Accounting Case
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Select one of the liquidity ratios covered in this course and tell us what it measures and how it is used in evaluating the financial position.
Generally, about Liquidity Ratios, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts.
The current ratio is a more dependable indicator of liquidity than working capital. The current ratio is a popular financial ratio used to test a companys liquidity by deriving the proportion of current assets available to cover current liabilities.
The concept behind this ratio is to ascertain whether a companys short-term assets are readily available to pay off its short-term liabilities.
A company that has more current assets than current liabilities can increase the ratio of current assets to current liabilities by using cash to pay off some current liabilities. So In theory, the higher the current ratio, the better.
Earnings management is the practice of inappropriately managing the earnings number reported in the companys income statement, and is quite different from the process of managing the companys underlying business.
Opportunities for earnings management are inherent in accrual accounting. Under the accrual method, management is asked to look beyond the simple cash inflows and outflows the company experienced during a period and give a more nuanced picture of the companys operations. Earnings management occurs when the decision makers skew issue-by-issue judgments, perhaps skirting their own policies, with an objective of forcing the earnings to a predetermined number.
So we can know without full disclosure, the enhanced income statement may well present a misleading picture of the companys operations. An income statement, enhanced by earnings management without adequate disclosure, may well be a fraudulent income statement.