This study examines the impact of working capital management on the profitability of 58 small manufacturing firms in Mauritius over the period of 1998-2003. The results show that firm profitability increases with efficient working capital management, measured by lower accounts receivable and accounts payable days and an optimal cash conversion cycle. Specifically, higher accounts receivable days negatively impacts profitability while higher accounts payable days positively impacts it. The paper and printing industry demonstrated the most effective working capital management practices and highest profitability, suggesting it could serve as a model for other industries. Further research with more firms is needed to better understand industry differences in working capital management strategies.

2. Nature of Working
Capital
Working capital management is concerned with the problems
that arise in attempting to manage the current assets, the current
liabilities and the interrelations that exist between them.
Current assets refer to those assets which in the ordinary course
of business can be, or will be, converted into cash within one
year without undergoing a diminution in value and without
disrupting the operations of the firm.
Examples- cash, marketable securities, accounts receivable and
inventory.
Current liabilities are those liabilities which are intended, at
their inception, to be paid in the ordinary course of business,
within a year, out of the current assets or the earnings of the
concern.
Examples- accounts payable, bills payable, bank overdraft and
outstanding expenses.

3. Objective of Working Capital
Management
The goal of working capital management is to manage
the firm’s current assets and liabilities in such a way
that a satisfactory level of working capital is
maintained.
The interaction between current assets and current
liabilities is, therefore the main theme of the theory of
the working capital management.

4. Concepts and Definitions of
Working Capital
There are two concepts of working capital:
Gross and Net.
Gross working capital- means thetotal current
assets.
Net working capital- can be defined in two ways-
o The difference between current assets and current
liabilities.
o The portion of current assets which is financed
with long term funds.

5. Determining Financing-
mix
There are two sources from which funds can be raised
for current assets financing-
o Short term sources, like current liabilities and,
o long term sources, such as share capital, long term
borrowings, internally generated resources like
retained earnings, etc.

6. The Operating-cycle and
Working Capital
Needs
The working capital requirements of a firm depends, to a great extent
upon the operating cycle of the firm. The operating cycle may be
defined as the time duration starting from the procurement of goods or
raw materials and ending with the sales realization.
The length and nature of the operating cycle may differ from one firm
to another depending upon the size and nature of the firm.
The operating cycle of a firm consists of the time required for the
completion of the chronological sequence of some or all of the
following-
o Procurement of raw materials and services.
o Conversion of raw materials into work-in-progress.
o Conversion of work-in-progress into finished goods.
o Sale of finished goods.
o Conversion of receivables into cash.

7. Operating cycle of a typical
company
Payable
Deferral period
Inventory conversion
period
Cash conversion
cycle
Operating
cycle
Pay for
Resources
purchases
Receive
Cash
Purchase
resources
Sell
Product
On credit
Receivable
Conversion period

8. Inventory conversionperiod
Avg. inventory
=
Cost of sales/365
Receivable conversion period
Accounts receivable
=
Annual credit sales/365

9. Cash conversion cycle = operating cycle – payables
deferral period.
and admn.
Payables deferralperiod
Accounts payable + Salaries, etc
=
(Cost of sales +
selling, general
Expenses)/365

10. Determinants of Working
capital Requirement
General nature ofbusiness
Production cycle
Business cyclefluctuations
Production policy
Credit policy
Growth and expansion
Profit level
Level of taxes
Dividend policy
Depreciation policy
Price level changes
Operating efficiency

11. Working capital: Policy and
Management
The working capital management includes and refers to the
procedures and policies required to manage the working
capital.
There are three types of working capital policies which a
firm may adopti.e.
Moderate working capitalpolicy
Conservative working capitalpolicy
Aggressive working capital policy.
These policies describe the relationship between the sales
level and the level of current assets.

12. Three alternative working capital investment
policies
Sales ($)
Current
Assets
($)
conservative
moderate
aggressive

13. Liquidity versus Profitability- A
Risk- Return Trade-off
An important aspect of a working capital policy is to
maintain and provide sufficient liquidity to the firm.
The decision on how much working capital be
maintained involves a trade-off i.e., having a large net
working capital may reduce the liquidity-risk faced by
the firm, but it can have a negative effect on the cash
flows. Therefore, the net effect on the value of the firm
should be used to determine the optimal amount of
working capital.

