Liquidity Ratios

# Liquidity Ratios

Liquidity ratios measure a firm's ability to meet short-term financial obligations (current liabilities). They look at how readily current assets can be converted to cash.

## 1. Current Ratio

$$\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$$

• A standard benchmark: 2 : 1.
• Includes inventories and prepaid expenses in CA.

## 2. Quick / Acid Test Ratio

$$\text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}}$$

Where Quick Assets = Current Assets − Inventories − Prepaid Expenses.

• Benchmark: 1 : 1. Removes the least-liquid items (stock and prepaids).

## 3. Absolute Cash Ratio (Absolute Liquidity Ratio)

$$\text{Cash Ratio} = \frac{\text{Cash} + \text{Marketable Securities}}{\text{Current Liabilities}}$$

Most stringent test. Cash + Marketable Securities includes:

• Cash in Hand
• Cash at Bank (Dr balance)
• Marketable Investments / Short-term securities (current investments)

## 4. Basic Defence Interval (Days)

$$\text{BDI} = \frac{\text{Quick Assets}}{\text{Cash Expenses per Day}} \quad \text{(in days)}$$

Where:

• Cash Expenses per Day = Annual Cash Expenses / 365
• Cash Operating Expenses = COGS + Selling/Admin/Other Expenses (excluding depreciation & non-cash items)
• Cash Expenses = Total Expenses − Depreciation − Write-offs

Significance: How many days the firm can keep meeting cash operating expenses purely out of its quick assets — i.e., how long it can defend itself in a no-cash-inflow scenario.

## How They Differ

Each ratio peels back a layer of liquidity to test progressively stricter solvency.