CFA Level I Exam · Financial Analysis Techniques

Activity and Liquidity Ratios for CFA Level I

Updated 7 October 2026

Activity ratios measure how efficiently a company uses assets, such as turnover and days of inventory, receivables and payables. Liquidity ratios measure ability to meet short-term obligations. To solve questions, pick the right formula, use average balances unless told otherwise, convert turnover to days with 365, and compare against peers or trend.

Understand Activity and Liquidity Ratios

A company buys inventory, sells it, collects cash, and pays suppliers. Activity ratios show how fast each step happens. Liquidity ratios show whether the company has enough liquid assets to pay bills due soon.

A turnover ratio tells you how many times a balance is used up or collected in a year. Inventory turnover is cost of goods sold divided by average inventory. Receivables turnover is revenue divided by average receivables. Payables turnover is purchases divided by average payables. Divide 365 by a turnover ratio and you get the matching days measure: days of inventory on hand (DOH), days sales outstanding (DSO) and days payables outstanding (DPO).

The cash conversion cycle (CCC) joins these three. It is the time cash is tied up: you pay for inventory, wait to sell it, then wait to collect. Delaying payment to suppliers shortens the cycle. So CCC = DOH + DSO − DPO. A shorter cycle usually means better working capital efficiency, but a very short one can signal tight credit terms or stock-outs.

Liquidity ratios compare liquid assets with current liabilities. The current ratio uses all current assets. The quick ratio removes inventory and other less liquid items. The cash ratio is the strictest and uses only cash and marketable securities. Higher means more cushion, but too high may mean idle assets. Always read ratios against the industry, the company's own history and the trend.

Key formulas to remember

Inventory turnover: COGS ÷ average inventory; Use ending inventory only if the question gives no average.
Days of inventory on hand (DOH): 365 ÷ inventory turnover; Equivalent to average inventory ÷ COGS × 365.
Receivables turnover: Revenue ÷ average receivables; Use credit sales if given.
Days sales outstanding (DSO): 365 ÷ receivables turnover; Average days to collect cash from customers.
Payables turnover: Purchases ÷ average trade payables; Purchases = COGS + ending inventory − beginning inventory.
Days payables outstanding (DPO): 365 ÷ payables turnover; Average days taken to pay suppliers.
Cash conversion cycle: DOH + DSO − DPO; Also called net operating cycle. Operating cycle = DOH + DSO.
Working capital turnover: Revenue ÷ average working capital; Working capital = current assets − current liabilities.
Fixed asset turnover: Revenue ÷ average net fixed assets; Total asset turnover uses average total assets.
Current ratio: Current assets ÷ current liabilities; Broadest liquidity measure.
Quick ratio: (Cash + short-term marketable securities + receivables) ÷ current liabilities; Alternative: (current assets − inventory) ÷ current liabilities; check what the question gives.
Cash ratio: (Cash + short-term marketable securities) ÷ current liabilities; Strictest measure.
Defensive interval ratio: (Cash + marketable securities + receivables) ÷ daily cash expenditures; Gives days the company can pay expenses without new cash.

How to solve Activity and Liquidity Ratios questions

Use this method for any calculation or interpretation question on activity and liquidity ratios.

1Identify what is asked: a turnover, a days measure, the cash conversion cycle or a liquidity ratio.
2Pick the formula and the right numerator: COGS for inventory, revenue for receivables, purchases for payables.
3Compute the average balance as (beginning + ending) ÷ 2 if both are given. Otherwise use the balance provided.
4Calculate the turnover, then divide 365 by it to get days. Keep the question's day count if it states one.
5For CCC, add DOH and DSO and subtract DPO. Check the sign of the result.
6For liquidity ratios, sort the balance sheet items: which are cash, securities, receivables, inventory, prepaid items.
7Interpret: compare with a peer, prior year or benchmark, and say what the change implies.
8Check that exactly one of the three options matches your result and its direction of change.

Quickest way: Days first, then combine

When to use it: Use when the question gives balances and asks for CCC or a days measure and you have about 90 seconds.

Compute days directly: average balance ÷ flow × 365 (inventory ÷ COGS, receivables ÷ revenue, payables ÷ purchases). For payables, use purchases. If purchases are not given, compute purchases = COGS + ending inventory − beginning inventory. Use COGS only if the question states that purchases equal COGS.
Write DOH, DSO and DPO on the scratch pad as three numbers.
Add the first two, subtract the third.
Scan the three options from smallest to largest and pick the closest match; rounding differences are small.
For liquidity questions, subtract inventory from current assets and divide by current liabilities to get the quick ratio in one step.

