in Section A and B objective questions, and for the interpretation part of a Section C answer when time is short.

Write each formula in short form next to the numbers.
For the quick ratio, subtract inventory from current assets before dividing.
For days ratios, divide first, then multiply by 365.
Check sense: a ratio far from the benchmark may signal a slip, such as the wrong denominator.
In written parts, use one line each: what changed, why, what risk.

Common mistakes in Working Capital Ratios and Liquidity Analysis

Including inventory in the quick ratio.
Students rush and copy the current ratio numerator.
Fix: Always write current assets minus inventory first, then divide.
Using revenue for inventory days.
Revenue is the most visible figure in the statement.
Fix: Inventory is held at cost, so use cost of sales.
Using average figures when the question gives only closing balances, or mixing the two.
Students recall a textbook version with averages.
Fix: Use closing balances unless the question asks for averages, and be consistent across years.
Saying a higher current ratio is always better.
Students link a high figure with safety.
Fix: Explain that excess ratios can show idle cash or slow inventory and receivables.
Stating the ratio with no comparison or reason.
Calculation feels like the main task.
Fix: Always add a benchmark and a cause, because Section C marks interpretation.
Reading longer payables days as purely good.
It improves cash in the short run.
Fix: Note the risk of lost discounts, strained supplier relationships and possible supply disruption.

Worked examples

Example 1

A company has inventory of $90,000, trade receivables of $120,000, cash of $30,000, trade payables of $100,000 and an overdraft of $60,000. Calculate the current ratio and quick ratio.

Show the solution

Current assets = 90,000 + 120,000 + 30,000 = $240,000.
Current liabilities = 100,000 + 60,000 = $160,000.
Current ratio = 240,000 ÷ 160,000 = 1.5.
Quick assets = 240,000 − 90,000 = $150,000.
Quick ratio = 150,000 ÷ 160,000 = 0.9375, about 0.94.

Answer: Current ratio 1.5 : 1 and quick ratio about 0.94 : 1. The business relies on inventory to cover part of its liabilities.

Example 2

Year-end figures: revenue $1,460,000 (all on credit), cost of sales $1,095,000, inventory $180,000, trade receivables $200,000, trade payables $150,000 (purchases are taken as cost of sales). Calculate the cash operating cycle and comment briefly.

Show the solution

Inventory days = 180,000 ÷ 1,095,000 × 365 = 60 days.
Receivables days = 200,000 ÷ 1,460,000 × 365 = 50 days.
Payables days = 150,000 ÷ 1,095,000 × 365 = 50 days.
Cash operating cycle = 60 + 50 − 50 = 60 days.
Comment: the business funds 60 days of operations itself. Faster collection or lower inventory would shorten it.

Answer: The cash operating cycle is 60 days. Assumptions: receivables use revenue and payables use cost of sales.

Exam tips

Show the formula and figures every time, because objective answers are all or nothing, but Section C awards method marks.
State your denominator assumption when purchases or credit sales are not given.
In Section C, structure the answer as ratio, comparison, reason, risk and recommendation.
Check units and rounding in objective questions, because options often differ only slightly.
Always compare with a benchmark; a lone ratio earns few marks.

Practice questions from Determining working capital needs and funding strategies

Working Capital Ratios and Liquidity Analysis in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Working Capital Ratios and Liquidity Analysis: frequently asked questions

What is the difference between the current ratio and quick ratio?

The current ratio uses all current assets. The quick ratio excludes inventory, because inventory may be slow to convert into cash. The quick ratio is a stricter test of short-term liquidity.

What is a good current ratio?

There is no single right figure. A rule of thumb is about 1.5 to 2, but the right level depends on the industry and business model. Retailers selling for cash can operate safely at lower levels.

Do I use sales or cost of sales for inventory days?

Use cost of sales, because inventory is recorded at cost. Use revenue for receivables days. For payables days, use credit purchases, or cost of sales if purchases are not given.

How do I interpret working capital ratios in the exam?

Calculate the ratio, compare it with a benchmark, explain the likely cause and state the risk or action. For example, rising receivables days suggest weak credit control and extra funding need.