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Unformatted text preview: ssets Increase Increase Increase Decrease Decrease Decrease Ratio it is. The opposite effects on profit and risk result from a decrease in the ratio of
current assets to total assets. Changes in Current Liabilities
How changing the level of the firm’s current liabilities affects its profitability–risk
tradeoff can be demonstrated by using the ratio of current liabilities to total
assets. This ratio indicates the percentage of total assets that has been financed
with current liabilities. Again, assuming that total assets remain unchanged, the
effects on both profitability and risk of an increase or decrease in the ratio are
summarized in the lower portion of Table 14.1. When the ratio increases, profitability increases. Why? Because the firm uses more of the less expensive current
liabilities financing and less long-term financing. Current liabilities are less expensive because only notes payable, which represent about 20 percent of the typical
manufacturer’s current liabilities, have a cost. The other curre...
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