CFA Level I Exam · Analyzing Balance Sheets

Common-Size Balance Sheet and Liquidity/Solvency Ratios

Updated 7 October 2026 · Fact-checked

A vertical common-size balance sheet divides every line by total assets, so each item becomes a percentage. Liquidity ratios (current, quick, cash) test short-term ability to pay bills. Solvency ratios (debt-to-equity, debt-to-assets, financial leverage) test long-term debt burden. Compute the ratio, then compare it with peers and with past years.

Understand Common-Size Analysis and Liquidity/Solvency Ratios

A balance sheet in raw currency is hard to compare. A company with USD 5 billion of assets and one with EUR 80 million of assets cannot be compared line by line. Vertical common-size analysis fixes this. You divide every balance sheet item by total assets. Each line then shows its share of the asset base. Total assets equal 100%. Total liabilities plus equity also equal 100%.

This lets you compare firms of different size and different currencies. It also shows structure over time. For example, if inventory rises from 20% to 35% of assets, working capital is tied up in stock. If goodwill is 40% of assets, the asset base depends on past acquisitions. Horizontal analysis is different: it compares one line across periods against a base year. Do not mix the two.

Liquidity ratios ask: can the firm meet obligations due within about a year? The current ratio uses all current assets. The quick ratio keeps only the most liquid ones: cash, marketable securities and receivables. It leaves out inventory and prepaid items. The cash ratio is stricter still. Higher means safer, but a very high ratio can signal idle cash or slow use of assets.

Solvency ratios ask: can the firm meet obligations over the long term? Debt-to-equity, debt-to-assets and financial leverage show how much of the firm is financed by creditors. Higher leverage means more risk when earnings fall. Definitions of debt vary. In the CFA curriculum, total debt usually means interest-bearing short-term and long-term borrowings. Use the definition the question gives.

Ratios are only useful in context. Compare a ratio with the industry, with the firm's own history and with covenant limits. A utility can carry more debt than a software firm. A ratio alone never proves a firm is sound.

Key formulas to remember

Vertical common-size item: Line item ÷ Total assets × 100%; Use total assets as the base for every balance sheet line, including liabilities and equity.
Current ratio: Current assets ÷ Current liabilities; Includes inventory, so it is the broadest liquidity measure.
Quick ratio: (Cash + Marketable securities + Receivables) ÷ Current liabilities; Also written as (Current assets − Inventory − Prepaids) ÷ Current liabilities. Use the version the data supports.
Cash ratio: (Cash + Marketable securities) ÷ Current liabilities; The strictest liquidity test.
Working capital: Current assets − Current liabilities; A currency amount, not a ratio.
Debt-to-assets: Total debt ÷ Total assets; Share of assets financed by debt.
Debt-to-capital: Total debt ÷ (Total debt + Total shareholders' equity); Capital here is debt plus equity, not total assets.
Debt-to-equity: Total debt ÷ Total shareholders' equity; Can exceed 1.0 for highly leveraged firms.
Financial leverage: Average total assets ÷ Average total equity; Also called the equity multiplier. Always at least 1 when equity is positive.

How to solve Common-Size Analysis and Liquidity/Solvency Ratios questions

Use this routine for any balance sheet ratio or common-size question.

1Read what the question asks: a common-size percentage, a liquidity ratio or a solvency ratio.
2Check the base. Common-size balance sheet items use total assets. Debt-to-capital uses debt plus equity.
3Pick out only the lines you need. For the quick ratio, drop inventory and prepaids.
4Check whether the question defines total debt. If it does, use that definition exactly.
5Compute the ratio and keep at least three decimals until the final step.
6Interpret: higher liquidity means more safety; higher leverage means more risk.
7Compare with the benchmark given, then eliminate the two options that contradict your result.

Quickest way: Base-first elimination

When to use it: Use this when time is short and the options are spread widely.

Identify the numerator and denominator in one glance.
Estimate roughly. If current assets are about double current liabilities, the ratio is near 2.
Remove options that fail the sanity checks: the quick ratio cannot exceed the current ratio (they are equal only when inventory and prepaids are zero); debt-to-assets cannot exceed 1 unless equity is negative.
Do the exact calculation only if two options remain close.

