Cash Conversion Cycle And Profitability Of A Firm

Cash Conversion Cycle and Profitability of a Firm in Food Sector of PakistanA THESIS SUBMITTED TO THE PUNJAB COLLEGE OF COMMERECE

(UNIVERSITY OF CENTRAL PUNJAB)

IN FULFILLMENT OF THE REQUIREMENT

FOR THE DEGREE

MASTERS IN COMMERCE (ACCOUNTING & FINANCE)

BYMuhammad Tayyab

Supervisor: Faisal Baloch

PUNJAB COLLEGE OF COMMERECEUniversity of Central Punjab2014

RESEARCH COMPLETION CERTIFICATECertified that the research work contained in this thesis Cash Conversion Cycle and Profitability of a Firm in Food Sector of Pakistan has been carried out and completed by Muhammad Tayyab Reg # S4F12MCOM0054 under my supervision during his masters of commerce.

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Principal Date:__________________

Punjab College of Commerce

University of Central Punjab Research Supervisor:______________________

Lahore, Pakistan

Certificate of ExaminationCertified that quantum and quality of the research work contained in the thesis Cash Conversion Cycle and Profitability of a Firm in Food Sector of Pakistan adequate for the award of degree of Masters of Commerce.

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Declaration:

I, Muhammad Tayyab Reg No S4F12MCOM0054, Student of masters of commerce during the session of 2012-2014, hereby declare that the matter printed in the dissertation titled Cash Conversion Cycle and Profitability of a Firm in Food Sector of Pakistan is my own work and has not been printed, published and submitted as research work in any form in any university, research institute etc in Pakistan or Abroad.Dedication:

I would like to dedicate this report to my dear parents and respected teachers who guided me through my studying carrier and still doing their best for me. To be here in this institution at this level I am just because of my parents, especially their training, guidance, love, affection and motivation. I pray that I can serve my parents as best as I can.

ACKNOWLEGEMENT

First of all I am very thankful to Almighty ALLAH who gave me courage and confidence to making this dissertation. I am also thankful to respected Sir Faisal Baloch & Sir Waqar Ahmed in the UCP campus sargodha, who gave me chance and opportunity to make such a professional project, in which I analyze the entire scenario regarding food industry. They have been a steady source of track throughout the course of this whole internship. Their innumerable ideas were precious and gave me with an insight to the path, which was off the beaten track otherwise. I have yet to see the limits of their sympathetic, stamina and altruistic concerns for me. I am especially thankful to my parents and friends for giving me the silent support in terms of courage and strength that I needed to accomplish my goals. Words might not be adequate to express my feelings towards them.

Abstract:

CCC is very important for every manufacturing firm because it helps the manager to maintain inventory keeping time properly. CCC tells us how a manufacturing firm is able to manage its inventory properly. There must be a balance between assets and liabilities in order to maintain working capital properly. The data which is used in this article is obtained from financial statements of companies registered in Karachi stock for the year 2006 to 2011. The sample consists of 54 firms in food sector. Regression analysis is used to examine the relationship of CCC with profitability of firms in food sector of Pakistan. In regression analysis we used Return on Assets and Gross profit to total asset as dependent variable. The study evaluated that there is Positive relationship between CCC and profitability of food sector of Pakistan from 2006 to 2011

KEY WORDS:Cash conversion cycle, profitability, food sector, Karachi stock exchange, CCCContents:

Chapter#1: Page# 1.1. Introduction.111.2. Food Industry of Pakistan.12-161.3. Cash conversion cycle....17-191.4. Purpose of study...201.5. Period of study..201.6. Problem Statement...211.7. Objectives..........................................................................................................................211.8. Research Question211.9. Research model221.10. Research hypothesis.231.11. Importance24Chapter#2:

