CFA Level I Exam · Working Capital and Liquidity

Liquidity Ratios: Current, Quick and Cash Ratio

Updated 7 October 2026 · Fact-checked

Liquidity ratios measure whether a company can pay its short-term obligations. The current ratio is current assets ÷ current liabilities. The quick ratio removes inventory and other less liquid items. The cash ratio uses only cash and marketable securities. The defensive interval shows how many days of expenses liquid assets can cover.

Understand Liquidity Measures and Ratios

Liquidity is a company's ability to meet short-term obligations as they fall due. A firm can be profitable and still run short of cash. That is why analysts look at the balance sheet, not only the income statement.

The ratios form a ladder from broad to strict. The current ratio counts all current assets. The quick ratio keeps only the assets that turn into cash fast: cash, marketable securities and receivables. The cash ratio is the strictest and keeps only cash and marketable securities. A higher number means more cushion.

The defensive interval ratio asks a different question: if no new cash came in, for how many days could the firm pay its daily cash expenses from liquid assets? It links the balance sheet to the income statement.

A high ratio is not always good. Too much idle cash or inventory can mean poor asset use. A low ratio is a warning, but a firm with strong cash flow or unused credit lines may still be safe. Interpret ratios against the industry, past trends and the firm's access to financing.

The curriculum also discusses drags and pulls on liquidity. A drag delays or reduces cash inflows, such as uncollected receivables, obsolete inventory or tight credit. A pull speeds up cash outflows, such as suppliers shortening credit terms, lines of credit being withdrawn or reduced credit limits. Both reduce liquidity.

Key formulas to remember

Current ratio: Current assets ÷ Current liabilities; Broadest measure. Inventory counts, so it can flatter a firm with slow stock.
Quick ratio: (Cash + Short-term marketable securities + Receivables) ÷ Current liabilities; Some texts use (Current assets − Inventory) ÷ Current liabilities. Use the version the question implies.
Cash ratio: (Cash + Short-term marketable securities) ÷ Current liabilities; Strictest ratio. Excludes receivables.
Defensive interval ratio: (Cash + Short-term marketable securities + Receivables) ÷ Daily cash expenditures; Answer is in days. Daily cash expenditures = (Cash operating expenses, such as COGS + SG&A, excluding non-cash charges like depreciation) ÷ 365.
Order of strictness: Cash ratio ≤ Quick ratio ≤ Current ratio; Holds because each ratio uses the same denominator and fewer assets in the numerator.

How to solve Liquidity Measures and Ratios questions

Use this method for any liquidity question, numerical or conceptual.

1Identify which measure the question asks for: current, quick, cash or defensive interval.
2Pull the right items from the balance sheet. Sort current assets into cash, securities, receivables, inventory and prepaid items.
3For the defensive interval, find daily cash expenditures: take annual cash expenses, remove non-cash items such as depreciation, and divide by 365.
4Compute the ratio and keep the units: a ratio in times, or a figure in days.
5Compare with the benchmark given: a prior year, a peer or a covenant. Decide if liquidity improved or weakened.
6For conceptual items, name whether the event is a drag or a pull, or whether it changes the numerator or the denominator.
7Check the answer makes sense: cash ratio ≤ quick ratio ≤ current ratio.

Quickest way: Rank the ratios and test the direction

When to use it: Use when options differ in size or when the question asks how a transaction changes a ratio.

Remember the order: cash ratio is smallest, current ratio is largest.
If the question asks for the quick or cash ratio, compute the current ratio first. It is the upper bound. Discard any quick or cash ratio option that is above it.
For transaction effects, ask which side changes. Paying a current liability with cash lowers both the numerator and the denominator by the same amount. This applies to the current ratio, the quick ratio and the cash ratio, because cash is in the numerator of each. It does not work the same way for the defensive interval, whose denominator is daily cash expenditure, not current liabilities.
If one of these three ratios is above 1, equal reductions in the numerator and denominator raise it. If it is below 1, they lower it.
Pick the option that matches the direction and magnitude. Three options only, so two eliminations leave the answer.

Common mistakes in Liquidity Measures and Ratios

Including inventory in the quick ratio.
Students treat the quick ratio as a small variation of the current ratio.
Fix: Quick ratio excludes inventory and prepaid items. Start from cash, securities and receivables.
Using total expenses, including depreciation, in the defensive interval.
Students take expenses straight from the income statement.
Fix: Use cash expenses only. Remove depreciation and amortization before dividing by 365.
Assuming a higher current ratio is always better.
Students link higher numbers to safety.
Fix: Ask what drives it. A high ratio may come from excess inventory or idle cash, which signals poor asset management.
Mixing up drags and pulls.
Both reduce liquidity, so the labels blur.
Fix: Drag = cash comes in slower or less (bad receivables, obsolete stock). Pull = cash goes out faster (shorter supplier terms, withdrawn credit lines).
Reporting the defensive interval as a ratio instead of days.
Students copy the pattern of the other three ratios.
Fix: Write the answer in days and check that the denominator is daily expenditure.

Worked examples

Example 1

A company reports cash of €40 million, marketable securities of €20 million, receivables of €90 million, inventory of €150 million and prepaid expenses of €10 million. Current liabilities are €200 million. Which is closest to its quick ratio? A) 0.75 B) 0.95 C) 1.55

Show the solution

Quick assets = cash + securities + receivables = 40 + 20 + 90 = €150 million.
Inventory and prepaid expenses are excluded.
Quick ratio = 150 ÷ 200 = 0.75.
Check: current assets are 310, so the current ratio is 1.55, which is the largest, as expected.

Answer: A) 0.75

Example 2

A firm has cash of $30 million, marketable securities of $50 million and receivables of $120 million. Annual cash operating expenses are $730 million, with $60 million of depreciation separate from this. Which is closest to its defensive interval ratio? A) 40 days B) 100 days C) 200 days

Show the solution

Liquid assets = 30 + 50 + 120 = $200 million.
The $730 million is already cash expenses, so depreciation is not added or used.
Daily cash expenditures = 730 ÷ 365 = $2 million.
Defensive interval = 200 ÷ 2 = 100 days.

Answer: B) 100 days

Exam tips

Read the balance sheet items carefully. The exam often adds inventory or prepaid items to tempt you into the wrong ratio.
For the defensive interval, look for depreciation in the expense list and exclude it unless the question says the figures are cash expenses already.
Questions about trends often ask what a drag or pull does. Classify the event first, then answer.
If a ratio looks high, ask whether the question is probing inefficiency, not strength.
Three options only: compute the current ratio, which is the upper bound, then discard any quick ratio or cash ratio options that are above it.

Practice questions from Working Capital and Liquidity

Liquidity Measures and 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 Measures and Ratios: frequently asked questions

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

The current ratio uses all current assets. The quick ratio keeps only the most liquid ones, such as cash, securities and receivables, and leaves out inventory and prepaid items. The quick ratio is therefore never above the current ratio.

What are drags and pulls on liquidity?

A drag is something that slows or reduces cash coming in, such as uncollectible receivables or obsolete inventory. A pull is something that makes cash go out faster, such as suppliers cutting credit terms or a bank withdrawing a credit line.

How do I measure liquidity of a company for the CFA exam?

Compute the current, quick and cash ratios from the balance sheet, and the defensive interval using daily cash expenses. Then compare them with prior years and peers, and consider access to credit lines.

Is a higher liquidity ratio always better?

No. A high ratio shows a larger cushion, but it can also mean idle cash or slow-moving inventory. You need to judge the quality of the assets and the firm's industry.