Line up everything the company must pay within a year. Those are its current liabilities. Then line up everything that is cash or will turn into cash within a year, its current assets. Liquidity ratios are just that comparison, run at three levels of strictness:
Current ratio = Current assets ÷ Current liabilities: everything counts, including inventory and prepaid expenses.Quick ratio (acid test) = (Cash + marketable securities + receivables) ÷ Current liabilities: drops inventory, which must first be sold, maybe at a discount. It also drops prepaids, which never become cash at all because they get used up.Cash ratio = (Cash + equivalents + marketable securities) ÷ Current liabilities: could you pay everyone tomorrow morning?
Each step down asks how much of the cushion is already money. When things get tense, a fourth lens helps. It's the defensive interval, (cash + securities + receivables) ÷ average daily operating expenses, and it tells you how many days the company can keep operating if inflows stop entirely.
Where do the numbers come from? You covered this in the balance sheet module. An Indian Schedule III balance sheet hands you the current/non-current split directly, and a US 10-K does the same in its classified balance sheet. Watch for the items learners misfile. Current maturities of long-term debt belong in current liabilities, because they're this year's problem. Restricted cash often hides inside "other current assets", or even among non-current assets. Read the note before you count it as ammunition.
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What is a good current ratio?
Older textbooks teach current ratio ≥ 2.0 and quick ≥ 1.0 as "safe." The two retailers below are your reason to distrust that rule, so hold them side by side. Treat the figures as illustrative, modeled on ~FY24/FY25 scale, and pull the actual filings. DMart is Avenue Supermarts.
| Illustrative | DMart (₹ cr) | Costco ($bn) |
|---|---|---|
| Cash + investments | ~2,500 | ~11 |
| Receivables | ~300 | ~2.7 |
| Inventory | ~3,900 | ~18.5 |
| Other current assets | ~300 | ~1.8 |
| Current assets | ~7,000 | ~34 |
| Current liabilities | ~2,000 | ~35 |
| Current ratio | 3.5 | 0.97 |
| Quick ratio | 1.4 | 0.39 |
| Cash ratio | 1.25 | 0.31 |
By the textbook rule, DMart is a fortress and Costco is one bad week from a crisis. In reality both are among the most creditworthy retailers on earth. Costco carries an A+ credit rating with a quick ratio of 0.39. How? It comes down to the deepest idea here: a liquidity ratio is meaningless until you know how fast the balance sheet spins. Costco's inventory turns into cash in ~30 days, every dollar of it, reliably, so a current ratio just below 1 keeps recycling itself. A machine-tool maker with 180-day inventory and 90-day receivables really does need the 2.0 cushion.
Only the business model can set the right threshold.
What do the stricter ratios catch?
Strict ratios are still useful for catching mismatch. If the current ratio looks fine while the quick ratio collapses, the cushion is turning into inventory. That's the classic early frame of a demand problem, and the forensic work drills it later. If both look fine but current maturities of debt exceed cash plus twelve months of expected CFO, you're looking at refinancing dependence. It's the IL&FS/DHFL failure mode you met in the liabilities work.