Current Ratio and Quick Ratio: How Banks Judge Your Liquidity Before Sanctioning a Loan
The current ratio is the gatekeeper of working capital loans. Fall below 1.33 and the bank won't even entertain your proposal. This guide explains both liquidity ratios, what drives them, and how to present them in your CMA report.
The Two Ratios That Gate Every Working Capital Loan
When a credit officer opens a CMA report, two numbers get checked within the first 60 seconds: the current ratio and the quick ratio (also called acid-test ratio). These liquidity ratios determine whether the business can meet its short-term obligations and whether the bank's working capital exposure is adequately covered.
Current Ratio
Formula
Current Ratio = Total Current Assets / Total Current Liabilities (including bank borrowings)
What Counts as Current Assets
- Inventory: Raw materials, WIP, finished goods, stores & spares
- Sundry debtors (trade receivables)
- Cash and bank balances
- Short-term loans and advances
- Prepaid expenses
- Other current assets realizable within 12 months
What Counts as Current Liabilities
- Bank borrowings: Cash Credit, Overdraft, Bill Discounting
- Sundry creditors (trade payables)
- Advances from customers
- Statutory dues: GST, TDS, PF, ESI
- Provisions for expenses
- Current portion of long-term debt (CPLTD)
- Other liabilities payable within 12 months
The Magic Number: 1.33
RBI and banking guidelines mandate a minimum current ratio of 1.33:1 for working capital lending. This means for every Rs 1.33 of current assets, there is Rs 1.00 of current liabilities.
Why 1.33? Because it ensures a 25% margin (1/1.33 = 0.75, meaning bank exposure is at most 75% of current assets). This aligns with Tandon Committee Method II, where 25% of current assets must come from long-term sources.
| Current Ratio | Bank Interpretation |
|---|---|
| Below 1.00 | Negative working capital. Immediate concern. |
| 1.00 - 1.10 | Technically solvent but highly stressed. |
| 1.10 - 1.33 | Below benchmark. Bank will ask for corrective action. |
| 1.33 - 1.50 | Meets minimum. Acceptable. |
| 1.50 - 2.00 | Comfortable liquidity. |
| Above 2.00 | Very comfortable, but may indicate idle assets. |
A Current Ratio Pitfall
A high current ratio isn't always good. If current assets are bloated with slow-moving inventory or sticky debtors, the ratio looks healthy on paper but the assets aren't truly liquid. Banks counter this with the quick ratio.
Quick Ratio (Acid-Test Ratio)
Formula
Quick Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities
Or equivalently:
Quick Ratio = (Cash + Bank Balances + Marketable Securities + Receivables) / Current Liabilities
The quick ratio strips out inventory because inventory cannot be instantly converted to cash. It measures whether the business can meet obligations from its most liquid assets alone.
Benchmark
| Quick Ratio | Interpretation |
|---|---|
| Below 0.5 | Severely illiquid. Highly dependent on inventory liquidation. |
| 0.5 - 0.8 | Below comfort. Typical for inventory-heavy businesses. |
| 0.8 - 1.0 | Acceptable for most industries. |
| 1.0 - 1.5 | Comfortable. Can meet obligations without selling inventory. |
| Above 1.5 | Very liquid. May indicate under-utilisation of assets. |
Banks accept a lower quick ratio for manufacturing and trading businesses (where inventory is a genuine business need) but expect a higher quick ratio for service businesses.
Real Example
Company: LMN Textiles Ltd
| Current Assets | Amount (Rs L) |
|---|---|
| Raw Materials | 35.00 |
| WIP | 15.00 |
| Finished Goods | 25.00 |
| Stores & Spares | 5.00 |
| Sundry Debtors | 40.00 |
| Cash & Bank | 5.00 |
| Prepaid Expenses | 3.00 |
| Total Current Assets | 128.00 |
| Current Liabilities | Amount (Rs L) |
|---|---|
| Cash Credit (Bank) | 50.00 |
| Sundry Creditors | 22.00 |
| Statutory Dues | 6.00 |
| Other CL | 4.00 |
| Provisions | 3.00 |
| Total Current Liabilities | 85.00 |
Current Ratio = 128 / 85 = 1.51 (Above benchmark. Acceptable.)
Quick Ratio = (128 - 35 - 15 - 25 - 5 - 3) / 85 = 45 / 85 = 0.53 (Low. Heavily inventory-dependent.)
This tells the bank: the company meets the current ratio benchmark, but its liquidity is almost entirely tied up in inventory. If the textile market softens, converting that inventory to cash becomes difficult. The bank may ask for:
- Tighter inventory monitoring
- Monthly stock statements with aging analysis
- Additional collateral
What Drives These Ratios in CMA Projections
Improving Current Ratio
- Infuse long-term funds (equity or term loan) to replace short-term borrowings
- Reduce reliance on CC/OD by improving collections
- Increase retained profits (ploughed back into current assets)
Improving Quick Ratio
- Speed up debtor collections (tighter credit policy)
- Reduce inventory holding periods
- Negotiate better payment terms with suppliers (increases creditors, which helps current ratio but not quick ratio)
Common Mistakes in CMA Reports
- Including CPLTD in term liabilities instead of current liabilities — artificially inflates the current ratio
- Not classifying bank CC/OD as current liabilities — a fundamental error that misrepresents liquidity
- Projecting improving current ratio without changing the underlying drivers — banks see through this instantly
- Ignoring seasonal impact — a business may have a 1.5 current ratio at year-end but 0.9 at peak season. Banks want to know the worst-case position.
In CMA Reports
CMA Report auto-computes both ratios from your Form III balance sheet data across all periods. It flags any year where the current ratio drops below 1.33 and provides a visual trend line so credit officers can see the trajectory at a glance.