Liquidity Ratio: Types, Formulas and Examples Explained

The liquidity ratio is a measure of how well the company can cover its short-term liabilities with current assets. There are three major types of ratios: current, quick, and cash ratios. 

A ratio greater than 1 indicates that the company has enough money to cover its short-term liabilities. A ratio less than 1 indicates financial difficulties.

Reading a company's balance sheet tells you whether it can pay its bills on time. For Indian retail investors, liquidity ratios are among the first numbers to check before making any investment decision. 

As part of a complete financial ratio analysis, liquidity ratios reveal how comfortably a company can handle its short-term obligations without needing emergency loans or asset sales. This article covers all major types, their formulas, real calculations using Infosys FY25 data, and how to use these ratios when picking stocks.

What Is a Liquidity Ratio?

The liquidity ratio is an indication of how easy it is for the business to liquidate its current assets in order to pay off its liabilities. This is measured using information from the balance sheet, and it looks at one-year liabilities.

Liquid assets include cash, bank balances, short-term investments, and receivables. They can be converted to cash quickly. Liquid assets such as land or machinery take months to sell.

• A ratio above 1 means the company has more liquid assets than current liabilities - a healthy position.

• A ratio below 1 means the company may struggle to pay short-term bills without borrowing.

• Liquidity ratios do not measure profitability. A company can be highly profitable yet face a liquidity crisis if cash is tied up in slow-moving inventory.

Liquidity Ratio vs Solvency Ratio

Beginners often confuse these two. The distinction matters.

A company can pass both tests and still struggle if its business model is declining. Use

both together, never in isolation.

Types of Liquidity Ratios

There are four ratios that are quite common in Indian finance to measure liquidity. All four ratios have a progressively stricter interpretation of what is liquid. Here is a brief introduction before going into detail:

Current Ratio

The current ratio is the most widely used liquidity measure. It compares all current assets to all current liabilities without filtering out any asset type.

Formula:

Current Ratio = Current Assets / Current Liabilities

What counts as current assets: Cash, bank balances, inventory, trade receivables, short-term investments, and prepaid expenses.

What counts as current liabilities: Trade payables, short-term borrowings, taxes payable, and accrued expenses due within one year.

Ideal range: 1.5 to 2.0 for most Indian companies. A ratio below 1.5 warrants a closer look at working capital management. Above 3.0 may suggest idle cash not being deployed productively.

Real example - Infosys FY25:

Infosys reported current assets of Rs 97,100 crore and current liabilities of Rs 42,900 crore for FY25.

Current Ratio = Rs 97,100 crore / Rs 42,900 crore = 2.3x

(Source: Equitymaster analysis of Infosys BSE filing, April 2025)

This confirms Infosys is in strong short-term financial health. For every Rs 1 of short-term obligation, the company holds Rs 2.30 of current assets.

For a deeper look at how this ratio is calculated step by step, see the dedicated guide on the current ratio.

Quick Ratio (Acid Test Ratio)

The quick ratio is a strict form of the current ratio. This is because the quick ratio omits inventories and prepaid expenses from the numerator, as these accounts cannot always be liquidated instantly.

The quick ratio is also referred to as the acid-test ratio; this name derives from the notion that the quick ratio is a tougher and stricter liquidity test compared to the current ratio.

Formula:

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

Or alternatively:

Quick Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities

Why inventory is excluded: The inventory will normally take weeks or even months before it can be sold out. If a business is unable to sell out its inventory quickly enough, then the current ratio will overstate its true liquidity position.

Ideal range: 1:1 is considered healthy. A quick ratio below 1 may signal that the company is depending on inventory sales to meet short-term obligations - a risk if demand slows.

Example: A retail company has current assets of Rs 500 crore (including Rs 200 crore in inventory) and current liabilities of Rs 300 crore.

• Current Ratio = 500 / 300 = 1.67

• Quick Ratio = (500 - 200) / 300 = 1.0

Both ratios tell different stories. The quick ratio shows the company has exactly enough liquid assets to cover bills, not much margin.

Cash Ratio

The cash ratio is the most conservative liquidity measure. It only counts cash and marketable securities - assets that are immediately available without any collection or selling process.

Formula:

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Ideal range: 0.5 to 1.0. A cash ratio above 1 means the company holds more cash than it needs to meet current liabilities. This is not always positive - excess cash that earns no return is a capital allocation concern.

Who uses it: Banks and lenders use the cash ratio to assess worst-case repayment ability. It answers the question: "If nothing else works out, can this company pay its bills today?"

Note for Indian investors: SEBI-listed companies are required to disclose cash and cash equivalents separately in their quarterly filings. This makes calculating the cash ratio straightforward using BSE or NSE financial statements.

Absolute Liquidity Ratio

The absolute liquidity ratio uses the same numerator as the cash ratio but is commonly referenced in Indian accounting standards and CA exam frameworks.

Formula:

Absolute Liquidity Ratio = (Cash + Marketable Securities) / Current Liabilities

Ideal level: 0.5 or above. A ratio below 0.5 suggests the company may not have enough immediately available cash to cover even half its short-term obligations.

Answer to this ratio is: "What are the 5 liquidity ratios?" – the fifth one is known as the basic defense ratio or the defensive interval ratio, and this measures the number of days a business will survive by spending money from its liquid resources only.

What Is a Good Liquidity Ratio? Sector-wise Benchmarks for Indian Companies

There is no single "good" liquidity ratio. The right benchmark depends on the industry. Companies in different sectors operate with fundamentally different working capital cycles.

