Speed drill · CA IntermediateFinancial Management

Liquidity and solvency ratios from a balance sheet extract

Compute the current ratio, quick ratio and debt-equity ratio, and say what each one is actually measuring.

Marks

4 marks

Exam time

6 min

Difficulty

Easy

The question

QuestionCA Inter · Financial Management

From the following extract, compute the current ratio, the quick ratio and the debt-equity ratio. Inventory ₹2,00,000; Debtors ₹1,50,000; Cash ₹50,000; Current liabilities ₹2,00,000; Long-term debt ₹6,00,000; Shareholders' funds ₹4,00,000.

Given
Inventory = ₹2,00,000Debtors = ₹1,50,000Cash = ₹50,000Current liabilities = ₹2,00,000Long-term debt = ₹6,00,000Shareholders' funds = ₹4,00,000

Formulas used

  • Current ratio = Current assets ÷ Current liabilities
  • Quick ratio = (Current assets − Inventory) ÷ Current liabilities
  • Debt-equity ratio = Long-term debt ÷ Shareholders' funds

Step-by-step working

Workingmarks →

  1. 01Total the current assets

    1
    Inventory                      ₹2,00,000
Debtors                        ₹1,50,000
Cash                           ₹  50,000
                               ─────────
Current assets                 ₹4,00,000

  2. 02Current ratio

    1
    Current ratio = ₹4,00,000 ÷ ₹2,00,000
              = 2 : 1

    Express ratios in the x : 1 form, not as a decimal. It is the convention the examiner expects.

  3. 03Quick ratio

    1
    Quick assets = ₹4,00,000 − ₹2,00,000 (inventory)
             = ₹2,00,000

Quick ratio  = ₹2,00,000 ÷ ₹2,00,000
             = 1 : 1

    Inventory is excluded because it must first be sold and then collected before it becomes cash. Prepaid expenses are excluded for the same reason.

  4. 04Debt-equity ratio

    1
    Debt-equity = ₹6,00,000 ÷ ₹4,00,000
            = 1.5 : 1

    State the basis you used. Some questions define debt as total outside liabilities rather than long-term debt only, and the answer changes materially.

Current · Quick · Debt-equity

2 : 1 · 1 : 1 · 1.5 : 1

Where marks are lost

  • Including inventory in quick assets, which defeats the purpose of the ratio.
  • Including current liabilities in the debt figure when the question defines debt as long-term.
  • Giving a bare number without stating the basis, when two defensible bases exist.
  • Computing correctly but not interpreting — most ratio questions carry a mark for saying what the figure indicates.

In the exam

Ratio questions almost always carry an interpretation sub-part. One line per ratio is enough: a current ratio of 2:1 indicates comfortable short-term liquidity, a quick ratio of 1:1 indicates the company can meet current liabilities without selling inventory, and a debt-equity of 1.5:1 indicates a leveraged capital structure.

Practise next

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FAQs

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Is a current ratio of 2:1 always good?

No. It is a common benchmark, not a rule. A very high current ratio can signal idle cash or slow-moving inventory, and the right level differs sharply by industry — a retailer with fast stock turnover operates comfortably below it.

Should bank overdraft be treated as a current liability?

Generally yes, since it is repayable on demand. But if the question describes it as a long-standing arrangement effectively used as core funding, state the treatment you have chosen and why. The examiner marks the reasoning.

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