Effect of the level of Current Assets on the Profitability Risk Trade off
The effect of the level of current assets on profitability risk and trade off can be shown, using the ratio of current assets to total assets. This ratio indicates the percentage of total assets that are in the form of current assets. A change in the ratio will reflect a change in the amount of current assets. It may either increase or decrease.
Effect of Increase Higher Ratio
An increase in the ratio of current assets to total assets will lead to a decline in profitability because current assets are assumed to be less profitable than fixed assets, assuming no change in current liabilities, will increase NWC.
Effect of Decrease Lower Ratio
A decrease in the ratio of current assets to total assets will result in an increase in profitability as well as risk. The increase in profitability will primarily be due to the corresponding increase in fixed assets which are likely to generate higher returns. Since the current assets decrease without a corresponding reduction in current liabilities, the amount of NWC will decrease, thereby increasing risk.
Effect of Changes in Current Assets of Hypothetical Ltd