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Financial Management and Business Data Analytics · Financial Ratio Analysis

Liquidity Ratios: Current, Quick and Absolute Liquid Ratio

Updated 10 October 2026 · Fact-checked

Liquidity ratios measure whether a firm can pay its short-term obligations from its short-term assets. Current ratio = current assets ÷ current liabilities. Quick ratio = quick assets ÷ current liabilities. Absolute liquid ratio = cash and marketable securities ÷ current liabilities. List the items, apply the formula, then comment on the result.

Understand Liquidity Ratios

Liquidity is a firm's ability to pay its short-term dues on time. A firm can be profitable and still fail if it has no cash when suppliers and lenders ask for payment. Liquidity ratios test this by comparing short-term assets with short-term obligations.

The three ratios differ in how strict they are. The current ratio counts all current assets. The quick ratio (acid-test ratio) removes inventories and prepaid expenses, because stock takes time to sell and convert to cash. The absolute liquid ratio (cash ratio) is the strictest. It counts only cash, bank balances and marketable securities.

The common benchmark is a current ratio of 2:1 and a quick ratio of 1:1. These are rules of thumb, not laws. The right level depends on the industry. A firm with fast-moving stock and quick collections, such as a retailer, can run safely with a lower ratio. A firm with slow inventory needs a higher one. A very high ratio is not always good either. It may mean idle cash, excess stock or slow-paying debtors.

Interpretation matters as much as calculation. Always compare a ratio with the industry norm, with earlier years and with the benchmark, and say what it means for short-term solvency.

Key rules to remember

Current ratio
Current ratio = Current assets ÷ Current liabilities
Written as x : 1. Current assets include inventories, debtors, bills receivable, cash, bank, marketable securities, prepaid expenses and loans and advances recoverable within a year.
Quick (liquid) ratio
Quick ratio = Quick assets ÷ Current liabilities
Quick assets = Current assets − Inventories − Prepaid expenses. Benchmark is commonly 1:1.
Absolute liquid ratio
Absolute liquid ratio = (Cash + Bank + Marketable securities) ÷ Current liabilities
Also called cash ratio. A commonly used benchmark is 0.5:1, though it varies.
Working capital
Net working capital = Current assets − Current liabilities
A rupee amount, not a ratio. Useful for finding missing figures.
Quick liabilities (variant)
Quick ratio = Quick assets ÷ Quick liabilities, where Quick liabilities = Current liabilities − Bank overdraft
Use only if the question asks for it or states that overdraft is a permanent source. Otherwise use total current liabilities.

How to solve Liquidity Ratios questions

Use this method for any liquidity ratio question, whether you are given a balance sheet or a few ratios.

  1. 1List all current assets and current liabilities from the balance sheet. Use Schedule III classification: current investments, inventories, trade receivables, cash and cash equivalents, short-term loans and advances, other current assets.
  2. 2Add current liabilities: trade payables, short-term borrowings, other current liabilities, short-term provisions. Include bank overdraft and outstanding expenses.
  3. 3Compute quick assets by removing inventories and prepaid expenses from current assets. State this deduction clearly.
  4. 4Identify cash, bank and marketable securities for the absolute liquid ratio.
  5. 5Apply each formula and show the working. Express the answer as x : 1, rounded to two decimals.
  6. 6Compare with the benchmark and comment on short-term solvency in one or two lines.
  7. 7If the question gives ratios and asks for a missing figure, build equations from the ratio definitions, starting with the one that has only one unknown.

Quickest way: Three-line liquidity table

When to use it: Use for MCQs and for the calculation part of 14-mark questions when the balance sheet is short.

  1. Write three totals first: Current assets (CA), Inventory plus prepaid (I), Cash plus marketable securities (C), and Current liabilities (CL).
  2. Compute CA ÷ CL, then (CA − I) ÷ CL, then C ÷ CL in that order. Each step reuses earlier figures.
  3. Sense check: absolute ratio ≤ quick ratio ≤ current ratio. If not, you have made an error.
  4. For missing-figure MCQs, use CA = ratio × CL, then work backwards. If working capital is given, CA − CL = WC and CA = k × CL gives CL = WC ÷ (k − 1).

Common mistakes in Liquidity Ratios

  • Leaving inventories in quick assets

    Students rush and take current assets as the starting point without deducting.

    Fix: Always write 'Quick assets = CA − Inventories − Prepaid expenses' as the first line of the quick ratio working.

  • Forgetting to deduct prepaid expenses

    Only inventory is remembered as the non-liquid item.

    Fix: Prepaid expenses cannot be converted into cash, so remove them too, unless the question defines quick assets differently.

