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Joseph P. Porter
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I am a retired college faculty in Philosophy, with specializations in Ethics, Socio-political Theory and Rational Choice/Decision Theory. My teaching focus was on Business Ethics, Medical Ethics and Logic. After retirement I freelanced as a Grant Writer/Fund Raising Consultant. I have taught at... More
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  • Updating Screener Criteria: Current Ratio Vs Quick Ratio 2 comments
    Nov 28, 2012 12:09 PM

    If you've been following my blog posts and my articles, you know that I've been working on a set of screener filters that would be maximally useful in identifying reasonable investment opportunities without being burdensome. I'm trying to identify those companies that are making a profit, able to handle debt, and have effective management.

    In terms of profit, I'm happy with a filter that looks for a (net) profit margin > 0, although I always reserve the right to make it higher.

    In terms of effective management, I think it is adequate to monitor the returns on equity, assets and investments, with each > 1. Again, I reserve the right to demand better, but a positive number is at least a good starting point.

    I have been satisfied with selecting for a current ratio > 1, that point at which a company is - or should be - able to pay all current liabilities with their current assets. I am considering strengthening this condition, however, and replacing current ratio with quick ratio, with the use of a company's quick ratio, the expectation being that a company's quick ratio be > 1.

    The reason for this is that the current ratio takes into account all current assets - including inventory. Inventory, however, cannot be liquidated at will; some companies (particularly those a with markedly cyclical business) may take months to liquidate their assets - and perhaps even a year. Counting those assets as part of the company's ability to pay its current liabilities is too permissive.

    Quick ratio measures the company's ability to pay current liabilities with cash and instruments that can readily be liquidated into cash (investments, for instance). It is, in other words, a more accurate measure of a company's ability to keep itself afloat without incurring debt to pay off bills (such a practice can become a vicious circle, ultimately leading to bankruptcy).

    This switch would primarily affect those companies that maintain inventories, and should not have much effect on financial companies, or companies that do not produce stockpiles of goods. The effect of this switch will be most noticeable in an upcoming article.


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Comments (2)
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  • nikhilsood27
    , contributor
    Comment (1) | Send Message


    Speaking in regards to quick ratio,
    what ethics would a company break if they understate a bank loan which is due in 14th month but been made to 12th month just to get get another loan.
    Is there any legal complication ?? besides what alternatives would a company have to correct that.
    4 Feb 2013, 10:38 AM Reply Like
  • Joseph P. Porter
    , contributor
    Comments (918) | Send Message
    Author’s reply » First, let me say that I am not a lawyer, so I would not be in a position to speak to legal complications, nor can I give legal advice. Next, I'm not sure just what you are asking - it's Monday morning, and I haven't finished my first cup of coffee, so I may not be particularly sharp here. But let's break the question down, and try to address it.


    1. A company intentionally understating liabilities or overstating assets would be acting immorally, and likely acting illegally (but this depends on the nature of the report in which the misstatement is made). It is always unethical to lie, particularly where one's fiduciary responsibilities are concerned. Legally, the type of form in which the misinformation is presented may or may not require that the data presented comply with GAAP, a loophole that enables companies to manipulate date on their 10-Qs in interesting ways, for instance.


    2. Are you asking if the lie is promulgated in order to put themselves in a better position to acquire a loan, is that materially relevant? Absolutely. In this case, the company is probably committing some level of fraud. Again, always unethical, and likely illegal. In any event, it would be sufficient for the lender to either reject the loan request or demand immediate repayment. Could certainly be actionable, and the SEC would no doubt be interested, as would DOJ.


    3. It's your last question that has me puzzled. Was the lie intentional - and provably so - or was the misinformation a matter of someone just getting their figures wrong (which is likely the defense the company would present)? One way out would be to admit to the error, return the new loan and reapply with the correct figures.


    Another way out would be to pay the old debt down to the level claimed (preferably without using the money from the new loan), and restate its case to the new lender to see if that is sufficient - in this case the new lender could still cry fraud and demand the loan back (and notify DOJ).


    In any event, coming clean with the new lender is an ethical requirement - they were "lied" to, and deserve to know the truth, especially since the lie led to their giving money that might not otherwise have been given.


    Ultimately, the matter boils down to the intention behind the misinformation, or whether there was any real intention to mislead anyone at all. This is the part that makes it hard to prove legally. Morally, if misinformation was passed on, it had to be because someone did not adequately exercise their fiduciary responsibilities, and that is unethical.


    An interesting question, but somewhat unclear.
    4 Feb 2013, 11:20 AM Reply Like
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