2 The effects on both profitability and risk of an increase or decrease in this

2 the effects on both profitability and risk of an

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2 The effects on both profitability and risk of an increase or decrease in this ratio are summarized in the upper portion of Table 14.1. When the ratio increases—that is, when current assets increase—profitability decreases. Why? Because current assets are less profitable than fixed assets. Fixed assets are more 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 receiv- able, 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
600 PART 5 Short-Term Financial Decisions TABLE 14.1Effects of Changing Ratioson Profits and RiskChange Effect Effect Ratioin ratioon profiton riskIncreaseDecreaseDecreaseDecreaseIncreaseIncreaseIncreaseIncreaseIncreaseDecreaseDecreaseDecreaseCurrent liabilitiesTotal assetsCurrent assetsTotal assetsit is. The opposite effects on profit and risk result from a decrease in the ratio ofcurrent assets to total assets.Changes in Current Liabilities

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