14. Types of working capital
needs
The working capital need can be bifurcated into permanent
working capital and temporary working capital.
Permanent working capital- There is always a minimum
level of working capital which is continuously required by a firm
in order to maintain its activities like cash, stock and other
current assets in order to meet its business requirements
irrespective of the level of operations.
Temporary working capital- Over and above the permanent
working capital, the firm may also require additional working
capital in order to meet the requirements arising out of
fluctuations in sales volume. This extra working capital needed
to support the increased volume of sales is known as temporary
or fluctuatingworking capital.

15. Difference between permanent & temporary working
capital
Variable Working Capital
Amount
of
Working
Capital
Permanent Working Capital
Time

16. Variable Working Capital
Amount
of
Working
Capital
Permanent WorkingCapital
Time

17. Approaches to determine an
appropriate Financing-mix
There are three basic approaches to determine an
appropriate financing mix:
• Hedging approach, also called the matching approach,
• Conservative approach,
• Aggressive approach.

18. Hedging Approach/ Matching
Approach
• According to this approach, the maturity of the sources of the
funds should match the nature of the assets to be financed. For
the purpose of analysis, the current assets can be broadly
classified into twoclasses-
o those which are required in a certain amount for a given level of
operation and, hence, do not vary over time.
o those which fluctuate over time.
• The Hedging approach suggests that long term funds should be
used to finance the fixed portion of current assets requirements
in a manner similar to the financing of fixed assets.
• The purely temporary requirements, that is, the seasonal
variations over and above the permanent financing needs should
be appropriately financed with short term funds.
• This approach, therefore, divides the requirements of total funds
into permanent and seasonal components, each being financed
by a different source.

19. Matching approach to asset
financing
FixedAssets
Permanent CurrentAssets
Total Assets
Fluctuating Current Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
Capital

20. Conservative
Approach
This approach suggests that the estimated
requirement of total funds should be met from long
term sources; the use of short term funds should be
restricted to only emergency situations or when there
is an unexpected outflow of funds.

21. Conservative approach to asset
financing
FixedAssets
Permanent CurrentAssets
Total Assets
Fluctuating Current Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
capital

22. Aggressive
approach
A working capital policy is called an aggressive policy if the
firm decides to finance a part of the permanent working
capital by short term sources. The aggressive policy seeks to
minimize excess liquidity while meeting the short term
requirements. The firm may accept even greater risk of
insolvency in order to save cost of long term financing and
thus in order to earn greater return.
The trade-off between risk and profitability depends
largely on the financial manager’s attitude towards risk, yet
while doing so he must take care of the following factors-
o Flexibility of the mix
o Cost of financing
o Risk attached withfinancing mix

23. Aggressive approach to asset
financing
FixedAssets
Permanent CurrentAssets
Total Assets
Fluctuating Current Assets
Time
$
Short-term
Debt
Long-term
Debt +
Equity
capital

24. Forecasting / Estimation of
Working Capital
Requirements
Factors to beconsidered
Total costs incurred on materials, wages and overheads
The length of time for which raw materials remain in stores before they
are issued toproduction.
The length of the production cycle or WIP
, i.e., the time taken for
conversion of RM into FG.
The length of the Sales Cycle during which FG are to be kept waiting for
sales.
The average period of credit allowed to customers.

25. The amount of cash required to pay day-to-day expenses
of the business.
The amount of cash required for advance payments if any.
The average period of credit to be allowed by suppliers.
Time – lag in the payment of wages and other overheads.

26. PROFORMA - WORKING CAPTIAL
ESTIMATES
1. TRADING CONCERN
STATEMENT OF WORKING CAPITALREQUIREMENTS
Amount (Rs.)
----
----
----
----
CurrentAssets
(i) Cash
(ii) Receivables ( For…..Month’s Sales)----
(iii) Stocks ( For……Month’s Sales)-----
(iv)Advance Payments if any
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)-
(ii) Lag in payment of expenses
WORKING CAPITAL ( CA – CL)
Add : Provision / Margin for Contingencies
----
-----_
xxx
-----
NET WORKING CAPITALREQUIRED XXX