Common mistakes in Activity and Liquidity Ratios

Using revenue instead of COGS for inventory turnover
Revenue is the first figure on the income statement and receivables turnover uses it.
Fix: Match the balance to the flow measured at the same basis: inventory is at cost, so use COGS.
Adding DPO in the cash conversion cycle
Students memorize the three components but forget payables are financing from suppliers.
Fix: CCC = DOH + DSO − DPO. Longer DPO shortens the cycle.
Using ending balance when averages are given
It saves time and feels simpler.
Fix: Use the average of beginning and ending balances when both appear, unless the question says otherwise.
Putting inventory in the quick ratio
The quick ratio looks like the current ratio with a small change.
Fix: The quick ratio excludes inventory and usually prepaid expenses. Use cash, marketable securities and receivables.
Treating a higher ratio as always better
Higher turnover or a higher current ratio sounds good.
Fix: Interpret in context. Very high inventory turnover may mean stock-outs. A very high current ratio may mean idle cash or slow use of assets.
Using purchases wrongly for payables turnover
COGS is given, purchases are not, so students use whichever is nearby.
Fix: If purchases are not given, calculate: COGS + ending inventory − beginning inventory. Use COGS only if the question states purchases equal COGS.

Worked examples

Example 1

A company reports revenue of €900 million and COGS of €540 million. Average inventory is €90 million, average receivables €100 million and average trade payables €60 million. Purchases equal COGS. Using 365 days, what is the cash conversion cycle? (A) 36.5 days (B) 60.8 days (C) 141.9 days

Show the solution

DOH = 90 ÷ 540 × 365 = 60.83 days.
DSO = 100 ÷ 900 × 365 = 40.56 days.
DPO = 60 ÷ 540 × 365 = 40.56 days.
CCC = 60.83 + 40.56 − 40.56 = 60.83 days.
Check the traps. Using revenue instead of COGS for DOH gives 90 ÷ 900 × 365 = 36.5 days, which is option A. Adding DPO instead of subtracting it gives 60.83 + 40.56 + 40.56 = 141.9 days, which is option C.
Choose the option that matches 60.8.

Answer: (B) 60.8 days

Example 2

A firm has cash of $40 million, marketable securities of $20 million, receivables of $60 million, inventory of $80 million and prepaid expenses of $10 million. Current liabilities are $120 million. Which is the quick ratio (cash, securities and receivables only) and the current ratio? (A) Quick 1.00, current 1.75 (B) Quick 1.33, current 1.75 (C) Quick 1.00, current 1.33

Show the solution

Quick assets = 40 + 20 + 60 = $120 million.
Quick ratio = 120 ÷ 120 = 1.00.
Current assets = 40 + 20 + 60 + 80 + 10 = $210 million.
Current ratio = 210 ÷ 120 = 1.75.
Only option A has quick 1.00 and current 1.75.

Answer: (A) Quick 1.00, current 1.75

Exam tips

Check whether the question gives average or ending balances, and which day count it uses; this changes the answer slightly.
Wrong options are often built by using revenue instead of COGS, or by adding DPO. Work out these traps and rule them out.
With numerical options listed smallest to largest, a quick estimate usually separates them. Do not over-round.
Interpretation questions test direction: slower collection raises DSO, longer supplier credit raises DPO and shortens CCC.
Practice the BA II Plus quickly: enter 90 ÷ 540 × 365 = and read the display; store results with STO and RCL to reuse DOH and DSO.

Practice questions from Financial Analysis Techniques

Activity and Liquidity Ratios: frequently asked questions

How do you calculate the cash conversion cycle?

Add days of inventory on hand and days sales outstanding, then subtract days payables outstanding. Each days measure is 365 divided by the matching turnover ratio. A shorter cycle means cash is tied up for less time.

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

The current ratio divides all current assets by current liabilities. The quick ratio leaves out inventory and other less liquid items, so it is a stricter test. It is the better measure when inventory is slow to convert to cash.

What is the formula for receivables turnover and DSO?

Receivables turnover is revenue divided by average receivables. DSO is 365 divided by that turnover. It shows how many days customers take on average to pay.

Which liquidity ratio is strictest?

The cash ratio is the strictest because it counts only cash and marketable securities. The quick ratio is next, then the current ratio. A very high value on any of them can also signal inefficient use of assets.