Common mistakes in Common-Size Analysis and Liquidity/Solvency Ratios

Using the wrong base in a common-size balance sheet, such as dividing liabilities by total liabilities.
Students copy the income statement habit of using one base for everything in a section.
Fix: The vertical base for every balance sheet line is total assets.
Leaving inventory in the quick ratio.
The two ratios look alike and the formula is rushed.
Fix: Remove inventory and prepaid expenses. Keep cash, securities and receivables.
Confusing debt-to-capital with debt-to-assets.
Both use debt in the numerator.
Fix: Capital is debt plus equity. Assets include non-debt liabilities such as payables.
Using total liabilities when the question asks for total debt.
Students treat all liabilities as debt.
Fix: Debt means interest-bearing borrowings. Exclude payables and accruals unless told otherwise.
Claiming a higher current ratio is always better.
Safety is the only interpretation students learn.
Fix: An excessive ratio can mean idle cash, slow inventory or poor use of resources. Judge against peers.

Worked examples

Example 1

A company reports cash EUR 40 million, receivables EUR 60 million, inventory EUR 100 million, other current assets (prepaids) EUR 20 million, current liabilities EUR 110 million. What is the quick ratio?
A. 0.91
B. 1.00
C. 2.00

Show the solution

Quick assets = cash + receivables = 40 + 60 = EUR 100 million.
Prepaids and inventory are excluded.
Quick ratio = 100 ÷ 110 = 0.909, about 0.91.
Check: current ratio = (40 + 60 + 100 + 20) ÷ 110 = 220 ÷ 110 = 2.00, which is option C and is the trap for keeping inventory and prepaids in. Option B, 1.00, would need a numerator of 110, which does not match the quick-asset total of 100.

Answer: A. 0.91

Example 2

A firm has total assets of USD 800 million, total debt of USD 240 million and total shareholders' equity of USD 400 million. The remainder of liabilities is payables and accruals. What are debt-to-equity and debt-to-capital, in that order?
A. 0.38 and 0.30
B. 0.60 and 0.38
C. 0.60 and 0.75

Show the solution

Debt-to-equity = 240 ÷ 400 = 0.60.
Capital = debt + equity = 240 + 400 = USD 640 million.
Debt-to-capital = 240 ÷ 640 = 0.375, about 0.38.
Option A lists 0.38 first, but 0.38 is debt-to-capital, not debt-to-equity. Its second value, 0.30, is debt-to-assets (240 ÷ 800), not debt-to-capital. Both values are wrong for the ratios asked.
Option C gets debt-to-equity right at 0.60, but 0.75 has no basis in these figures and is not debt-to-capital. The second value is wrong.
Option B gives debt-to-equity of 0.60 and debt-to-capital of 0.38, in the order the question asks. It is the only correct pair.

Answer: B. 0.60 and 0.38

Exam tips

Read the denominator of every ratio before calculating. Many wrong options are the right numerator over the wrong base.
Check whether the question defines debt. Use its definition even if it differs from your habit.
For common-size questions, convert only the lines asked about. Do not rebuild the whole statement.
Expect interpretation items: a rising share of inventory, goodwill or debt in the common-size sheet points to a specific risk.
With no penalty for wrong answers, always answer. Eliminate options that violate the check that the quick ratio is at most the current ratio.

Practice questions from Analyzing Balance Sheets

Common-Size Analysis and Liquidity/Solvency Ratios in other exams

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

Common-Size Analysis and Liquidity/Solvency Ratios: frequently asked questions

What base is used for a vertical common-size balance sheet?

Total assets. Every asset, liability and equity line is divided by total assets. The result shows the structure of the balance sheet as percentages.

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

The current ratio uses all current assets. The quick ratio keeps only cash, marketable securities and receivables. It excludes inventory because inventory may be slow to turn into cash.

Is a high debt-to-equity ratio always bad?

No. Higher leverage raises financial risk, but acceptable levels depend on the industry and on how stable earnings are. Compare the ratio with peers and with the firm's own history.

How is financial leverage different from debt-to-equity?

Financial leverage is average total assets divided by average total equity. It includes all liabilities, not just debt, and is used in DuPont analysis. Debt-to-equity uses only debt.