B. Sales and working capital do not measure the profitability of the company.

C. Liquidity relates to the ability of the company to meet its liabilities as they come due. Most ratios that involve working capital are liquidity measures, as is this one.

Sales divided by average working capital is called the working capital turnover ratio. It is a measurement of management's ability to use its working capital effectively to generate revenue. The ratio is only meaningful when compared with the industry average, or perhaps with the company's own historical sales to working capital ratio.

If the ratio is lower than the industry average, it indicates an inefficient use of working capital. In other words, the company could be doing more with its resources, such as investing some of its cash in equipment that could increase the firm's productive capacity and cause sales to increase.

If the ratio is higher than the industry average, it can indicate that the company is attempting to make excessive use of available working capital. This could be an indication that the company is using hort-term liabilities to fund long-term sales growth. Rapid sales growth puts pressure on a company's working capital because the company needs more inventory and its accounts receivable increase. Its payables will increase because of the increased purchases of inventory. However, the time it will have to wait to collect the receivables from those increased sales will be greater than the amount of time it will have to pay its vendors. So cash can become a problem.

Short term borrowings should not be used to fund permanent increases in accounts receivable and inventory. Short-term borrowings should be used only to fund short-term sales variations, such as a seasonal buildup of inventory which then decreases after the selling season is over, the accounts eceivable are collected and the short-term borrowings can then be paid off. But if sales increases are permanent, then the accounts receivable and inventory will not go down, and the company will not be able to pay off short-term loans and payables that it has incurred to fund the increases in accounts receivable and inventory.

If the sales growth is expected to continue, then the company needs more capital to support its growth instead of more short-term borrowings. If the company had additional capital, either in the form of more stockholder equity or more long-term debt, its short-term debt (payables and/or short-term notes payable) could be paid down, its working capital would increase, and its sales to working capital ratio would come down. The company's cash flow would be improved.

Note: The sales to average working capital ratio, also called the working capital turnover ratio, is not covered in the HOCK textbook, because it is not in the exam content. However, this question has been included just in case something is asked about it on an exam.

D. Financial leverage looks at the use of debt and equity to capitalize the company and sales and working capital are not used in the calculation of financial leverage.