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Financial Management and Strategic Management · Financial Analysis and Planning - Ratio Analysis

Liquidity Ratios: Current Ratio, Quick Ratio and Cash Ratio

Updated 4 October 2026 · Fact-checked

Liquidity ratios show whether a firm can pay its short-term dues. Current ratio = current assets ÷ current liabilities. Quick ratio = quick assets ÷ current liabilities. Cash ratio = cash and near-cash ÷ current liabilities. To solve, list current assets, remove stock and prepaids, pick the right liabilities, then divide and interpret.

Understand Liquidity Ratios

A firm can be profitable and still fail if it cannot pay bills when they fall due. Liquidity is the ability to meet short-term obligations on time. Liquidity ratios test this by comparing short-term resources with short-term claims.

The current ratio compares all current assets with current liabilities. It is the broadest test. It assumes stock and debtors will turn into cash in time. A common benchmark is 2:1, but this is a rule of thumb, not a law. A good level depends on the industry.

The quick ratio (acid test ratio) is stricter. It removes stock and prepaid expenses because stock may be slow to sell and may not fetch book value. What remains are quick assets: cash, bank, marketable securities and debtors. A common benchmark is 1:1.

The cash ratio is the strictest. It uses only cash, bank balance and marketable securities (near-cash). It shows the ability to pay dues immediately, even if debtors do not pay.

A higher ratio means more safety, but too high can mean idle cash, excess stock or slow collection. Always read the ratio with the business type and trend.

Key rules to remember

Current ratio
Current ratio = Current assets ÷ Current liabilities
Current assets include stock, debtors, cash, bank, marketable securities, loans and advances (short-term) and prepaid expenses. Benchmark often quoted: 2:1.
Quick (liquid) assets
Quick assets = Current assets − Stock − Prepaid expenses
Some questions also exclude advance tax or other non-liquid items. Follow the question's data and state your assumption.
Quick ratio
Quick ratio = Quick assets ÷ Current liabilities
Also called liquid ratio or acid test ratio. Benchmark often quoted: 1:1.
Quick ratio with quick liabilities
Quick ratio = Quick assets ÷ Quick liabilities, where Quick liabilities = Current liabilities − Bank overdraft − Cash credit
Use this only when the question defines quick liabilities or says overdraft is a continuing source of finance.
Cash ratio
Cash ratio = (Cash + Bank + Marketable securities) ÷ Current liabilities
Also called absolute liquid ratio.
Working capital
Net working capital = Current assets − Current liabilities
Useful to back-solve missing figures from a given current ratio.

How to solve Liquidity Ratios questions

Use the same sequence for any liquidity question, whether you must compute a ratio or back-solve a missing figure.

  1. 1Read what is asked: which ratio, and which year or years.
  2. 2List every current asset and every current liability from the data or balance sheet. Leave out fixed assets, investments held long term and long-term loans.
  3. 3Check the liability side: include creditors, bills payable, outstanding expenses, short-term borrowings, provisions due within a year and the current part of long-term debt.
  4. 4For quick ratio, subtract stock and prepaid expenses from current assets to get quick assets.
  5. 5For cash ratio, keep only cash, bank and marketable securities.
  6. 6Divide and show the ratio as x : 1 or in times, to two decimals.
  7. 7Compare with the benchmark or the previous year and give one line of interpretation.
  8. 8If a figure is missing, use the given ratio with the formula and solve algebraically.

Quickest way: List, strip, divide

When to use it: Use this in the exam for both MCQs and written answers when figures are given in a block of data.

  1. MCQs: first find current liabilities, as it is the denominator in all three ratios.
  2. Compute quick assets as current assets less stock and prepaids. Do not recompute from scratch.
  3. Eliminate options where quick ratio exceeds current ratio, since it can never be higher when stock is positive.
  4. For back-solving, assume current liabilities = x and write current assets = ratio × x.
  5. Written answers: show the formula, the list of items used, the division and a one-line conclusion. Each earns step marks even if one figure is wrong.

Common mistakes in Liquidity Ratios

  • Including stock in quick assets.

    Students copy the current assets total without adjusting.

    Fix: Always write 'Quick assets = CA − Stock − Prepaids' as a separate line before dividing.

  • Ignoring prepaid expenses when finding liquid assets.

    Students remember to remove stock only.

    Fix: Prepaid expenses cannot be converted to cash, so deduct them too, unless the question says otherwise.

