Business Finance · Interpreting company accounting information

Liquidity and Efficiency Ratios for CB1 Business Finance

Updated 11 October 2026 · Fact-checked

Liquidity ratios (current and quick) test whether a company can pay its short-term debts. Efficiency ratios (stock, debtor and creditor days, asset turnover) show how well it uses assets and working capital. Calculate each from the accounts, state the formula and the year-end basis used, then comment against a benchmark.

Understand Liquidity and Efficiency Ratios

A company can be profitable and still fail if it cannot pay bills on time. Liquidity is the ability to meet short-term obligations as they fall due. The two standard tests compare current assets with current liabilities.

The current ratio uses all current assets. The quick ratio (acid test) removes stock, because stock is the hardest current asset to turn into cash quickly. A quick ratio therefore shows a harsher, safer view of liquidity.

Efficiency ratios show how fast money moves through the business. Stock days is how long stock sits before sale. Debtor days is how long customers take to pay. Creditor days is how long the company takes to pay suppliers. Together they build the working capital cycle: stock days + debtor days - creditor days. A shorter cycle means less cash is tied up.

Asset turnover shows how much sales each rupee of assets produces. A higher figure suggests assets are used well, but it must be compared with similar companies and with earlier years.

No ratio has one correct value. A supermarket sells for cash and gets credit from suppliers, so a current ratio below 1 can be normal. A manufacturer usually needs a higher one. Always interpret in the context of the industry and the trend.

Key rules to remember

Current ratio: Current ratio = Current assets ÷ Current liabilities; Shown as a ratio, e.g. 1.5 : 1, or as a number of times.
Quick ratio: Quick ratio = (Current assets - Stock) ÷ Current liabilities; Also called the acid test. Some questions also exclude prepayments; follow the question's definition.
Stock days: Stock days = (Closing stock ÷ Cost of sales) × 365; Use cost of sales, not revenue. Some questions use average stock.
Debtor days: Debtor days = (Trade receivables ÷ Credit sales) × 365; Use revenue if credit sales are not given, and say so.
Creditor days: Creditor days = (Trade payables ÷ Credit purchases) × 365; If purchases are not given, use cost of sales and state the assumption.
Working capital cycle: Cycle = Stock days + Debtor days - Creditor days; Measured in days. It is the time cash is tied up in operations.
Asset turnover: Asset turnover = Revenue ÷ Total assets (or capital employed); State which asset base you used and use it consistently.

How to solve Liquidity and Efficiency Ratios questions

Use this method for any liquidity or efficiency question, whether it asks for calculation, comment or both.

1Read the question for the exact definitions given, such as average or closing balances, or a 360-day year. Follow them.
2List the figures you need from the balance sheet and income statement: current assets, stock, receivables, payables, revenue, cost of sales.
3Write each formula before you substitute numbers. This earns method marks even if arithmetic slips.
4Calculate for every year or company given. Keep the same basis throughout.
5Round sensibly (days to the nearest whole day, ratios to two decimals) and state units.
6Compare with the prior year, a peer or an industry norm. Describe the direction of change.
7Give likely causes and consequences, such as slower collection or stock build-up, and say what you would check next.
8State any assumption, for example using revenue because credit sales are not given.

Quickest way: Table-first calculation

When to use it: Use when the exam gives two years of accounts and asks for several ratios under time pressure.

Draw a small table with ratios down the side and years across.
Pull all needed figures in one pass through the accounts and mark them.
Compute current and quick ratios first, as they use only the balance sheet.
Compute the three day measures using 365 and the right base: cost of sales for stock and creditors, revenue for debtors.
Add the working capital cycle as one line.
Write one comment per ratio: direction, likely cause, implication.

Common mistakes in Liquidity and Efficiency Ratios

Using revenue instead of cost of sales for stock days and creditor days.
Students memorise debtor days with revenue and copy it across.
Fix: Stock and creditors are valued at cost, so match them with cost of sales or purchases. Only debtors match revenue.
Forgetting to remove stock in the quick ratio.
Students rush and reuse the current ratio numerator.
Fix: Write (CA - Stock) explicitly before dividing.
Saying a higher current ratio is always better.
Students link high liquidity with safety only.
Fix: A very high ratio may mean idle cash, excess stock or slow collection. Comment on both sides.
Mixing closing and average balances between years.
The first year has no opening balance, so figures get mixed.
Fix: Use closing balances for all years unless told otherwise, and say so.
Adding creditor days to the cycle instead of subtracting.
Students treat all three day figures as costs of time.
Fix: Creditors fund the business, so they shorten the cash cycle. Subtract them.
Giving numbers without comment.
Calculation feels like the whole answer.
Fix: Add a comparison, a cause and an implication for every ratio asked for.

Worked examples

Example 1

A company has current assets of ₹8,40,000, including stock of ₹3,00,000, and current liabilities of ₹4,50,000. Calculate the current ratio and quick ratio and comment briefly.

Show the solution

Current ratio = 8,40,000 ÷ 4,50,000 = 1.867, about 1.87.
Quick assets = 8,40,000 - 3,00,000 = ₹5,40,000.
Quick ratio = 5,40,000 ÷ 4,50,000 = 1.20.
Comment: current assets cover current liabilities 1.87 times, and even without stock the company covers them 1.2 times.

Answer: Current ratio 1.87; quick ratio 1.20. Liquidity looks comfortable, though a benchmark for the industry is needed for a firm conclusion.

Example 2

A company has revenue of ₹36,50,000 (all on credit), cost of sales of ₹21,90,000, closing stock ₹3,60,000, trade receivables ₹4,50,000 and trade payables ₹2,40,000. Use 365 days. Assume purchases equal cost of sales. Calculate stock days, debtor days, creditor days and the working capital cycle.

Show the solution

Stock days = 3,60,000 ÷ 21,90,000 × 365 = 0.16438 × 365 = 60 days.
Debtor days = 4,50,000 ÷ 36,50,000 × 365 = 0.12329 × 365 = 45 days.
Creditor days = 2,40,000 ÷ 21,90,000 × 365 = 0.10959 × 365 = 40 days.
Cycle = 60 + 45 - 40 = 65 days.
Comment: cash is tied up for about 65 days. Faster collection or lower stock would shorten this.

Answer: Stock days 60; debtor days 45; creditor days 40; working capital cycle 65 days.

Exam tips

Write the formula and the base you chose. Markers reward stated assumptions.
Always comment. Calculation alone usually earns only part of the marks.
For MCQs, check whether the question wants days or times, and whether stock is excluded.
Compare across years or companies and name a specific cause, not just 'it got worse'.
Check the 365 or 360 day basis in the question before you start.

Practice questions from Interpreting company accounting information

Liquidity and Efficiency Ratios in other exams

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

Liquidity and Efficiency Ratios: frequently asked questions

What is the difference between current ratio and quick ratio?

The current ratio divides all current assets by current liabilities. The quick ratio first removes stock, so it shows liquidity without relying on selling inventory. The quick ratio is the stricter test.

How do I calculate debtor days and creditor days?

Debtor days = trade receivables ÷ credit sales × 365. Creditor days = trade payables ÷ credit purchases × 365. If credit figures are missing, use revenue or cost of sales and state the assumption.

What is the working capital cycle?

It is stock days plus debtor days minus creditor days. It measures how many days cash is tied up between paying suppliers and receiving money from customers.

Is a low current ratio always bad?

No. Businesses that collect cash quickly and get supplier credit, such as retailers, can run safely with a low ratio. Judge it against the industry and the trend.