1. DETERMINANT OF WORKING CAPITAL MANAGEMENT POLICY
By
RANA ATIF
A Thesis Submitted to the Faculty of the HITEC University school of Management Sciences,
Taxila, in Partial Fulfillment of the Requirements for the Degree of
BBA (Finance)
HAZARA University, Haripur
2010-2013
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2. Certificate of Approval
I am here by certifying that I have read DETERMINANT OF WORKING CAPITAL
MANAGEMENT POLICY by HAIDER ALI, and in my opinion this work meets the criteria for
approving a thesis submitted in partial fulfillment of the requirements for the BBA (FINANCE)
at HITEC University, Taxila.
Supervisor
Name: Muhammad Ali
Designation: Lecturer
Signature: __________________
Coordinator
Research and Development Department
Name:
Signature: ____________________
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3. Declaration
I, declare that, I am aware of the fact that in case my work is found to be plagiarized or not
genuine, the department has full authority to cancel my thesis and I am liable to penal action.
Student’s Name: Rana Atif
Date: ________________________
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4. Dedication
I am happy to dedicate this thesis to my parents and especially to my mother, whose prayers
always made my journey easy at every step of my life, and to my supervisor Madam Shagufta
Parveen who helped me throughout my research and never minded my scores of childish
questions.
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5. Acknowledgment
All praises to Allah Almighty, the merciful, the superior and sovereign who gave me the power
and energy to undertake this research.
At first I would like to thank Muhammad Ali from the core of my heart for his support and help.
Had he not been so generous in sparing her precious time for me to guide, I am afraid, I would
have not been able to accomplish the task so nicely. Thanks to my family members and friends
whose pieces of advice and comments always worked as driving force for me move ahead, and
particularly to Sir Jawad Ahmed who helped me a lot in my data gathering for my research.
I am also thankful to the faculty members and management of the university, from which I
collected the data, for their nice behavior and support.
Rana Atif
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6. List of Acronyms and Abbreviations
CR Current ratio
FATA Fixed asset to total asset
ROA Return on assets
IN TA Natural Log of total asset
OCF Operating cash flow
CCC Cash Conversion Cycle
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7. ABSTRACT:
The Working capital management is an important area of finance .It deals with the current asset and the
current liabilities finance manager job is to have an ideal balance between current asset and current
liabilities so that to get a proper tradeoff between liquidity and profitability. In the present research fifty
three companies were analyzed the data was taken from the annual reports of the companies listed on
Karachi stock exchange for the period of six year ( 2005 – 2010).These 53 companies were chosen by non
–probability random sampling method, data was taken from only non-financial listed company. The
population comprises of 450 non –financial industries.The present study was conducted on determinant of
working capital. In this study cash conversion cycle was taken as dependent variable and current ratio,
fixed asset to total asset, natural log of total asset, return on asset ,operating cash flow were taken as
independent variables.
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8. Table of Contents
Certificate of Approval.................................................................................................................................ii
Declaration..................................................................................................................................................iii
Dedication...................................................................................................................................................iv
Acknowledgment.........................................................................................................................................v
List of Acronyms and Abbreviations............................................................................................................vi
ABSTRACT:.................................................................................................................................................vii
Table of Contents......................................................................................................................................viii
CHAPTER 1 INTRODUCTION........................................................................................................................ix
Chapter 2 LITERATURE REVIEW:..................................................................................................................xi
CHAPTER 3 METHODOLOGY.......................................................................................................................xv
3.1 Objective........................................................................................................................................xv
3.2 Hypothesis....................................................................................................................................xv
3.3 Population..................................................................................................................................xv
3.4 Sample size.................................................................................................................................xv
3.5 Sampling Technique...................................................................................................................xvi
3.6 Data Collection..........................................................................................................................xvi
3.7 Data Analysis..............................................................................................................................xvi
3.8 Data Interpretation.....................................................................................................................xvi
3.9 Variable and Model of the study:...............................................................................................xvi
Chapter 4ANALYSIS AND INTERPRETATION:............................................................................................xviii
4.1 Regression analysis:.......................................................................................................................xviii
4.2 DISCUSSIONS....................................................................................................................................xx
Chapter 5CONCLUSION:............................................................................................................................xxi
6. References............................................................................................................................................xxii
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9. CHAPTER 1 INTRODUCTION
Literature on finance has mostly emphasized on long term monetary areas, like capital structure valuation,
dividend, merger and investments. However for short term liquidity and profitability, proper
management of short term assets and liabilities is essential for the overall firms strategy in creating and
enhancing shareholders wealth.(Deloof,2003;Howorth and Westhead,2003;and Afza and Nazir,2007).