2.1. LITERATURE REVIEW...24-29Chapter#3:

Research Design and Methodology

3.1. Population..303.2. Research Approach/Design..303.3. Data Collection..303.4. Analysis..303.5. Regression analysis...303.6. Cash Conversion Cycle Operationalization313.7. Profitability Operationalization.32-33Chapter#4:

Analysis4.1. Regression Equation: 1 & Results..34-364.2. Regression Equation: 2 & Results...36-37Chapter#5:

Recommendations and Conclusion5.1. Recommendation385.2. Conclusion39 References..40-43Table of contents:Table #TitlePage #

1Production pattern of sugarcane in the world12

2Pakistan Sugarcane Area and Yield13

3Province wise sugar production14

4Food processing units in Pakistan16

5Regression equation 1st results 35

6Regression equation 2nd results 37

Figures

Figure #TitlePage #

1Urban population trend in food sector across Asian countries15

2Cash flow cycle17

3Cash conversion cycle20

4Research model22

List of Abbreviations:Sr#AcronymsAbbreviation

1CCCCash conversion cycle

2GPtoTAGross profit to total assets

3CRCurrent ratio

4WCMWorking capital management

5ROAReturn on assets

6ROEReturn on equity

7NPMNet profit margin

8TATRTotal assets turnover ratio

9WCtoTAWorking capital to total assets

Chapter#1:

1.1. Introduction The size of global processed food industry is estimated to be valued around US $3.5 trillion and accounts for threefourth of the global food sales following countries are subject of growth in food sector in developing countries in Asia, Europe, and AsiaPacific, which are suffering of high population

There is still potential in ASEAN countries that can be covered with respect to food sector, having population more than 550 million people. Despite its large size, only 6% of processed foods are traded across borders compared to 16% of major bulk agricultural commodities

From past five years there is a growth in food sector about 15.9 % annually. The main food processing industries in the world are America and Europe. Convenience products such as dried instant soups, reconstituted fruits and juices, shelf cooking meals are becoming popular throughout the worldEmployment ratio in this sector in different major countries is as follows.

US: 12 million

Europe: 2.5 million

After India and china the largest food market in Asian countries is Japan. The most technologically strong food industry is in Australia; the reason is that the cost of production in this country is very low.

There are four steps in food industry that are; production, process, transportation and distribution. We can see that this chain involves all the stakeholders of this sector from small farmer to a retail distributor. There should be alignment in all of these steps so that it will produce significant effects and can work effectively around the whole cycle. In order to maintain competitive edge we should focus on food beverages and Tobacco other then the agricultural inputs like wheat, maize, cotton and sugarcane, fruits, vegetables and dairy these also play a significant role in food sector of Pakistan.Production pattern of sugarcane in the world

Country

Cane Yield (T/ha)

Sugar Recovery (%)

Sugar Yield (t/ha)

Australia Egypt Brazil USAColombia Mexico India PakistanWorld Avg.

100.4110.8 68.4 80.2 80.5 79.5 66.9 49.0 64.4

13.811.514.511.711.511.6 9.9 9.210.6

13.8512.74 9.91 9.38 9.26 9.22 6.64 3.54 6.82

Table#11.2. Food Industry of PakistanThe total production ratio of food sector in Pakistan is 27% and the total employment ratio is 16% which belongs to manufacturing sector. Pakistan having huge consumer base and Pakistan is at eighth number in the world that covers approximately 169 million consumers, having more than 1000 large scale food processing units. As effect of globalization food style of consumers is totally changed in Pakistan. The average individual consumer spending is about 42% of his income on food items.There are many fast food chains in Pakistan that are changing the life style of individuals .The efficiency of food industries depends upon availability of the raw materials and Pakistan is a bigger producer of many crops (such as wheat, rice, sugarcane and oilseeds)

There are many problems in the food industry of Pakistan. But still there is increasing trend In our food industry due to the changing demands of the customers as result of globalization. Some of the major problems include:

