Liquidity is one of the simplest ideas in lending until one tries to measure it properly.
Bankers reach quickly for the current ratio because it is neat, familiar, and easy to defend. If current assets sit comfortably higher than current liabilities, the borrower appears liquid. The interpretation is somewhat problematic at times. A high current ratio is not a sufficient condition for liquidity, nor is a low one necessarily a death blow.
The issue is not that the current ratio is useless. The problem is it is too neat for the condition it is being asked to measure. The ratio has survived the vagaries of banking because it offers a clean answer to a messy question. It is extremely useful for paperwork. It is less useful for judgment.
Liquidity is not a single number. Before one can reasonably describe a borrower as liquid or illiquid, at least three separate problems need to be solved.
1. The Problem of Bundling
A rupee of cash, a rupee of receivables and a rupee of inventory are all current assets. That is an accounting truth. It is not a liquidity truth.
In liquidity terms, they are very different.
Cash is available and most liquid. Receivables are one step away, waiting for a customer payment. Inventory is sitting a few miles away from converting to cash and may be sitting anywhere between raw material and WIP, waiting for manufacturing to complete, or as finished goods waiting for sales to happen. Yet the current ratio consolidates these as if they have near-similar liquidity.
In some cases that may be true. In many it may not.
Polycab and Finolex are two well-known cables and wires manufacturers. In FY24, Polycab reported a current ratio of 2.47x and Finolex reported 10.56x — on the face of it, Finolex looks dramatically more liquid. But the more instructive question is what sits inside those current assets. Polycab holds only 24.8% of its current assets in cash and liquid investments, with 38.2% locked in inventory and a further 27% in trade receivables. Finolex, by contrast, holds 64.2% of its current assets in cash, bank balances and liquid investments, with inventory accounting for just 16.2% and receivables a mere 5%. The ratio is right — Finolex is more liquid. But the reason is composition, not the number itself. A banker who stops at the ratio misses the entire story of why.
CR bundles current assets together, with no difference between them. But liquidity depends on how close those assets are to being really liquid.
So, the first real question is not: Do current assets exceed current liabilities?
It is: How much of current assets can actually pay current liabilities?
2. The Problem of Speed
Hawkins Cookers and TTK Prestige both manufacture and sell kitchenware through similar dealer networks, and both reported decent current ratios in FY24— Hawkins at 2.51x and TTK Prestige at 4.15x. The ratio, if anything, flatters TTK Prestige. But Hawkins reported working-capital days of around 25, while TTK Prestige’s working-capital cycle stretched to approximately 78 days. That difference is the real story: liquidity is not just about the stock of current assets over current liabilities, but also about the speed at which cash moves through the business.
The faster the cash conversion cycle, the greater the liquidity comfort. A business that turns inventory quickly, collects receivables efficiently, and manages payable days well, within the limits of its industry structure, can operate with far greater ease than the current ratio alone may suggest.
This becomes especially important where the current ratio appears tight. A business with a lower current ratio but a shorter working-capital cycle carries the comfort of speed, thereby reducing liquidity stress. By contrast, a business with a similar or even higher current ratio but a slower cycle may still face the speed breaker where liquidity looks adequate on paper, but cash remains tied up for longer.
That is why a lower current ratio does not automatically signal weak liquidity. Speed can compensate for tightness and slowness can undermine apparent comfort.
3. The Problem of Liability Mix
Just as current assets need unpacking, current liabilities are not a unified bundle either. They require a look under the hood.
A rupee of trade payable, a rupee of customer advance, and a rupee of current debt all sit under current liabilities. But they do not impose the same outflow pressure on cash.
In FY24, Havells India reported a current ratio of 1.84x while Polycab reported 2.47x – both operating in the cables and electricals industry, both selling through large distribution networks. Polycab’s higher ratio might suggest greater comfort. But look inside the liabilities. For Havells, trade payables accounted for 62.9% of current liabilities and current debt was effectively zero. For Polycab, trade payables were only 27.5% of current liabilities, while acceptances – bank-backed bills of exchange with hard repayment deadlines – accounted for 54% of current liabilities.
That distinction matters because each liability carries a different kind of cash pressure. Acceptances are time-bound. Miss one, and the bank is on the phone the same morning — the consequences are immediate. A few days of delay with a long-standing supplier may require some relationship management, but not a default event. Customer advances put an obligation to deliver on time but no payment pressure. Other liabilities may sit anywhere between fire and ice.
This is the problem of liability mix. The current ratio counts all current liabilities equally. Real liquidity does not.
The Current Ratio is a Soldier, Not the Strategist
At this point, it is tempting to dismiss the current ratio altogether. That would be a mistake.
The current ratio is a valid starting point. The absurdity lies in what lending systems often make of it.
Because credit policy asks for a liquidity number, the banker looks for a number. If the current ratio clears the threshold, the box gets ticked. The current ratio is then elevated into the hero of the analysis, not because it fully answers the liquidity question, but because it satisfies the process question.
But a real view of liquidity does not emerge from that act of compliance. It lies in the harder questions: what is the quality of current assets, how quickly do they turn into cash, and what kind of pressure sits inside current liabilities?
Disclaimer: The opinions expressed here are those of the author and do not reflect the views of FrankBanker.com
