Lahore Business School
University of Lahore, Lahore
The capital of a business which is used in its day-to-day trading
WC= Current Assets-Current Liabilities
This ratio indicates whether a company has enough short term assets
to cover its short term debt. Anything below 1 indicates negative
W/C (working capital). While anything over 2 means that the
company is not investing excess assets.
WCM involves managing the firm’s current assets and current
liabilities and optimally financing its net working capital needs,
WCM is very important because it directly affect the liquidity and
profitability of the firm.(Smith, 1980)
Measure of Amount by which company’s revenue exceeds its relevant
Rate of return of firms investment. An unwarranted high investment
in current assets would reduce this rate. (Vishani, 2007).
Having enough money in form of cash or near cash to meet
Principal of risk and return.
WCM have been approached in numerous ways.
Researcher studied on
The impact of Optimum inventory management.
Management of account receivables.
IMPACT OF OPTIMUM
Large inventory + Trade credit
(Rehman A Nasir, 2007)
(Long MS, Malitz IB 1993)
TRADE CREDIT POLICY
An agreement where a customer can purchase goods on account
(without paying cash), paying the supplier at a later date. Usually
when the goods are delivered, a trade credit is given for a specific
amount of days - 30, 60 or 90. Jewelry businesses sometimes extend
credit to 180 days or longer. Basically, this is a credit a company
gives to another for the purchase of goods and services.
Lesser the time a firm needs to realize cash from its customers
relative to the time it require to pay off its creditors the better it
is for its liquidity position and reduce the risk of dependency
on external and more expensive sources of capital.
CASH CONVERSION CYCLE
The gap in the midest of the disbursement made for the
procurement of raw material and the assortment of sales of
finished goods.. (Deloof, 2003)
ESTIMATION OF CCC
CCC=Inventory conversion period+ Average collection period-Average
IMPORTANCE OF CASH
25 years ago, Largay and Srickney in 1980 has reported the importance of cash position for sustainability of the firm.
analysis of the W. T. Grant Company’s bankruptcy and subsequent liquidation helped give rise to a general recognition
among financial analysts of the need for inclusion of the statement of cash flows in corporate financial reporting. While
standard ratio analysis of profitability, turnover, liquidity, and solvency as applied to W. T. Grant’s balance sheet and
income statements though the mid-1970’s gave investors confidence in the continuing viability of that firm, these ratios
belied an anemic multi-year trend in the company’s operating cash flows that continued until its bankruptcy in 1975.
Largay and Stickney demonstrate that disparate signals can - and in the case of W. T. Grant most certainly did - arise
between standard ratio analysis involving the balance sheet and income statement on the one hand, and measurements
of cash flow on the other.
IMPORTANCE OF WCM
In 1980, Smith discussed about importance of WCM, he said
WCM is important because of its effect on the firm’s profitability
and Risk & consiquently its value.
Efficient WCM involves planning and controlling of current assets and
Current assets are short lived investment that are continually being converted
into other assets type. (Rao, 1989)
And for this purpose, manager spend considerable time on day-to-day
problems that involve working capital decisions. (Eljelly, 2004)
TRADE CREDIT, QUALITY
Long, malitz and Ravid(1993), developed model of trade credit in which
asymmetric information leads good firms to extend trade credit so that
buyers can verify product quality before payment.
They found evidence consistent with the model. The find suggest that
producer may increase the implicit cost of extending trade credit by
financing their receivables through payable and short-term borrowing.
TRADE CREDIT AND
Previous studies have analyzed the high cost of trade credit,
Firms finance themselves with seller credit when they do not have other
more economic sources of finance available. (Petersen and Rajan, 1994
WORKING CAPITAL AND
WC consist of large portion of firm’s total investment in assets, 40%
in manufacturing and 50%-60% in retailing and wholesale industries
respectively. Moyer, Mcguigan and Kretlow (1995).
Smith and begemann, 1997 emphasized that those who promoted WC
theory shared that profitability and liquidity comprised the salient goals
of working capital theory.
Results indicates that there were no significant differences amongst the
years with respect to the independent variables.
Standard measure of WC is CCC
Shin and Soenen (1998) found a strong negative relationship between the
length of the firms net trade cycle and its profitability,
They also suggest that one possible way to create shareholder value is to
reduce firm’s NTC.
SOURCE OF FINANCING
In 1999 Smith and Smith said that Trade policy is a
spontanous source of financing that reduce the amount
required to finance the sums tied up in inventory and customer
WCM AND CORPORATE
Deloof (2003), used a sample of 1008 large Belgian non-financial firms.
Test Correlation and regression.
Found significant negative relationship between gross operating income and CCC.
Suggests that manager can increase corporate profitability by reducing the number of
days A/R and inventory
WCM AND INDIAN
In 2003, Ghosh and Maji examine the efficiency of indian cement company
Calculated 3 indexes, Performance index, Utilization Index, and Overall effficiency
Run regression analysis
Results found that some of the firms successfully improved efficiency during these
Profitability and liquidity measured by current ratio and cash gap on
sample of 929 joint stock companies in Saudi Arabia.
Using correlation and regression analysis,
Results found a negative relationship between the firms profitability and
Lazaridis and tryfonidis (2006), conducted cross sectional anaylysis
Sample of 131 listed firms on Athens Stock Exchange for period of 2001-2004.
Using correlation and regression analysis.
Suggest that manager can create profit for their companies by collecting handeling CCC
and by keeping CCC at optimal level.
EFFECT OF WCM
Raheman and Naser in 2007, Sample of 94 Pakistani listed companies.
Used Correlation and regression analysis.
Found negative relationship between variables of WCM and profitability
of the firm.
WCM AND SMES
In 2007, Garcia-Teruel and Martinez-Solano conducted Panel data analysis
on 8872 SMEs from Spain covering period of 1996-2002.
Demonstrate that managers could create value by reducing their inventory
and the number of days for which their accounts are outstanding.
Shorten CCC and increase profitability.
In 2009, Falope and Ajilore used sample of nigarian non-financial sector.
Panel data analysis
VARIABLES IN ALL
Retren on Investment
Debt to total assets
Return on Assets.
Debt to equity ratio
Net Operating Profit.
Age of inventory
Age of debtor
Age of creditor
The research indicates that working capital management impacts on the profitability of
the firm but there still is ambiguity regarding the appropriate variables that might serve s
proxies for WCM.
Slow collection of A/R is correlated with low profitability.
Manager can improve profitability by reducing the credit period granted to their