A profitable business can run out of cash. The reason is almost always the working capital: the money tied up in inventory and in amounts owed by customers, less the credit taken from suppliers.
If goods sit in the warehouse for months, customers pay slowly and suppliers must be paid quickly, the business needs a large amount of financing for the same sales. A bad month can make it unable to pay its bills. Two groups of ratios look at this. The working capital efficiency ratios measure how many days each part of the cycle takes.
The liquidity ratios measure whether current assets cover current liabilities. This topic covers both, using the Zaria Plc figures introduced in the previous topic, with the interpretation for each. The next topic covers solvency, gearing and investors’ ratios.
The working capital ratios are tested as part of the larger performance questions. The memo-style questions on performance and viability, such as November Diet, 2023, Question 2 (20 marks), expect efficiency and liquidity to be commented on alongside profitability. Read return and profitability ratios first.
In 30 seconds
Receivables days = receivables ÷ credit sales × 365. Inventory days = inventory ÷ cost of sales × 365. Payables days = payables ÷ cost of sales (or purchases) × 365. The cash operating cycle = inventory days + receivables days − payables days. A longer cycle ties up more cash. The current ratio = current assets ÷ current liabilities, and the quick ratio = (current assets − inventory) ÷ current liabilities. There is no ideal figure: judge the ratio over time, against competitors and against the industry. For groups, use the consolidated figures.
Working capital efficiency ratios
These ratios estimate the average time for each stage of the trading cycle. Use average balances if opening figures are given, otherwise year-end balances. All three compare a balance with a flow in the statement of profit or loss.
- Average time to collect (receivables days)
trade receivables ÷ credit sales × 365.
It is the average credit period given to customers.
If credit sales are not given, use total revenue.
A long period suggests slow collection or generous terms.
Zaria: Year 2 200 ÷ 1,200 × 365 = 60.8 days
Year 1 140 ÷ 1,000 × 365 = 51.1 days. - Average inventory holding period (inventory days)
inventory ÷ cost of sales × 365.
It estimates the time goods are held before being sold.
Year 2 150 ÷ 720 × 365 = 76.0 days
Year 1 110 ÷ 600 × 365 = 66.9 days. - Average time to pay suppliers (payables days)
trade payables ÷ cost of sales (or credit purchases) × 365.
Year 2 210 ÷ 720 × 365 = 106.5 days
Year 1 160 ÷ 600 × 365 = 97.3 days.
A very long period can mean relying on suppliers for finance, with a risk to supply and reputation.
The same ideas are sometimes expressed as turnover multiples: inventory turnover = cost of sales ÷ inventory (Zaria 720 ÷ 150 = 4.8 times against 5.5 times), and receivables turnover = revenue ÷ receivables (6.0 against 7.1). A lower multiple means slower movement.
The cash operating cycle
The cash operating cycle (working capital cycle) is the average time between paying suppliers for the resources and receiving cash from customers for the goods made from them:
Inventory days + receivables days − payables days = cash operating cycle.
For Zaria, Year 2: 76.0 + 60.8 − 106.5 = 30.4 days; Year 1: 66.9 + 51.1 − 97.3 = 20.7 days. The cycle has lengthened by about ten days because inventory and receivables both take longer while the payment period lengthened by less. A longer cycle means the business needs more finance for the same sales, which is part of the reason why its cash fell from ₦90m to ₦50m while profit rose.
Liquidity ratios
Liquidity is the ability to pay debts as they fall due in the near future. Two ratios, both from the year-end statement of financial position:
- Current ratio. = current assets ÷ current liabilities.
Zaria: Year 2 400 ÷ 250 = 1.60
Year 1 340 ÷ 193 = 1.76. - Quick ratio (acid test) = (current assets − inventory) ÷ current liabilities, because inventory is assumed to be the least liquid current asset.
Year 2 (400 − 150) ÷ 250 = 1.00
Year 1 (340 − 110) ÷ 193 = 1.19.
It is sometimes said that a current ratio of 2 to 1 is ideal, but that is not a rule. Supermarkets, which sell for cash and have fast-moving inventory, often operate well with a current ratio below 1. A manufacturer with slow inventory and credit customers needs more. The ratios should be judged by looking at changes over time, at other companies in the same period and at the industry average.