27. MANUFACTURING
CONCERN
STATEMENT OF WORKING CAPITALREQUIREMENTS
Amount (Rs.)
-----
-----
-----
-----
-----
-----
-----
CurrentAssets
(i)Stock of R M( for ….month’s consumption)
(ii)Work-in-progress (for…months)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(iii) Stock of Finished Goods ( for …month’ssales)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(iv) Sundry Debtors ( for …month’s sales)
(a) Raw Materials
(b) Direct Labour
(c) Overheads
(v) Payments in Advance (ifany)
(iv) Balance of Cash for dailyexpenses
(vii)Any other item
-----
-----
-----
-----
-----
-----
-----
-----
-----
Less : Current Liabilities
(i) Creditors (For….. Month’s Purchases)
(ii) Lag in payment of expenses
(iii) Any other
WORKING CAPITAL ( CA – CL)xxxx
Add : Provision / Margin forContingencies -----
NET WORKING CAPITALREQUIRED XXX

28. Trends in Working Capital Management and its
impact
on Firms’ Performance:AnAnalysis of Mauritian Small
Manufacturing Firms
Kessseven Padachi (2006)

29. Purpose of the
Study
The primary aim of this paper is to investigate the
impact of WCM on corporate profitability of Mauritian
small manufacturing firms.
The trend in working capital needs and profitability of
firms are examined to identify the causes for any
significant differences between the five major
industries.

30. Research
methodology
Sample of 58 small manufacturing firms operating in five
major industry groups which are both registered and
organized as proprietary/ private companies.
The data set covers 58 firms from five industry sub-sectors:
food and beverages, leather garments, paper products,
prefabricated metal products and wood furniture. This has
given a balanced panel data set of 348 firm- year
observations for a sample of 58 firms.
Panel data analysis for the period 1998- 2003.
The sample was drawn from the directory of Small Medium
Industrial Development Organisation (SMIDO), a database
for registered manufacturing firms operating in diverse
activities.

31. Variables used in the
study
Explanatory variables- the efficiency ratios, namely
accounts receivable, inventory and accounts payable,
cash conversion cycle. The cash conversion cycle is
used as a comprehensive measure of working capital.
Return on total assets is used as a measure of
profitability.
Control variables- sales, gearing ratio, gross working
capital turnover ratio, ratio of current assets to total
assets, ratio of current liabilities to total assets.

32. Notations used in the
study
OPM- Operating profit margin is PBIT/sales
ROTA- Return on total assets is PBIT/ Total assets
CCC- Cash conversion cycle is ( number of inventory
days+ number of days accounts receivable – number of
days accounts payable)
WCM- Working capital management

33. Empirical
results
ROTA is significantly positively correlated with OPM and
capital- turnover ratio, but negatively correlated with the
measures of WCM, except for the cash conversion cycle.
This positive relation for CCC is consistent with the view
that resources are blocked at the different stage of the
supply chain, thus prolonging the operating cycle. This
might increase profits due to increase sales, especially
where the costs of tied-up capital is lower than the benefits
of holding more inventories and granting more trade credit
to customers.
Also the small manufacturing firms may be able to obtain
trade credit from the suppliers and this is supported by the
higher proportion of current liabilities to total assets for all
the industries except for the paper products.

34. Coefficient of inventories variable is positive in
Regression
1 but it is not significantly different from zero.
The coefficients of the other variables included in
the model are significant, except for financial
debt and working capital financing.
Thefirms’ profitability asmeasuredby ROT
A increases
with firms’ size,gross working capital efficiency, andwith
a lesser aggressiveness of asset management.
This could be explained by the fact that small firms
tend to have a lower fixed assets base and thus
rely mostly on the turnover of current assets to
generate more profits.

35. In regression 2, a highly significant relation is found
between ROTA and number of days accounts receivable,
which implies that an increase in the number of days
accounts receivables by 1 day is associated with a
decrease in profitability by 0.04%.
The coefficient for accounts payable days is negative
and confirms the negative correlation between
profitability and the number of days accounts
payable.
The results of pooled OLS confirm the relationship
between profitability and the working capital
measurement except for inventory days, the
coefficients of accounts receivables, accounts payable
and CCC are significant.
The adjusted R2s of the OLS regressions is much lower
than the adjusted R2s ‘within’ of the fixed effects

36. Conclusio
ns
The small firms should ensure a good synchronization of its
assets and liabilities.
The paper and printing industry has been able to achieve high
scores on the various components of working capital and this has
positive impact on its profitability. On this premise this industry
could thus be used as best practice among the SMEs.
Further, this research concludes that there is a pressing need for
further empirical studies to be undertaken on small business
financial management, in particular their working capital
practices by extending the sample size so that an industry- wise
analysis can help to uncover the factors that explain the better
performance for some industries and how these best practices
could be extended to the other industries.