Working Capital Management^179
term funds is 8 percent. Ignoring the changes made in the preceding example, the
effect of shifting $300 from long-term funds into current liabilities will increase current
liabilities to $1,900 ($1,600 + $300) and decrease long-term funds to $5,100 ($5,00 ñ
$300). The new ratio of current liabilities to total assets will be .271 ($1,900 ̃ $7,000).
The result of this change will be a decrease in costs from the current level of $480
[(3% ∑ $1,600) + (8% ∑ $5,400)1 to $465 [(3% ∑ %1,600) + (8% ∑ $5,100)]. The firmís
net working capital will decrease from the initial level of $1,100 to $800 ($2,700 ñ
$1,900). These results of the increase in the ratio of current liabilities to total assets
are tabulated in Table .3.
Table 3: The effects of a change In GHlís current liabilities
V alue
Initial value after change
Ratio of current liabilities to total assets .229 .271
Cost of finanacea $480 $465
Net working capital $1,100 $800
aA decrease in any of the firmís costs is equivalent to an increase in profitability by
the same amount.
Table 3 illustrates that as the firmís ratio of current liabilities to total assets increases
from .229 to .271, the firmís profits increase by $15 (since its costs drop from $480
to $465). Meanwhile, the firmís risk, measured by the level of net working capital,
increases since its net working capital, or liquidity, decreases. This example illustrates
only the effects of an increase in the ratio of current liabilities to total assets; a
decrease would have an opposite effect.
Combined effects The combined effects of changes in current assets and changes
in current liabilities can be measured by considering them simultaneously. In the preceding
two examples, the effects of a decrease in the ratio of current to total assets and the
effects of an increase in the ratio of current liabilities to total assets were illustrated.
Both changes, considered independently, were shown to increase the firmís profitability
while increasing its risk. Logically, then, the combined effect of these actions should
be to increase profits and risk and decrease net working capital. Table 4 illustrates the
effects of combining the changes in current assets and current liabilities presented in
Tables 2 and 3.
Table 4: The combined effects of changer in GHlís current assets and liabilities
Change in Change in net
profits working capital
Decrease in ratio of current to total assets + $30 -$300
Increase in ratio of current liabilities to total assets +$15 -$300
Net Effect +$45 -$600