Ratio Benchmarks for Industry Ratios Based on NSE Stocks from Annual Reports of BSE/NSE, FY25

Important takeaway: If an FMCG company has a current ratio of 1.1, there is no problem. Its inventory rotates in a few weeks, hence low ratios are natural. However, the same ratio in the case of a manufacturing company whose inventory moves slowly is a problem.

The liquidity ratio should always be compared to a similar company in the same industry.

Real Example: Reading Infosys Liquidity Ratios (FY25)

Infosys (NSE: INFY) is a useful benchmark for IT sector liquidity analysis. Here is a step-by-step ratio calculation using FY25 annual report data.

Data from Infosys FY25 (BSE filing, April 2025):

Source: Equitymaster analysis of Infosys BSE filing; Infosys FY25 press release, April 17, 2025.

Ratio Calculations:

Current Ratio = 97,100 / 42,900 = 2.27x

Quick Ratio = 97,100 / 42,900 = 2.27x (same as current ratio - no inventory in IT)

Cash Ratio = 47,549 / 42,900 = 1.11x

What this tells an investor:

• Infosys can cover its short-term liabilities more than twice over using current assets.

• Its cash ratio above 1.0 means even without collecting receivables, the company can pay all current bills from cash alone.

• This reflects Infosys's near-zero debt and asset-light IT services model.

Infosys has been able to keep the current ratio at a level higher than 2 during the last ten years. This is in line with the structure that Infosys follows – no inventory, good free cash flow of Rs 35,700 crore in FY25 (According to Infosys Press Release, April 2025), and dividends payout.

What Happens When Liquidity Is Too High or Too Low?

Liquidity ratios work as warning signals at both extremes.

When Liquidity Is Too Low (Ratio Below 1)

A current ratio below 1 means current liabilities exceed current assets. This signals:

• The company may need to borrow short-term to pay suppliers or staff.

• It may delay payments, damaging supplier relationships.

• Credit ratings may suffer, making new loans expensive.

• In severe cases, the company faces a working capital crisis.

In India, during the IL&FS liquidity crisis of 2018, several NBFCs saw their short-term obligations exceed liquid assets rapidly. Investors who tracked quick ratios early saw the warning signs before the defaults became public.

When Liquidity Is Too High (Ratio Above 3 to 4)

An abnormally high current ratio is not always good news. It can mean:

• The company is sitting on idle cash that earns little return.

• Management is not deploying capital into growth, new machinery, or R&D.

• Shareholders may question why dividends or buybacks are not being increased.

Example: A capital goods company with a current ratio of 5.5 may be holding excess cash instead of investing in new plant capacity. This drag on return on equity (ROE) is visible when you compare the liquidity ratio alongside the ROE trend.

The ideal range sits between both extremes - enough liquidity to run smoothly, not so much that capital is being wasted.

How to Check a Company's Liquidity Ratio Before Investing

No broker or analyst will hand you this data pre-interpreted. You need to read it yourself. Here is how:

Step 1: Open the company's latest annual report or quarterly results on BSE or NSE .

Step 2: Go to the balance sheet. Find Current Assets (total of all items maturing within 12 months) and Current Liabilities (total of all short-term obligations).

Step 3: Calculate the current ratio = Current Assets / Current Liabilities.

Step 4: Remove inventory from current assets and calculate the quick ratio.

Step 5: Compare your result to the sector peer average, not a generic benchmark.

Step 6: Pull the same data for the past 3 to 5 years. A declining current ratio over 3 consecutive years is a structural warning, not a one-year anomaly.

For a detailed walkthrough of reading balance sheet line items, see how to read a balance sheet.

Use the Dhanarthi stock screener to filter and compare current ratios across sectors and peer companies in seconds, without manually pulling annual reports.

Limitations of Liquidity Ratios

Liquidity ratios are useful but incomplete on their own. Know what they cannot tell you.

Snapshot in time:

This ratio is tied to the balance sheet date, not the average situation across the whole year. A firm can also shuffle payables close to quarter-end, just to look like the ratio is cleaner or higher.

Ignores asset quality:

It kind of sweeps under the rug things like inventory that’s slow-moving, or receivables that are doubtful. So a “high” current ratio can still mean pretty shaky liquidity, at least in reality.

No profitability signal:

You can end up with a current ratio of 3 and still be loss-making. Liquidity, i mean, and profitability are separate beasts; they don’t automatically move together.

Industry blind:

Putting a retail company’s figures side by side with an IT company’s figures doesn’t really tell you much. The setting matters more than the number, basically.

Does not capture cash flow timing:

A company can look fine on paper, yet hit a cash crunch if collections stretch to 120 days while payables are due in 30 days. Timing can make all the difference, even when the assets look adequate.

Conclusion

Basic liquidity ratios, but a starting point, should be part of stock analysis. Our current ratio will provide short-term financial health. Some of the quick ratio that removes the distortion of slow inventory. The cash flow shows some worst-case repayment ability. 

These are key rules for indian retail investors:
No single number is universally "good." Compare within the same sector.

• Watch the trend over 3-5 years, not just the latest quarter.

• A ratio below 1 is a warning. Above 3-4, ask why the cash is sitting idle.

• For IT companies like Infosys (current ratio 2.27x in FY25), higher ratios are structurally normal. For FMCG, ratios below 1.5 are acceptable

Start with the balance sheet. Calculate the ratios. Compare to peers. Track the direction over time.

Disclaimer: This article is for educational purposes only. It does not constitute investment advice. Please consult a SEBI-registered financial advisor before making investment decisions.

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