* Political instability* Monopolistic trend* Lack of resources* lack of skilled workers* rough infrastructural facilities* ineffective utilization of factors of production* Transportation issues* High cost of production.Pakistan is at fifth number in the world with respect to farming of sugar cane, in production Pakistan is at eleventh number and in yield of sugar Pakistan is at 60Th number in the world. Sugarcane is major raw material for this industry production. After the Indo-Pak separation there is an increase in the total cultivated area of sugar cane. The sugarcane is cultivated over the area covering more than 1 million hectares.In Pakistan there are more than 81 firms which are engaged in production of sugar and their annual production is more than 6.1 million tons. This sector contribute large amount in GDP of the country by exporting sugar to other countries and earn foreign reserves.Pakistan Sugarcane Area and YieldYearArea (000 Ha)Produced 000 TonesYield per HectareUtilization % by Sugar Mills

2000-01

960.0

43,620

45.4

67.47

2001-02

999.7

48,041

48.1

76.33

2002-03

1,099.7

52,049

47.3

80.28

2003-04

1,074.8

53,800

50.1

81.15

2004-05

966.4

43,533

45.0

73.74

Table#2Mostly sugar is produced in province of Punjab and Sindh. Very small amount is produced in NWFP in past Punjab was partly dependent on supply of sugar from Sindh. But now Punjab is self sufficient in production of sugar due to development in sugar industry in Punjab .Sugar production is seasonal activity. The mills works approximately 150 day s throughout the year Province wise sugar production (In Tones)

Province2005-062004-052003-042002-032001-02

Punjab 1,832,2282,182,330

2,599,490

2,351,102

2,152,175

Sindh1,038,122801,063

1,221,268

1,158,674

940,959

NWFP128,157

132,407

176,252

166,983

104,611

Total2,998,507

3,115,801

3,997,010

3,676,759

3,197,745

Table# 3A variety of imported food (given below) can be easily seen on shelves of modern retail stores. The products are as follows soft drinks and fruit juices, Jams and jellies, dry milk, cheese, Ice creams, almonds, pistachios, Biscuits and wafers, vegetables, medicines, Chocolates ,cereals, Honey, Tea and coffee, noodles and Baby items.Growth trend in urban population is as follows in figure #1.

Figure # 1

The soft drink industry in Pakistan has become major sector in the economy of Pakistan from several years. As per the latest survey byAAJ TV, almost 170 firms are working in the Pakistan in this industry. The beverage industry covering Juices, drinks, drinking water, milk, energy drinks tea and coffee as well. In Pakistan different firms are leading in different products in beverages based upon their specialization and product

Recently a survey is conducted in 2013 was conducted in October 2013 byDynamic Research Consultants The survey results based upon a comparative study between two types of gender first one is young adult age from 16 to 22 years and second one is matured having age more than 22 years results survey are given below.

The survey findings explain the different consumption patter between the genders having different age limit. Overall, the results of survey concluded that the females are more probable to consume different drinks then males. Tea is the more preferred drinks in the mature adults (having age more than 22 years). While the energy drinks are more consumed by young adults then the mature adults Drinks that are consider as healthy drinks like mil and fruit juices are consumed greater in mature the soft drinks are consumed in a huge amount among both of genders

Now the tea has become a part of Pakistani culture, Pakistan is at first number in tea consumption in the world. In Pakistan per capita tea consumption is 1 kg and average tea consumption in the world is in the world 0.75 kg .

Table#2In soft drink classification, there are two major competitors all over the world which are PepsiCo and Coca Cola, and locally in Pakistan gourmet cola is emerging and giving tough competition to Pepsi and just because of their low cost then both brands. There is also significant growth in juice industry in Pakistan just because of healthy vitamins qualities in juices. The solid growth in particular industry is just because multiple fruits are cultivated in Pakistan. The government of Pakistan has removed custom duty on export of locally manufactured juice. There are 38 units which are engaged in production of juices and the vital firms in this industry are nestle Pakistan Limited, Benz industries and Mitchell

Energy drinks are scored as less consumed beverage then others as the least consumed beverage. The significant company in this industry is Red Bull, which is a multinational brand with aggressive strategies covering 63% share in 2012 .recently Sting was introduced by PepsiCo in Pakistan and becoming major cold drink and consumed at huge number in adults.

