DQ1C - bankruptcy when, after reviewing the actual big...

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Which ratios measure a corporation’s liquidity? What are some of the problems associated with using financial ratios? How would the Dupont analysis overcome some of these problems? There are generally 3 ratios that measure a corporation's liquidity: 1. Working Capital, or Current Assets - Current Liabilities 2. Current Ratio, or Current Assets/Current Liabilities 3. Quick Acid Test, or (Current Assets - Inventory - Prepaid Assets)/Current Liabilities The most major problem with these ratios is the fact that long term debts and assets do not appear in the calculation. That could lead an observer to conclude that a company is in much better (or worse) financial shape as otherwise shown. A company with a poor Working Capital ratio could be used that the company is out of cash and is on the verge of
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Unformatted text preview: bankruptcy when, after reviewing the actual big picture, the company is healthy. The second problem is that these ratios are industry specific. There is no set "healthy" ratio for all companies, as all companies should maintain some debt and some liquidity. Certain entities that deal with large projects may not need as much liquidity simply because of the projects that they are involved in. To avoid mistaken assumptions, a more in-depth knowledge of ROE is needed. In the 1920s the DuPont corporation created a method of analysis that fills this need by breaking down ROE into a more complex equation. DuPont analysis shows the causes of shifts in the number....
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