A falling current ratio is a warning only if it falls below what is normal for the business. A very high ratio may mean idle cash or too much inventory.
Zaria’s liquidity has weakened: the current ratio fell from 1.76 to 1.60 and the quick ratio from 1.19 to 1.00, because the cash balance fell, receivables and inventory rose and current liabilities increased. A quick ratio of 1.00 still just covers the current liabilities from assets other than inventory, but the lengthening cycle needs watching.
Groups
In consolidated accounts, the ratios are calculated from the consolidated statement of financial position. Intra-group balances have been cancelled, so the ratios reflect balances with outsiders only. Be careful if the group includes a subsidiary with very different working capital, for example a finance company within a manufacturing group, because the combined ratios may be hard to interpret.
The ideas in more depth
Why credit sales and cost of sales
Receivables arise only from credit sales and inventory and trade payables are carried at cost, so each balance should be related to the flow that created it. Using total revenue for receivables when some sales are for cash understates the days.
Why a long payment period is not always good
Paying suppliers late shortens the cash cycle but can damage relationships, cost discounts and, in an extreme case, stop supply. An analyst should ask whether the longer period is a deliberate use of credit or a sign of shortage of cash.
Sources and references
- The working capital and liquidity ratios are conventional analytical measures, built from figures prepared under International Accounting Standard (IAS) 1 Presentation of Financial Statements.
These points are stated as at 5 November 2026.
Worked examples
Example 1: the cycle. Receivables days 60.8, inventory days 76.0, payables days 106.5. Required: the cash operating cycle.
- Cycle.
76.0 + 60.8 − 106.5 = 30.4 days.
Example 2: liquidity. Current assets ₦400m, inventory ₦150m, current liabilities ₦250m. Required: the current and quick ratios.
- Current ratio.
400 ÷ 250 = 1.60. - Quick ratio.
(400 − 150) ÷ 250 = 1.00.
Example 3: the effect of a policy. The company tightens credit so that receivables days fall from 60.8 to 45. Required: the effect on the cycle.
- New cycle.
76.0 + 45 − 106.5 = 14.5 days, a reduction of 15.9 days.
How to answer in the exam
- State the formulas and use the right base: credit sales for receivables, cost of sales for inventory and payables.
- Compute the cycle and compare with the previous year.
- Comment on cause, effect and risk: what has moved, why, and what it means for cash and solvency.
- Avoid the ideal ratio myth: say what is normal for this kind of business.
Common mistakes in the exam
- Using revenue for inventory days.
- Adding payables days instead of subtracting them in the cycle.
- Saying that a current ratio below 2 is always a problem.
- Including inventory in the quick ratio.
- Using total revenue for receivables when credit sales are given.
- Calculating but not commenting on the ratios.
Quick revision
- Receivables days (credit sales), inventory days (cost of sales), payables days (cost of sales or purchases).
- Cycle = inventory + receivables − payables.
- Current ratio = current assets ÷ current liabilities; quick ratio excludes inventory.
- No ideal ratio: compare over time, with competitors and the industry.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. Receivables days are calculated as:
- Receivables ÷ cost of sales × 365
- Receivables ÷ inventory × 365
- Receivables ÷ credit sales × 365
- Receivables ÷ assets × 365
Show the answer
C. Using total revenue if credit sales are not given.
Question 2. Inventory days use:
- Revenue
- Cost of sales
- Purchases only
- Profit
Show the answer
B. Inventory is carried at cost.
Question 3. Payables days use:
- Cost of sales or credit purchases
- Revenue
- Profit
- Cash
Show the answer
A. Payables arise from purchases.
Question 4. The cash operating cycle equals:
- Inventory days only
- Receivables days + payables days
- Inventory days − receivables days
- Inventory days + receivables days − payables days
Show the answer
D. Supplier credit shortens it.
Question 5. The quick ratio:
