An accounting professor at the University of California at Berkley was quoted in The Wall Street Journal (December 17, 1990) as saying, “The most important items on the financial statements are trends in inventory, accounts receivable, and order backlogs. These are the strongest indicators and are more closely related to stock returns than reported earnings. In par¬ ticular, investors should look at how companies’ inventories of finished goods track their sales. If inventories are rising faster than sales, its a bad signal. . . . For similar reasons it pays to watch accounts receivable. ... If these are rising faster than sales, not only can this signal trou¬ ble with sales but may show vulnerability to customer defaults.” REQUIRED:

a. Which of the financial ratios best captures the indicators suggested by the Berkeley pro¬ fessor.

b. Explain how these ratios provide information about solvency and earning power, and why they might be more closely related to stock prices than earnings.