The amount needed for daily operation in the business, and is found by subtracting short term liabilities
from short term assets ,also known as net working capital .It shows the efficiency and effectiveness of
short term financial position of a company. If working capital is positive means that the company is able
to pay its short term obligations (accounts payable,), and if it is negative it means company is not able to
pay its short term obligations from its current asset (store & spares, inventory, trade debts…).It is a very
delicate tool it should be handle with very care, the main reason of failure and bankruptcy of many firm is
the inefficient and unbalanced way of handling working capital. It’s the liquidity and profitability
tradeoff. If you want to increase liquidity by increasing current asset in the form o f cash and cash
equivalent or inventory, its impact will be that your profitability will decline, on the other hand if you
want to increase profitability, you will have to decrease investments in idol assets like inventory or cash
and cash equivalent due to which liquidity will be effected. So it’s the job of the finance manager to keep
an optimal balance between liquidity and profitability.
Working capital management is important for all firms specially manufacturing firms because fifty
percent of the total assets of manufacturing firms are in the form of current assets. (Horne and
wachowicz,2000).finance manager work on working capital ,to reduce the idol asset in current assets and
increase the cash for other projects, so that non-optimal level of working capital is converted to optimal
working capital(Lamerson,1995).
A Company may assume an agressive working capital management policy with a small level of
investment in current assets as % of total assets, or it might also be use for the financing decision of the
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10. firm in the form of high level of current liability as % of overall liabilities. Excessive level of current
assets might have a depressing effect on a firm’s profitability; while a low level of current assets could
lead to lower levels of liquidity & stock out, resulting in difficulties in maintain smooth operation (Van
Horne and Wachowicz, 2004).
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11. Chapter 2 LITERATURE REVIEW:
(Nazir & Afza, 2009) Working capital is an important area for finance manager, they devote important
quantity of time for getting a perfect balance b/w risk & returns liquidity & profitability in order to
generate worth for the company.
(Lamberson, 1995), (Appuhami, 2008) taking decision regarding policy, checking the performance of
each component and taking decisions to reduce target variation forecast current asset and current liability
in their company.
(Padachi, 2006) uses panel data of a sample manufacturing companies from year 1998 to 2003 their result
show that major investment in inventories &account receivables are linked with lower profitability. The
main variable used in the analysis is inventory days, account receivable day, account payable day & cash
conversion cycle.
(Raheman & Nasr, 2007) carried out their research for 6 year data from 1999 to 2004.they use the sample
of 94 companies listed on stock exchange in Pakistan. They use the average collection period, average
payment period, current ratio, cash conversion cycle and inventory turnover in days is an independent
variable while net operating profit as a dependent variable. Debt ratio, size of the firm measured in terms
of natural logarithm of sales) and financial asset to total assets. Ratios have been used as control
variables. There result shows that if cash conversion cycle increase it will decrease the profitability of the
firm, there research shows that there is negative relationship between liquidity and profitability, they also
find that there is a positive relationship between size of firm and its profitability. There is also significant
indirect relationship between debt used by firm and its profitability.
(Deloof, 2003) conducted research on working capital management &profitability using a sample of 1009
Belgium firms for a period of 5 year from 1992 to 1996.he concluded that there is considerable negative
relationship between gross operating income and cash conversion cycle. If manager want to increase
shareholder wealth he should have to reduce cash conversion cycle. Similarly he found negative
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12. association between account payable days and profitability which is due to the fact that less profitable
firm pays their dues later.
(Jose, Lancaster, & Stevens, 1996) uses cash conversion cycle as a measure of working capital
management of U.S firms. The impact aggressiveness of working capital management policy on cash
conversion cycle was shown by shorter cycle. It shows a major negative relationship between the cash
conversion cycle and profitability, representing the more aggressive working capital management is
related with high profitability.
(Hussain, Farooq, & Khan, 2012) in their research paper they investigate the relationship of conservative
and aggressive working capital policy with respect to profitability of the firm. They concluded that
profitable firm in Pakistan using aggressive working capital policy. Moreover, there other research
finding tells us that company size and growth have positive impact on working capital policy. The
financial leverage shows negative effect on working capital.