  • Leaving out bank overdraft or outstanding expenses from current liabilities

    Overdraft is seen as a bank item and outstanding expenses are hidden in notes.

    Fix: Scan the whole liabilities side and the adjustments. Include overdraft, outstanding expenses, proposed dividend payable and short-term provisions.

  • Treating 2:1 as a rule that must always be met

    Textbooks state the benchmark without its limits.

    Fix: Call it a conventional guide. Comment relative to the industry, past trend and the quality of current assets.

  • Including long-term investments or fixed deposits not maturing within a year in the absolute liquid ratio

    Any 'investment' looks like cash.

    Fix: Include only cash, bank and marketable (readily saleable) current investments.

  • Writing a high ratio as always good

    Students link higher liquidity with safety only.

    Fix: Add that too high a ratio may show idle funds or slow-moving stock and weakens profitability.

Worked examples

Example 1

From the balance sheet of Kaveri Traders Ltd. as on 31 March: Inventories ₹4,00,000; Trade receivables ₹3,00,000; Cash and bank ₹1,00,000; Marketable securities ₹50,000; Prepaid expenses ₹50,000. Trade payables ₹2,50,000; Outstanding expenses ₹50,000; Bank overdraft ₹1,00,000; Short-term provisions ₹1,00,000. Calculate the current ratio, quick ratio and absolute liquid ratio and comment.

Show the solution
  1. Current assets = 4,00,000 + 3,00,000 + 1,00,000 + 50,000 + 50,000 = ₹9,00,000.
  2. Current liabilities = 2,50,000 + 50,000 + 1,00,000 + 1,00,000 = ₹5,00,000.
  3. Current ratio = 9,00,000 ÷ 5,00,000 = 1.8 : 1.
  4. Quick assets = 9,00,000 − 4,00,000 − 50,000 = ₹4,50,000.
  5. Quick ratio = 4,50,000 ÷ 5,00,000 = 0.9 : 1.
  6. Absolute liquid assets = 1,00,000 + 50,000 = ₹1,50,000.
  7. Absolute liquid ratio = 1,50,000 ÷ 5,00,000 = 0.3 : 1.
  8. Comment: current ratio is slightly below the 2:1 guide and quick ratio is below 1:1. The firm depends on selling its inventory to meet short-term dues, so liquidity is somewhat tight. Compare with industry norms before concluding.

Answer: Current ratio 1.8:1; quick ratio 0.9:1; absolute liquid ratio 0.3:1. Liquidity is slightly tight.

Example 2

A company has a current ratio of 2.5 : 1 and net working capital of ₹6,00,000. Inventories are ₹4,00,000 and prepaid expenses are ₹50,000. Find current assets, current liabilities and the quick ratio.

Show the solution
  1. Let current liabilities = CL. Then current assets = 2.5 × CL.
  2. Working capital = 2.5 CL − CL = 1.5 CL = ₹6,00,000.
  3. CL = 6,00,000 ÷ 1.5 = ₹4,00,000.
  4. Current assets = 2.5 × 4,00,000 = ₹10,00,000.
  5. Quick assets = 10,00,000 − 4,00,000 − 50,000 = ₹5,50,000.
  6. Quick ratio = 5,50,000 ÷ 4,00,000 = 1.375 : 1, or 1.38 : 1 rounded.

Answer: Current liabilities ₹4,00,000; current assets ₹10,00,000; quick ratio about 1.38 : 1.

Exam tips

  • Show the list of current assets and current liabilities as a neat working note. Step marks are given for correct totals even if the final ratio is wrong.
  • In MCQs, check for traps: prepaid expenses, bank overdraft and whether the question asks for quick ratio or absolute liquid ratio.
  • Always add a one-line interpretation to written answers. Calculation alone usually does not earn full marks.
  • In missing-figure questions, define CL as x and express everything else in terms of x. This avoids algebra errors.
  • Round ratios to two decimals and write them as x : 1 unless told otherwise.

Practice questions from Financial 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?

The current ratio uses all current assets. The quick ratio removes inventories and prepaid expenses, which are not quickly turned into cash. So the quick ratio is a stricter test of short-term solvency.

How do you calculate the absolute liquid ratio?

Add cash in hand, bank balance and marketable securities. Divide the total by current liabilities. It is the strictest liquidity test because debtors are also excluded.

Why is 2:1 considered the ideal current ratio?

It is a traditional rule of thumb. It means current assets are twice current liabilities, giving a cushion if some assets such as stock or debtors cannot be realised in full. It is not universal, and suitable levels differ by industry.

Can the current ratio be too high?

Yes. A very high ratio may show excess inventory, slow-paying debtors or idle cash. These tie up funds and reduce profitability, so you should comment on the quality of current assets.