As valuable as the fundamentals are, there are hidden flaws in some of the popular ratios. One of these flawed indicators is the favorite one used to test working capital: the current ratio.
This ratio divides current assets by current liabilities to judge and compare how much liquidity a company has to pay current obligations. But this ratio is easily manipulated by changing the levels of assets and liabilities.
By changing long-term debt to keep the current ratio high, it makes the impression that working capital is in good shape - when it might not be. Nothing illegal is involved here. Increasing current assets by also increasing long-term debt is allowed under GAAP, but it has the effect of artificially holding up current ratio even though working capital is suffering.
One of the many flaws in the GAAP standard is that it does not help analysts or investors to uncover deceptive or inaccurate outcomes. The current ratio is one of many valuable trend tracking indicators. But it cannot be relied upon by itself to draw conclusions about the health of working capital. For that, a more complete analysis is required, combining current ratio and the debt ratio.
Smart options trading relies on picking strong stocks as underlying for many different strategies. This is daunting, as the fundamentals cover a wide range of ratios and indicators. ThomsettOptions.com provides many training courses and a members' forum where these issues can be explored and ideas developed to improve stock selection.
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