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Impact of working capital on firm profitability


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Impact of working capital on firm profitability

  1. 1. IMPACT OF WORKING CAPITAL ON FIRM’S PROFITABILITY 0 A case study of sugar and leather sector of Pakistan
  2. 2. Impact of Working Capital Management on profitability (Case study of Sugar and Leather Firms) 1
  3. 3. Waqas mehmood Baf05103057 1. Introduction: This article examines the impact of working capital management on Firm’s profitability within the context of Pakistan Sugar and Leather Companies. Working capital management plays a vital role in companies’ financial performance. Working capital is represented as the availability of capital to satisfy day to day operations of the business. The Firm can run simply their day to day operations through excessive level of current assets. Effective and economical utilization of the resources of firm can maintain the profitability level of the firms. Cash flows area unit enhanced by effective management of assets. The major elements of Working Capital (WC) are debtor collection period, creditor payment period and inventory holding period. Trade credit policy and huge 2
  4. 4. stock will enhance the sales volume of Sugar and Leather firms. Firm will increase their profitability by reducing their debtors collection period and stockholding period. Inventory is that the main part of Working Capital. High level of inventory can increase the sales growth, reducing the cost of supply and additionally reducing the cost of production. The second element of Working Capital is debtor collection period. The profitability of firm may be magnified by the short length of debtor days. The next necessary element of Working Capital is creditor’s payment period. The firm can enhance their profitability by taking long creditors payment period. We are selected 4-years data from 2008-2012 of firms listed in the Pakistan Stock Exchange.Working capital management directly affects the firm’s profitability. 2. Objective of the Study: The objective of this analysis is to focusing on working capital management and its impact on gain for a sample of 5 Sugar and Leather firms over a time period of 4 years from 2008-2012. To analyze the problem statement we have got developed some objectives of the research.  To evaluate the independent variables that has a significant impact on gain.  To verify the connection among working capital management and gain of Sugar and Leather firms over 4 years 2008-2012. 3
  5. 5.  To measure the relationship among gain and leverage.  To construct a knowledgeable conclusion concerning the impact of assets management on firm’s financial performance. 4. Problem Statement: “Have the Asset Management a vital impact on gain of Pakistan sugar and leather industries?” Without sensible and proper management of working capital elements, firms cannot continue their essential day to day operations effectively. In this research we will analyze that whether there is any relation between working capital and profitability. This relation may be positive or negative. In addition the analysis in this paper will allow us to identify the variables which are of key importance to Sugar and Leather Industry. 5. Research Question 4
  6. 6. As I previously described that the aim of my research is the measurement of the effect of working capital management on financial performance of Sugar and Leather firms, so at this stage we develop a set of testable hypothesis, the Null hypothesis and the impact on Alternative hypothesis: Hypothesis: H0 = Working Capital has negative profitability. H1= Working Capital has positive impact on profitability. 6. Significance of the study: The significance of this research provides easy way to understand about the relationship between components of working capital management and corporate profitability. Similarly, this research will be helpful for managers, firm’s stakeholders such as creditors and investors, professionals, financial analysts, and policy makers of those selected Sugar and Leather firms to take strong 5
  7. 7. decision on management of working capital. This research provides a direction that profitability level of the firm could be enhanced by the good management of working capital. 7. Literature Review Working capital management can be considered an important source of profitability of firm. Many researchers investigated the impact of working capital management of firm. Many researcher have worked on the same issue but study of shin and soenen (1998) and deloof (2003) founded the working capital management strongly affected the cooperate profitability. Therefore sugar and leather sector should address this issue seriously. In 2010 Lecturer balashundaram nimalathasan from university of Jaffna srilanka studied the impact of working capital on profitability of selected listed manufacturing companies of sri lanka from year 20032007 and revealed the results that the cash conversion cycle and return on assets are negative correlated 6
  8. 8. which mean cash conversion cycle increase when return on asset decrease. Amarjeet gill Nahum biger and Neil mathur studied the relationship of working capital management and profitability in 2010 of the sample of 88 firms listed at New York stock for the period of three years from 2005 to 2007 and found statistically significant relationship between cash conversion cycle and profitability, measured through gross operating profit. Alipour(2011) took the sample of 1063 firms listed at Tehran stock exchange and found a negative significant relationship between no of days account receivable, inventory turnover and cash conversion cycle whereas positive significant relationship between number of days accountable with profitability and hence concluded that working capital management significant affect the profitability of the firm. Kulkanaya napompech in 2012 examined theeffect of working capital management on profitability. 7
