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Without fixed assets the firm could not produce the

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Unformatted text preview: e profitable because they add more value to the product than that provided by current assets. Without fixed assets, the firm could not produce the product. The risk effect, however, decreases as the ratio of current assets to total assets increases. The increase in current assets increases net working capital, thereby reducing the risk of technical insolvency. In addition, as you go down the asset side of the balance sheet, the risk associated with the assets increases: Investment in cash and marketable securities is less risky than investment in accounts receivable, inventories, and fixed assets. Accounts receivable investment is less risky than investment in inventories and fixed assets. Investment in inventories is less risky than investment in fixed assets. The nearer an asset is to cash, the less risky 2. In order to isolate the effect of changing asset and financing mixes on the firm’s profitability and risk, we assume the level of total assets to be constant in this and the following discussion. 600 PART 5 Short-Term Financial Decisions TABLE 14.1 Effects of Changing Ratios on Profits and Risk Change in ratio Effect on profit Effect on risk Current assets Total assets Increase Decrease Decrease Decrease Increase Increase Current liabilities Total a...
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