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There are two important points to note about high values for the Current Ratio and other liquidity ratios:

  1. It is possible to that high values indicate “false liquidity”
  2. Values that are “too high” impose an opportunity cost on the firm in the form of lowered returns.

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The topic of Time Value of Money (TVM) is an important part of learning accounting and finance. The concept of compound interest can be challenging, but it must be mastered by all business students. There are several ways to calculate compound interest:

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Profitability ratios are in some sense the “bottom line” ratios. Since, profitability is a result of many factors – such as asset management, sales generation, expense control, etc. – these ratios in some ways sum up the total level of success or failure of the organization. There are many different profitability ratios. Each one focuses on a slightly different measure of profit or return.
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There is no governing authority (like FASB or the SEC) that determines official ratios or official formulas for ratios.  In some ways this lack of oversight provides benefits for financial analysts and users of financial information.  Analysts are free to create their own ratios from scratch or modify existing ratio formulas in an attempt to capture information from a firm’s financials.  Any ratio, even a “homemade” one, is useful as long as it helps you understand what is going on in the organization. Continue Reading…

Different Approaches for Ratio Calculation

As mentioned in the Financial Ratios: Chaos and Clarity, one of the major problems with using ratios is the lack of standardization in ratio formulas. One of the most obvious places where this lack of standardization occurs relates to the treatment of balance sheet accounts in certain ratios. It is probably easiest to demonstrate this issue with an example.  Continue Reading…