- Includes inventory
- Excludes inventory from current assets
- Excludes receivables
- Uses non-current assets
Show the answer
B. Inventory is the least liquid current asset.
Question 6. An ideal current ratio of 2 to 1 is:
- Not a rule, because what is normal depends on the business
- Required by law
- A minimum for all
- Set by the Institute
Show the answer
A. Compare over time and with the industry.
Question 7. Rising receivables days suggest:
- Faster collection
- Lower sales
- Slower collection or more generous credit terms
- Lower inventory
Show the answer
C. More cash is tied up in receivables.
Question 8. A shorter cash operating cycle means:
- More finance is needed
- Lower sales
- Higher inventory
- Less cash is tied up in working capital
Show the answer
D. The business needs less finance for the same sales.
Question 9. Liquidity ratios are normally calculated from:
- The statement of profit or loss only
- Average balances only
- The year-end statement of financial position
- The notes
Show the answer
C. Average values are not needed.
Question 10. A business that sells for cash and turns inventory quickly may have:
- A low current ratio and still be sound
- No payables
- A negative cycle that is always unsound
- No liquidity
Show the answer
A. A supermarket is an example.
Section B style: written questions
Question 11 (10 marks). (a) State the formulas for receivables days, inventory days and payables days. (6 marks) (b) State why there is no ideal current ratio. (4 marks)
Question 12 (15 marks). Credit sales are ₦730m, receivables ₦120m, cost of sales ₦438m, inventory ₦73m and trade payables ₦54m. (a) Calculate receivables days, inventory days and payables days. (9 marks) (b) Calculate the cash operating cycle. (3 marks) (c) State the effect of an increase in the cycle. (3 marks)
A further written question
Question 13 (20 marks). Year 2: current assets ₦330m (inventory ₦120m), current liabilities ₦220m. Year 1: current assets ₦290m (inventory ₦90m), current liabilities ₦160m.
(a) Calculate the current ratio and quick ratio for both years. (8 marks) (b) Comment on the change in liquidity, giving TWO possible causes. (8 marks) (c) State TWO actions management could take to improve it. (4 marks)
Model answers
Show the model answer to Question 11
(a)
- Receivables days = receivables ÷ credit sales × 365 (2).
- Inventory days = inventory ÷ cost of sales × 365 (2).
- Payables days = payables ÷ cost of sales (or credit purchases) × 365 (2).
(b) The appropriate level depends on the type of business (1.5), for example a supermarket sells for cash and holds fast-moving inventory (1). The ratio should be judged over time, with other companies and with the industry average (1.5).
Show the model answer to Question 12
(a)
- Receivables days 120 ÷ 730 × 365 = 60.0 days (3).
- Inventory days 73 ÷ 438 × 365 = 60.8 days (3).
- Payables days 54 ÷ 438 × 365 = 45.0 days (3).
(b) 60.8 + 60.0 − 45.0 = 75.8 days (3).
(c) A longer cycle means that cash is tied up for longer (1.5), so the business needs more finance and is more exposed to a shortage of cash (1.5).
Show the model answer to Question 13
(a)
- Year 2: current ratio 330 ÷ 220 = 1.50
- quick ratio (330 − 120) ÷ 220 = 0.95.
- Year 1: current ratio 290 ÷ 160 = 1.81
- quick ratio (290 − 90) ÷ 160 = 1.25 (8).
(b) Liquidity has weakened: the current ratio fell from 1.81 to 1.50 and the quick ratio from 1.25 to 0.95 (2). The quick ratio is now below 1, so liquid assets no longer cover current liabilities (2). Possible causes are a build-up of inventory, which raised the current ratio less than the liabilities increased (2), and current liabilities rising faster than current assets, for example more short-term borrowing or payables (2).
(c) Reduce inventory levels (2); collect receivables faster or arrange longer-term finance in place of short-term liabilities (2).
Pathfinder on Financial analysis (ii): working capital efficiency and liquidity ratios
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
The memo on the performance and viability of a company to be acquired expects efficiency and liquidity to be commented on alongside the profitability ratios and the sector averages.
Revise first: Working capital efficiency ratios
Source: ICAN Pathfinder, Financial Reporting. Diets covered: Every diet in the Pathfinder, from November Diet, 2021 to May Diet, 2026, was reviewed here. These ratios appear within the larger performance questions..
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