(Palombini & Nakamura, 2012) `analyze the factors affecting the working capital management of
Brazilian companies using statistical sample of 2976 companies from 2001 to 2008 the result showed
that debt ratio, size and growth rate are the factors affecting the management of working capital.
(Appuhami, 2008) in his research paper the auther examine the effect of capital expenses on working
capital management.The net liquidity balance and working capital requirement is used by the author
dependent variable.while operating expenses, financial expenses, capiatl expenditure, market to book
value ratio,total debt to total assets,growth of firm and operating cash flow as a dependent variable. For
the study he used multiple regression modeltheir finding showed that capital expenditure have positive
impact on working capital which means by increasing capital expenditure the requirement for working
capital and net liquidity is also increase.the operating cash flow is also found significant variable in the
study which were the control variable in the study.
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13. Zariyawati, et al. (2010) manager should consider all the factors of affecting working capital management
because it is a part of financial decision and inefficient decisions had a negative impact on company. This
research was done on Malaysian companies for the period of 5 years from 2000 to 2006.cash conversion
cycle was used as a measure of working capital management. The results indicated that company size,
debt ratio and sales growth are factors effecting working capital management.
Nilsson, et al. (2010) uses cash conversion cycle as a proxy for working capital management in Swedish
companies .The independent variable used were profitability, operating cash flow, company size, sales
growth, current ratio, quick ratio and debt ratio. For data analysis and hypotheses testing Pearson
correlation and multiple regressions were used. The results showed that there is positive connection
between profitability and cash conversion cycle and the second is a negative correlation of cash
conversion cycle with sampling size, sale growth and operating cash flow.
(Valipour, Moradi, & Farsi, 2012) in their research they analyze the company characteristic like
Profitability, size of firm, operating cash flow, growth of firm, current ratio and quick ratio. They used the
cash conversion cycle for working capital for working capital policy. They used the correlation and
multiple regression models for the research. There results indicated that profitability, operating cash flow,
size of firm, growth and debt to equity ratio is a significant impact cash conversion cycle.
(Caballero, Teruel, & Martı´nez-Solano, 2010) They in their paper analyze the determinants of cash
conversion cycle for small and medium firm. Their results showed that older firms with larger cash flow
maintain longer cash conversion cycle while the growth, financial leverage, investment in fixed assets and
Return on assets maintain a more aggressive policy. It showed that the cost of financing has a negative
impact on cash conversion cycle.
(Mongrut, Fuenzalida, Cubbilas, & Cubillas, 2008) in their research paper they used the Cash conversion
cycle as a dependent variable while average industry cash conversion cycle, firm size, proportion of
tangible assets, growth of firm, herfindahlhirschman index and country risk. There results showed that
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14. Cash conversion cycle is negatively correlated with firm size and country risk is positively related with
cash conversion cycle.
(Nazir & Afza, 2009) they worked on to explore the determinants of working capital. They used the
working capital requirement deflated by total asset is a dependent variable while Return on assets, Size of
firm, leverage, Operating cash flow, Tobin’s q and growth of firm as an independent variable. There
study results showed that operating cycle, leverage, Return on Assets and Tobin’s q is found to be vital
and important determinants of working capital management policy of the firm in Pakistan.
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15. CHAPTER 3 METHODOLOGY
3.1 Objective
The purpose of the study investigate the effect of operating cash flow, current ratio, fixed asset
to total assets, natural log of total assets, return on assets on cash conversion cycle.
3.2 Hypothesis
Ho: There is positive relationship between cash conversion cycle and operation cash flow,
current. Ratio, fixed assets to total. Assets, natural log of total assets and return on assets.
H1: There is no positive relationship between. Cash conversion cycle and operating cash flow,
current ratio, fixed .assets to total assets, natural log of total assets and return on assets
3.3 Population
The population included 450 non-financial manufacturing industries listed on Karachi stock
exchange from 2005 to 2010.divided into 30 sectors.
3.4 Sample size
The sample consists of fifty three companies from ten sectors for a period of six year from 2005-
2010. The companies for the study were selected according to State Bank of Pakistan
classification of sectors. The sectors included in the study are: Oil and Gas, Cement, Food,
Chemical, Pharmaceutical, textile and Automobile.
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16. 3.5 Sampling Technique
Research study comprise of 5 sectors according to State bank of Pakistan classification of
sectors. Companies from each sector have been chosen on the basis of probability random
sampling.