  • Treating bank overdraft inconsistently.

    Overdraft is a current liability in the standard ratio but may be excluded in quick liabilities.

    Fix: Include it in current liabilities for the usual quick ratio. Exclude it only if the question uses quick liabilities or says it is a permanent source.

  • Including long-term items such as fixed deposits beyond one year or long-term loans.

    Students classify by name, not by due date.

    Fix: Classify by whether the item is due or realisable within 12 months or the operating cycle.

  • Declaring a high ratio always good.

    Students link liquidity with safety only.

    Fix: State that very high ratios may show idle funds or slow stock and debtors, which lowers profitability.

  • Using average balances for liquidity ratios.

    Students mix with turnover ratios, which often use averages.

    Fix: Liquidity ratios use closing balance sheet figures unless the question states otherwise.

Worked examples

Example 1

A company has: stock ₹4,00,000; debtors ₹3,00,000; cash ₹50,000; bank ₹1,50,000; prepaid expenses ₹20,000; creditors ₹2,50,000; bills payable ₹1,00,000; outstanding expenses ₹50,000; bank overdraft ₹1,00,000. Compute the current ratio, quick ratio and cash ratio.

Show the solution
  1. Current assets = 4,00,000 + 3,00,000 + 50,000 + 1,50,000 + 20,000 = ₹9,20,000.
  2. Current liabilities = 2,50,000 + 1,00,000 + 50,000 + 1,00,000 = ₹5,00,000.
  3. Current ratio = 9,20,000 ÷ 5,00,000 = 1.84 : 1.
  4. Quick assets = 9,20,000 − 4,00,000 − 20,000 = ₹5,00,000.
  5. Quick ratio = 5,00,000 ÷ 5,00,000 = 1 : 1.
  6. Cash ratio = (50,000 + 1,50,000) ÷ 5,00,000 = 2,00,000 ÷ 5,00,000 = 0.40 : 1.

Answer: Current ratio 1.84 : 1; quick ratio 1 : 1; cash ratio 0.40 : 1. The firm meets the quick benchmark but is below the 2:1 current benchmark. Its immediate cash cover is thin at 0.40.

Example 2

A firm has a current ratio of 2.5 : 1 and a quick ratio of 1.5 : 1. Working capital is ₹6,00,000. Find current assets, current liabilities, quick assets and stock (assume no prepaid expenses).

Show the solution
  1. Let current liabilities = x. Current assets = 2.5x.
  2. Working capital = 2.5x − x = 1.5x = ₹6,00,000, so x = ₹4,00,000.
  3. Current liabilities = ₹4,00,000.
  4. Current assets = 2.5 × 4,00,000 = ₹10,00,000.
  5. Quick assets = 1.5 × 4,00,000 = ₹6,00,000.
  6. Stock = 10,00,000 − 6,00,000 = ₹4,00,000.

Answer: Current liabilities ₹4,00,000; current assets ₹10,00,000; quick assets ₹6,00,000; stock ₹4,00,000.

Exam tips

  • Most questions combine liquidity ratios with a balance sheet or with other ratios, so extract current assets and liabilities first.
  • In MCQs, check the sign: if stock is positive, the quick ratio must be lower than the current ratio.
  • Write ratios as x : 1 with two decimals and add a one-line comment. The comment often carries a mark.
  • When asked to compute liquid assets, show the deduction of stock and prepaids clearly, and state any assumption on overdraft.
  • Back-solving problems are common. Assume current liabilities as x and build everything from it.

Practice questions from Financial Analysis and Planning - Ratio Analysis

Liquidity 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 Ratios: frequently asked questions

What is the difference between current ratio and quick ratio?

Current ratio uses all current assets. Quick ratio removes stock and prepaid expenses, so it uses only assets that can turn into cash fast. Quick ratio is therefore a stricter test of liquidity.

How do I calculate liquid assets for the quick ratio?

Take total current assets and subtract stock and prepaid expenses. What remains is cash, bank, marketable securities and debtors. If the question gives other instructions, follow them.

Is a current ratio of 2:1 always ideal?

No. It is a traditional rule of thumb. The right level depends on the industry and the speed of the operating cycle. A firm with fast-moving stock and quick collections can work safely with a lower ratio.

Is bank overdraft included in current liabilities?

Yes, in the standard calculation it is a current liability. Some questions exclude it when finding quick liabilities, because it often acts as a continuing source of finance. Use the method the question states.