Liquidity Ratios: Current Ratio, Quick Ratio, and Cash Ratio

Liquidity is a company’s ability to meet its short-term obligations without raising external capital. It reflects the firm’s capacity to convert assets into cash to pay for liabilities due within a year — a critical factor in financial stability and operational efficiency.

Three key financial metrics are used to assess short-term liquidity:

✦ Current Ratio – measures overall ability to cover current liabilities using all current assets

✦ Quick Ratio – excludes inventory and prepaid expenses for a stricter test of liquidity

✦ Cash Ratio – the most conservative, using only cash and cash equivalents

1. Current Ratio

Definition:

The current ratio measures a company’s ability to pay off short-term obligations using all current assets.

Formula:

Current Ratio = Current Assets ÷ Current Liabilities

Includes in current assets:

Cash, marketable securities, accounts receivable, inventory, and prepaid expenses

Includes in current liabilities:

Accounts payable, short-term loans, accrued liabilities, and current portion of long-term debt

Example

If current assets = $800,000 and current liabilities = $500,000:

Current Ratio = 800,000 ÷ 500,000 = 1.6

2. Quick Ratio (Acid-Test Ratio)

Definition:

The quick ratio refines the current ratio by excluding inventory and prepaid expenses, focusing only on liquid assets.

Formula:

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities

Example:

If cash = $150,000, marketable securities = $100,000, accounts receivable = $250,000, and current liabilities = $500,000:

Quick Ratio = (150,000 + 100,000 + 250,000) ÷ 500,000 = 1.0

3. Cash Ratio

Definition:

The cash ratio measures the company’s ability to pay current liabilities using only cash and equivalents.

Formula:

Cash Ratio = (Cash + Cash Equivalents) ÷ Current Liabilities

Example

If cash and equivalents = $150,000 and current liabilities = $500,000:

Cash Ratio = 150,000 ÷ 500,000 = 0.3

4. Summary of Formulas

Current Ratio = Current Assets ÷ Current Liabilities

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities

Cash Ratio = (Cash + Cash Equivalents) ÷ Current Liabilities

5. Interpretation Guidelines

✦ Current Ratio > 1.0 → sufficient coverage with current assets

✦ Quick Ratio ≥ 1.0 → stable liquid position, even without selling inventory

✦ Cash Ratio 0.2–0.5 → typically adequate, depending on industry

6. Why Liquidity Ratios Matter

✦ Used by creditors to assess repayment capacity;

✦ Highlight ability to handle seasonal cash flow cycles;

✦ Indicate operating efficiency and financial flexibility;

✦ Essential in distress prediction models.