3.6 Data Collection
The data used in this research is secondary in nature collected from the published financial
reports, of the companies quoted on Karachi Stock Exchange in Pakistan. Six year data was used
from 2005 to 2010, only those companies were included which has complete financial records.
3.7 Data Analysis
The data is analyzed through multiple regressions and correlation because the data use panel in
nature
3.8 Data Interpretation
Data is analyzed statistically through Statistical package of social sciences.
3.9 Variable and Model of the study:
The study uses Proxy Cash conversion cycle as dependent variable which was found by account
receivable turn over plus inventory turnover minus account payable turnover.
The independent variable use in this study were, size, current ratio, fixed assets to total assets, ,
return on assets, operating cash flow.
Total asset is use as proxy for size & is calculated by taking natural log of total assets. Current
ratio is found by dividing current asset over current liability, operating cash flow is taken from
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17. net cash flow from operating activities in cash flow statement. Return on asset is found by
dividing profit after tax over total asset, fixed assets to total assets, and is ratio of fixed asset to
total asset .fixed asset is calculated by subtracting current asset from total asset.
The model for the research is follow
Y = a + b1x1 + b2x2 + b3x3 + b4x4 + b5x5
By putting the variable in the model:
CCC = a + b1OCF + b2CR + b3 ROA+ b4FATA + b5IN TA
CCC = Cash conversion cycle
OCF = Operating cash flow
C.R = Current ratio
ROA = Return on Assets
FATA = Fixed Asset to total asset
xvii

18. Chapter 4ANALYSIS AND INTERPRETATION:
4.1 Regression analysis:
Table: 1 Model Summary
Model R R Square Adjusted R Square Std. Error of the Estimate Durbin-Watson
1 .465a
.216 .204 55.37412 1.043
a. Predictors: (Constant), INTA, ROA, OCF, FATA, CR
b. Dependent Variable: CCC
R Square shows the explanatory power of the independent variable on dependent variable. In this research
result R square is 0.21 or 21 percent ,it means that 21 percent variation in dependent variable that is cash
conversion cycle (CCC) is explained by the independent variables (OCF,CR,ROA,FATA ,IN TA).The
rest 79 percent is not explained in this research which may be due to other factors and variables.
ANOVAs
Model Sum of Squares Df Mean Square F Sig.
1 Regression 276963.707 5 55392.741 18.065 .000a
Residual 1005744.296 328 3066.294
Total 1282708.002 333
a. Predictors: (Constant), INTA, ROA, OCF, FATA, CR
b. Dependent Variable: CCC
F –test shows the overall significances of the model. The results clearly show that the overall model is
significant .Significance Value of F is less than 0.05. (0.000< 0.05)
Coefficientsa
Model
Unstandardized Coefficients
Standardized
Coefficients
t Sig.B Std. Error Beta
1 (Constant) -196.008 34.521 -5.678 .000
OCF -1.045E-6 .000 -.009 -.189 .850
CR -11.180 3.432 -.189 -3.257 .001
ROA 92.903 39.621 .135 2.345 .020
FATA 72.005 12.558 .301 5.734 .000
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19. Coefficientsa
INTA 9.512 2.217 .217 4.291 .000
The results show that except operating cash flow all the independent variables are significant.
In the above table the operating cash flow is insignificant i.e. its prob-value is 0.850 >0.05.
The results that current ratio is significant i.e. its p-value is 0.001<0.05 and its coefficient is
10.357 so it means it is negatively significant with CCC (Cash Conversion Cycle) which means
by increasing current ratio the cash conversion cycle will decrease.
Return on asset is also significant i.e. its Value of P is 0.020<0.05 .and its coefficient shows that
it is positively related with cash conversion cycle, that is if we increase return on asset the cash
conversion cycle will also increase.
Fixed asset to total asset is also significant i.e. its p-value is 0.000<0.05 .and its coefficient
shows that it is positively related with cash conversion cycle, that is if we increase FATA the
cash conversion cycle will also increase.
Natural log of total asset is also significant i.e. its p-value is 0.000<0.05 and its coefficient shows
that it is positively related to cash conversion cycle.
