Liquidity ratio: how it is calculated and what it should be

19 October 2026, 10:34

The liquidity ratio is the ratio between short-term assets and short-term liabilities. The numerator holds the money already in the bank accounts and what will turn into money within a year: receivables from customers, inventory, other amounts to be collected. The denominator holds the debts to be paid over the same period: suppliers, banks for short-term credit lines, employees, the tax authorities and social security bodies. A result of 1.3 means that for every euro of those debts there are 1.30 in accounts, receivables and stock. The capital portions of loans falling due within the year stay out: banks compare them with the cash the company generates in a different indicator, the DSCR (Debt Service Coverage Ratio).

There are two ratios, and the difference lies in the inventory

In textbooks the ratio described above is called the current ratio. Removing inventory from the numerator gives the quick ratio, also known as the acid test.

Receivables from customers turn into money when the invoices fall due. Stock, on the other hand, must first be processed and sold, and the money only comes in after the sale. The current ratio says whether short-term assets cover short-term debts; the quick ratio says whether the company can pay them without relying on selling its stock. Read together, they measure how much the cash of the coming months depends on inventory.

The calculation is done on the financial statements, even in abbreviated form

Article 2435-bis of the Italian Civil Code, which governs abbreviated financial statements, requires the amounts due beyond the following financial year to be shown separately among receivables and among payables. Short-term assets are therefore current assets without long-term receivables. Short-term liabilities are total payables minus those due after the following financial year and minus the capital portions of loans falling due within the year. The financial statements leave those portions among short-term payables, without showing them separately: the amount can be read in the loans' repayment schedules. For the quick ratio, the inventory item is removed from the numerator.

An example. A company making cardboard packaging has a turnover of €18 million a year. At year end its short-term assets are worth €6 million, half of which is inventory, while short-term liabilities are €4 million. The current ratio is 1.5; the quick ratio, without stock, falls to 0.75. To pay the year's debts, accounts and receivables are not enough: €1 million is missing, which has to come from selling stock and amounts to a third of the inventory.

Thresholds only hold for the formula they were built on

Textbooks give reference values. For the current ratio, above 1.5 the structure is considered solid, between 1 and 1.5 acceptable, below 1 under strain. For the quick ratio, above 1 good, between 0.8 and 1 sufficient, between 0.5 and 0.8 to be watched carefully, below 0.5 critical.

In Italy, in October 2019, the National Council of Chartered Accountants (CNDCEC) published the alert indices provided for by the Italian Business Crisis Code, Legislative Decree 14 of 2019. Among them is a «liquidity ratio»: short-term assets over short-term liabilities, inventory included. The thresholds change with the sector and range from 69.8 to 108 per cent; the signal goes on when the ratio is equal to or below its sector's value. Those indicators never became mandatory: since Legislative Decree 83 of 2022 the Code no longer refers to them, and today they remain a reference of practice.

The typical mistake comes from the name. The same label circulates with different formulas: some textbooks call «quick» only the ratio between cash and short-term liabilities, a stricter step than the acid test. And the CNDCEC thresholds, built with inventory in the numerator, applied to the ratio without inventory set off a false alarm in almost every manufacturing company. That is why the formula used must always be written next to the name of the ratio, including when it is presented by a bank or an analyst.

In your own financial statements you look at the gap between the two ratios

A good current ratio with a weak quick ratio describes a company that holds up as long as its inventory turns: if sales slow down, stock stays on the shelves and debts fall due all the same. Two close ratios describe a company that pays with its receivables and its cash, and depends little on its warehouse.

The calculation is repeated on the last three financial statements and, when available, on the quarterly reports of the current year. Controlling puts the two ratios next to the average number of days goods stay in the warehouse. If the gap between the current ratio and the quick ratio grows from one set of financial statements to the next, the cash of the following months depends more and more on stock.