Ｄｅｆｅｃｔｓ ｉｎ Ｃｅｒｔａｉｎ Ｆｉｎａｎｃｉａｌ Ｒａｔｉｏｓ ａｎｄ Ｃｏｒｒｅｓｐｏｎｄｉｎｇ Ｃｏｒｒｅｃｔｉｖｅ Ｍｅａｓｕｒｅｓ

陈　官

Financial ratios are useful in measuring the performance of a corporation.in modern capital market.Investors get most of the valuable information from the financial reports to support their investment decisions.But,cautions must be paid in consideration of possible accounting fraud and cheat.Managements are usually under the pressure to report a high profit and appropriate financial ratios about the solvency,profitability,efficiency of the management,etc,to demonstrate that their control of the enterprise is benefitial to the stockholders.

The importance of ratios pales primarily for two reasons:

First,it may be derived from falsified sources.

Second,the ratios themselves do not make sense.

In this thesis,we assume that we were in a world that is free of accounting fraud,we concentrate on the inherent defects with the ratios themselves.

Usually,the generally accepted means of determining some financial ratios are defined as follows.

Current ratio=current asset/current liability

Quick ratio=queck asset/current liability

Accounts receivable turnover=net sales/average accounts receivables

Total asset turnover=net sales/total assets-net value

Not all of them are perfect in the sense of economic natures they represent. We will devote the rest of the paper to showing you why.

1.current ratio and quick ratio

These two ratios measure the ability to repay short-term liabilities with current assets.The higher the ratio,the less likely the enterprise would default on its debts. It is commonly accepted that they should be around 1 and 2,respectively.But the benchmarks against which these ratios are compared are not always that evident. We cannot judge whether a corporation is making a good performance only by the ratios,in addition,different circumstances should also be taken into account.Similar problems are encountered when analyzing with other ratios.

2.the accounts receivable turnover

We have to point out that three adjustments should be made to this calculation according to drawbacks.

First,instead of the net value, the original value should be taken into this function to represent the accounts receivable. We support this argument with the fact that this ratio is intended to indicate the ability to cash on the receivables. If we subtract the allownces for accounts receivable from the book value, indeed we exaggerate this rate by deflating the value of the receivables. Obviously, recording allownces for uncollected accounts receivable does not mean the enterprise is collecting their cash more quickly,but the ratio does get higher. This case strongly contradicts the belief we hold that the higher the rate is, the better. So ,we argue that the accounts receivables should be represented by the original values.

Second,the net sales is the revenue net of value-added tax. Nonetheless, value-added taxes are reflected in the accounts receivables. This results in that the two components,net sales and receivables, do not match each other, rendering this ratio of less significance.

Third, this rate comes across another problem,should there be a great proportion of notes receivables. Notes receivables can also stimulate credit sales,thus increasing the net sales of the corporation. However,the accounts reveivalbes stay unaffected.The fact that the increase in the revennue does not match that of the accounts receivables makes the result not suitable for indicating how the corporation is managing their accounts receivables.

3.total asset turnover

usually accounting practioners calculate this ratio by dividing the net sales by the net value of the total asset. Some defects can be easily found in this function. Imagine that,ABC companys total assets have an original cost of 1,000,000,and they are physically in good shape. In the sencond year, ABC neither disposes any assets ,nor does it replace any assets with new ones. Accounting priciples command that assets should be depreciated during its useful life. So the book value of the total assets becomes,say,900,000 in the ensuing year.While the ratio gets greater under the assumption that the revenues stay the same,it does not mean the company is operating more efficiently. To sum up,we commend that the original cost should take the position of the net value to be more indicative of the efficiency with which the firm is operating.

Users of the financial reports are not interested in the ratios themselves. What they want to acquire is what these financial statistics mean economically. So the homework before we get financial statements is to figure out whether the ratios we use can accurately and objectively tell us the economic nature of the enterprises concerned or not.And we have to stress that more defects with other financial ratios are not covered in this article. Their absence here does not necessarily mean they are logical.