OCF CR ROA FATA INTA C.C.C
OCF 1
CR 0.341489712 1
ROA 0.426104458 0.513347359 1
FATA -0.017691932 -0.261386292 -0.214969577 1
INTA 0.384817941 -0.104749521 0.009603341 0.227672597 1
C.C.C -0.051863451 -0.221658512 -0.025292899 0.369898813 0.305996866 1
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20. Pearson correlation shows exhibits week positive correlation between operating cash flow and cash
conversion cycle. The relation between natural log of total asset and cash conversion cycle, and fixed
asset to total relation with cash conversion are more positive as compared to relation of operating cash
flow and cash conversion cycle. This weak relationship among the independent variable shows that there
is no problem of multi collineriaty.
The relationship between cash conversion cycle and ROA, CR is weak negative.
4.2 DISCUSSIONS
Current ratio shows negative relationship with cash conversion cycle which means when liquidity
increase firms are able to pay accounts payable early and can take discount due to which cash conversion
cycle decrease, similarly chances of defaults also reduces.
Return on assets and cash conversion cycle has also positive relationship, is in line with earlier studies of
Afza & Nazir (2008) and wu (2001), the firm with higher profits pay less attention to efficient
management of working capital.
Cash conversion cycle increases with size, means large firms becomes inefficient, because of market
power and big group it can take credit at cheaper rate similarly large firm has large inventory due to big
demand and extend product to customer and lose its collection policy due to which CCC increases, they
buy less goods on credit and due to large cash flow they pay early. This is in line with the findings of
Chiou, Cheng & Wu (2006) and Kieschnick, Laplante and Moussawi (2006).
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21. Companies having there large share of their large share of asset in the form of fixed long term asset, has
positive relationship with CCC (Cash Conversion Cycle). Firm with large fixed asset mean having large
capacity to produce hence will have large inventory turnover and to increase their sales they will have to
use low collection policy thus CCC will increase.
Operating cash flow is an insignificant factor, has no impact on cash conversion cycle.
Chapter 5CONCLUSION:
Working capital management is an important area of finance, highly neglected by researchers and
practitioners. The main reason of financial crises and bankruptcy is the management’s inability to
properly manage the current asset and liabilities, those firms which are managing these efficiently are
enjoying huge profits and are having less chance of insolvency.
This study uses Cash conversion cycle as dependent variable and uses operating cash flow, size, current
ratio, fixed asset to total asset ratio, return on asset as independent variable. Profitability ratio, tangibility,
and size were directly related to cash conversion cycle, means when firm size, profitability and fixed asset
increase, due its market power and influence, it become inefficient, increases its inventory due to large
demand in market, to increase its sales lose its collection policy and due to its large fixed asset make its
goods itself and reduces its accounts payable, buy mostly on cash due to its large cash flows.
Current ratio is negatively related to cash conversion cycle.
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22. 6. References
Appuhami, B. R. (2008). The Impact of Firms’ Capital Expenditure on Working Capital.
International Management Review , 4 (1).
Caballero, S., Teruel, G., & Martı´nez-Solano, P. (2010). Working capital management in SMEs.
Accounting and Finance , 50, 511–527.
Deloof, M. (2003). Does Working Capital Managementeffect the profitibility of Belgium firms?
Journal of Business Finance & Accounting , 30 (3), 0306-686X.
Hussain, A., Farooq, S. U., & Khan, K. U. (2012). Aggressiveness and Conservativeness of
Working Capital. European Journal of Scientific Research , 73 (2), 171-182.
Jose, M. L., Lancaster, C., & Stevens, j. L. (1996). Corporate Returns and Cash Conversion
cycle. Journal of Economics and Finance , 20 (1), 33-46.
Lamberson, M. (1995). “Changes in Working Capital of Small Firms in Relation to Change in
economic activity. Mid-American Journal of Business , 10 (2), 45-50.
Mongrut, S., Fuenzalida, D., Cubbilas, C., & Cubillas, J. (2008). Detrminants of working capital
in Latin America.
Nazir, M. S., & Afza, T. (2009). Working Capital Requirements.
Padachi, K. (2006). Trends in Working Capital Management and its Impact on Firms’
performance. International Review of Business Research Papers , 2 (2), 45-58.
Palombini, N. V., & Nakamura, W. T. (2012). KEY factors affecting the working capital in
Brazilian Market. Evaluated in a double blind review , 52 (1), 055-069.
Raheman, A., & Nasr, M. (2007). Working Capital Management And Profitability. International
Review of Business Research Papers , 3 (1), 279 - 300.
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