What is the purpose of arbitrary standards in ratio analysis?

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BlackTom AI · Accepted Answer

Question restated: What is the purpose of arbitrary standards in ratio analysis?

Option a: 'Compare ratios with the same industry.' This suggests using the standards to benchmark within the identical industry. While industry comparisons are common in ratio analysis, arbitrary standards themselves are not primarily about matching industry peers; they are general reference points rather than industry-specific benchmarks. This makes this option partially aligned but not the core purpose of arbitrary standards.

Option b: 'Specify what a ratio should be.' This implies that arbitrary standards dictate exact target values for ratios. In reality, arbitrary standards function as rough reference points, not rigid prescriptions. They set expectations but do not prescribe precise, universal targets.

Option c: 'Serve as crude points of initial assessment.' This describes the typical role of arbitrary standards: they provide quick, rough benchmarks to begin evaluating a company’s ratios before deeper analysis, signaling whether ratios look reasonable or out of line. This aligns with how arbitrary standards are used in ratio analysis as preliminary, heuristic aids.

Option d: 'Compare ratios with different industries.' Comparing across industries is a form of benchmarking, but arbitrary standards themselves are not specifically defined to compare ratios across industries; they are general thresholds used for initial checks, not an explicit cross-industry comparison rule. This makes this option less accurate as a description of the primary purpose.

Overall, the reasoning for each option emphasizes the intended use of arbitrary standards as lightweight, initial reference points rather than precise prescriptions or broad cross-industry comparisons. The option that best captures this purpose is option c, describing them as crude points of initial assessment.

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What is the purpose of arbitrary standards in ratio analysis?

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