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Background/Objectives: Postmenopausal women face an elevated risk of sarcopenia and functional decline, yet the distinct roles of type 2 diabetes mellitus (T2DM) and physical inactivity in these outcomes remain unclear. This study aimed to determine the independent and combined effects of T2DM and physical activity on sarcopenia and functional performance in postmenopausal women. Methods: Cross-sectional study of 175 postmenopausal women stratified by T2DM status and physical activity level (active ≥150 min/week vs. insufficiently active). Body composition was assessed via dual-energy X-ray absorptiometry, muscle strength by handgrip dynamometry, and functional performance by gait speed. Sarcopenia was diagnosed using the Asian Working Group for Sarcopenia 2019 criteria. Binary logistic regression calculated odds ratios (OR) for adverse outcomes. Results: Physical inactivity was the strongest predictor of functional decline, with insufficiently active women showing nearly four-fold increased odds of slow gait speed (<1.0 m/s) compared to active counterparts (OR: 3.93; 95% CI: 1.24–12.45). While T2DM appeared protective against sarcopenia in unadjusted analysis, multivariate adjustment revealed obesity (OR: 4.97; 95% CI: 1.62–15.20) and T2DM (OR: 3.80; 95% CI: 1.59–9.08) as independent sarcopenia predictors. Conclusions: Distinct etiological pathways underlie sarcopenia and functional decline in postmenopausal women. While T2DM and obesity drive sarcopenia through metabolic mechanisms, physical inactivity primarily determines functional impairment. These findings support targeted interventions: metabolic optimization for muscle mass preservation and structured physical activity, particularly resistance training, for maintaining functional independence in this high-risk population.