  9. 9. Theregression analysis was based on the panel sample of 255 companies listed on the Thailand stock exchange from 2007 through 2007 and reveled the result of negative relationship between gross operating profit and the inventory conversion period and the receivable collection period. He suggested that mangers can increase the profitability of firm by shorting the cash conversion cycle, inventory conversion period and receivable conversion period. Zafar ullah Malik and athar Iqbal from Iqra University in 2012 studied the impact of working capital management on firm’s profitability in sugar industries of Pakistan for the year 1999to2009.they used secondary data of 19 sugar mills which are listed at Karachi stock exchange and showed the result that the sale growth, current ratio, number of days inventory and number of days account payable are significant affecting profitability of the firm with sale gearing rationed no of days account receivable are insignificant in the research. 8
  10. 10. Zubair Arshad and Muhammad yasir ghondal in 2013 studied the working capital management and profitability of Pakistan cement sector and revealed that there is significant negative relation between working capital management on profitability of firm. In Pakistanthere have been few researcherson working capital management .Sana and shah (2006) worked on oil and gas sector. They took very small sample of 7 firms and they concluded that profitability shareholder value can be increased by managing the working capital efficiently. Nazir and Afza (2007) in their research analyze the relationship between aggressive and conventional way of investing in working capital for 205 firms for 17 different sub sectors. Their result showed negative relationship between aggressive approach in working capital investment and the profitability of firm. Though researcher have studied the relation between the components of working capital management and the 9
  11. 11. corporate profitability with reference to Pakistan but it’s not enough. There is still lack of evidence of relationship between the two variables. This is the motivational force to do a research on sugar and leather sector of Pakistan. For the purpose sample of 5 sugar and 5 leather firms listed on Karachi stock exchange has been taken during 2008 to 2012. 8. Methodology: In this study we have to identify sample companies and key variables that has a relationship between working capital and profitability of Sugar and Leather firms. The secondary data necessarily required to perform the research was gathered from official site of sugar and leather firms and some require data was abstracted from the library of state bank and Karachi stock exchange. Rest of data is collected from annual reports. 10
  12. 12. Sample size: In this study, we have utilized the secondary data to estimate the above data. We are generally selected sample of 5 out of 35 mills of Sugar and 5 out of Leather firms listed in Stock Exchange and gather the data of 4years from period 2008 to 2012. Table 1: Selected sugar and Leather Companies (Companies will be selected when research start) Sr. No. 1 Sugar Companies Sr No. 1 2 2 3 3 4 4 5 Leather Companies 5 11
  13. 13. Variables Selected: In this study we identify different key variables that has effect on company’s liquidity and profitability. Choice of variables depends on previous studies. They include dependent and independent variables. Independent variables include current asset, liquid asset, Acid test ratio or Quick ratio. The dependent variable is return on investment Table 2: Selected Variables Sr No. Independent Variable 1 Cash conversion cycle (CCC) Interest Coverage Ratio (ICR) Debt Equity Ratio (DER) Age of Inventory (AI) Age of Debtors (AD) Age of Creditors(AC) 2 3 4 5 6 Dependent Variable Return on Assets (ROA) Table 3: method of computation Variables Method of Computation 12
  14. 14. Cash Conversion Cycle (CCC) Interest Coverage Ratio (ICR) Debt-Equity Ratio (DER) Age of Inventory (AI) Stockholding Period + Debtors Collection Period – Creditors Payment Period PBIT/ Interest External Equities or debts/Equity capital (Average Inventory/Average Cost of Sales) x 365 days Age of Debtors (AD) (Average Debtors/Average Annual Credit Sales) x 365 days Age of Creditors (AC) (Average Creditors/Average Cost of Sales) x 365 days PBIT/ Total assets Return on Assets (ROA) 9. Bibliography Kulkanaya Napompech effect of working capital on the profitability of Thai listed firmsInternational journal of trade economics and finance vol 3 no 3 June 2012 Zubair Arshad and yasir gondal IMPACT OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY A CASE OF THE PAKISTAN CEMENT INDUSTRY INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS vol 5 no 2 June 2013 Lecturer balashundaram nimalathasan working capital management and its impact on profitability a case study of selected listed manufacturing companies in srilanka information management Amarjit gill nahum biger and neil mathur the relationship between working capital and profitability evidence from the united states business and economics journal vol 2010:bej-10 13
  15. 15. Zafar ullah Malik and athar Iqbal affect of working capital management of firm profitability in sugar industry of Pakistan mpra 1 may 2012 Alipour Mohammad (2011) working capital management and corporate profitability evidence from Iran world applied science journal 12 (7), 1093-1099 Deloof m 2003 does working profitability of Belgian FIRMS? MANGEMENT 25 3 945-968 capital JOURNAL management OF BUSINESS affects FINANCE Shah A & a Sana 2006 impact of working capital management on the profitability of oil and gas sector of Pakistan European journal of scientific research 15 3 301-307 Zubairi, H. Jamal (2011). Impact of Working Capital Management and Capital Structure on Profitability of Automobile Firms in Pakistan. Finance and Corporate Governance Conference. 14