Investment Theory and Portfolio Development - Ratio analysis: Liquidity Ratios

Candidates are expected to be able to compute the basic types of financial ratios and interpret them, so as to be able to gain a better understanding of a company's financial position. Current financial accounting pronouncements, the nuances of generally accepted accounting principles, as well as exercises requiring candidates to make adjustments to financial statements are not considered for the purpose of the CFP® exam.


  1. Liquidity Ratios - measure the ability of a company to meet its current financial commitments.
    1. Working Capital: the amount of liquid assets available to pay for near-term obligations. Not a ratio, its formula reads thus:

Working Capital = current assets-current liabilities.

    1. Current Ratio: compares current assets to current obligations and is calculated as follows:

Current Ratio = Current assets/current liabilities

    1. Acid-test (quick) ratio - a more extreme measure of a company's short-term liquidity, it measures 'quick' assets (current assets-inventory (less liquid)) as a percentage of current liabilities:

Quick Ratio = Quick assets (current assets-inventory)/current liabilities.

    1. Cash Assets Ratio - more stringent a measure, still, of a company's near-term liquidity, this ratio is calculated as follows:

Cash Assets Ratio = Cash and Equivalents/Current Liabilities.

    1. Debt Service Ratio:

Debt Service Ratio = EBIT (Earnings Before Interest and Taxes)/Annual interest and principal payments

Ratio Analysis: Activity, Profitability and Debt Ratios


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RELATED TERMS
  1. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  2. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. ...
  3. Cash Asset Ratio

    The current value of marketable securities and cash, divided ...
  4. Liquidity Ratios

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  5. Liquidity

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  6. Cash Ratio

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RELATED FAQS
  1. How can a company quickly increase its liquidity ratio?

    Discover what high and low values in the liquidity ratio mean and what steps companies can take to improve liquidity ratios ... Read Answer >>
  2. What are some alternative liquidity ratios to the cash ratio?

    Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >>
  3. What are the main differences between the current ratio and the quick ratio?

    Find out how the quick ratio and the current ratio can offer different views on a company's ability to pay off liabilities. Read Answer >>
  4. To what extent should you take a company's liquidity ratio into account before investing ...

    Find out how important it is for an investor to know a company's liquidity ratio before deciding to invest, and why relying ... Read Answer >>
  5. What is the relationship between the cash ratio and liquidity?

    Understand the relationship between a company's cash ratio and its liquidity. Learn what the cash ratio measures and what ... Read Answer >>
  6. What is the formula for calculating the current ratio?

    Find out how to calculate the current ratio and what that result can tell you about a potential investment. Read Answer >>
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