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CFA Level I · CFA Level I Exam · Working Capital and Liquidity

Two companies in the same industry have identical current ratios of 1.8. Company X holds most of its current assets in cash and receivables, while Company Y holds most in slow-moving inventory. Which statement best describes their liquidity?

Company X is more liquid. Although the current ratios match, X's current assets are mainly cash and receivables, which turn into cash quickly and reliably. Y's slow-moving inventory takes longer to sell and may realize less than book value, so the current ratio overstates Y's liquidity.

  1. ACompany Y is more liquid because inventory has a higher book value
  2. BCompany X is more liquid because its current assets convert to cash fasterCorrect
  3. CBoth are equally liquid because their current ratios are the same

Explanation

The current ratio ignores the composition of current assets. Cash and receivables convert to cash more quickly and with less value uncertainty than slow-moving inventory, so X is more liquid. A quick ratio would reveal the difference.

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