Current Assets to Fixed Assets Ratio
- The finance manager is required to determine the optimum level of current assets so that the shareholders’ value is maximized.
- A firm needs fixed and current assets to support a particular level of output.
- As the firm’s output and sales increases, the need for current assets also increases. Generally, current assets do not increase in direct proportion to output; current assets may increase at a decreasing rate with output. As the output increases, the firm starts using its current asset more efficiently.
- The level of the current assets can be measured by creating a relationship between current assets and fixed assets. Dividing current assets by fixed assets gives current assets/fixed assets ratio.
- Assuming a constant level of fixed assets, a higher current assets/fixed assets ratio indicates a conservative current assets policy and a lower current assets/fixed assets ratio means an aggressive current assets policy assuming all factors to be constant.
- A conservative policy implies greater liquidity and lower risk whereas an aggressive policy indicates higher risk and poor liquidity. Moderate current assets policy will fall in the middle of conservative and aggressive policies. The current assets policy of most of the firms may fall between these two extreme policies.
- The following illustration explains the risk-return trade off of various working capital management policies, viz., conservative, aggressive and moderate.
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