The beverage industry in Pakistan has many opportunities and gaps which are too be filled. Beverage industry is one of the fewest industries in Pakistan which shows significantly growth from past years and probably to grow faster in future due to increasing consumption pattern among both of genders. According to recently report Pakistan beverage industry in facing two major threats which are, politically instability and increasing inflation rate in the country .1.3. Cash conversion cycle Liquidity management is one of the most important financial management techniques. It measures the time in which the inventory is converted into cash again and the account receivables are recovered. Figure#2In accordance with (Siddiquee and Khan, 2009) effective capital management policies may become firms competitive edge. And the firm will not need to get loan from outside sourcesAccording to Gardner et al. 1986 there is much importance of Working capital management in firms operations because it has a direct relationship with the financial performance of a firm.

Companies can increase their profitability by Decreasing the period of cash conversion cycle by decreasing the accounts receivables collection time period, and increasing the time period of cash payments or credit payments. The basic objective of every company is to increase the profitability of the company so the company focuses on all the factors which affect the profitability of firm. Filbeck and Krueger (2005) focus on the performance of working capital management and find that there are variations in working capital tools from time to time .WCM theory presented by Richards and Laughlin (1980) explain that cash conversion cycle is a great measure to check the efficiency of organizational working capital management. It is a great measure to know that how fine a corporation is organizing its working capital (Nobanee et al. 2011). According to Gitman (1974) cash conversion cycle is a good evidence of working capital management efficiency, Cash conversion cycle guide managers regarding investment and credit decisions, inventory and suppliers management. Padachi, 2006 tells us that Cash conversion cycle and collection cycle are good indicators for analyzing firms performance. According to Weinraub and Visscher aggressive working capital management policies has higher number of risk and also higher volume of payoff and conservative working capital management policies has lower risk, and lower risk lead towards lower returns. According to Jose et al. (1996) aggressive working capital management will tends towards shorter cash conversion cycle which will leads towards higher profitability of a firm.In the opinion of Shin and Soenen (1998) in order to get higher returns we have to invest fewer amounts in current assets, the purpose is to reap the higher risk which will lead towards higher profits.

Smith (1980) suggested that in order to lower the risk the firm will have to invest in their current assets heavily but due to lower risk the returns will fall down. According to the old concept of firms profitability and cash conversions there is inverse relationship between both of them. But there is a disadvantage that this may harm the working of an organization and also impact the profitability.(AlHajja, 2009) suggested that the firm can increase their profitability by reducing the conversion cycle and cash conversion cycle is reduced by increasing the payment period to creditors and increasing the time of payment to debtors and inventory days period cycle, the receivable collection period and the inventory conversion period. (Malitz and Ravid, 1993) open credit terms increases the sale volume of the firm but it effects the short term financial operations of a firm but narrow credit terms will reduce the sale volume of firm which lead towards lower profitability.

In contradiction with other studies (Lyroudi and Lazaridis) argue the relationship between profitability and CCC of a firm and concluded that there is a direct relationship between profitability of a firm and cash conversion cycle. There are many reasons of this harmful impact one of them is that when reducing inventory conversion period there may be a problem of reduction in the collection period, another reason is that firm may loses its good customers due to demanding of early payment of their debts. And when the firm increases its firms payable period the reputation of the firm may be on stake, there should be a proper management between receivables and payables.

Capitalism works through a complex and sometimes confusing process. The basic principle however is fairly simple. It is basically and free enterprise system that rewards hard work.

We have to identify a proper match between amount receivables and payables. In order to work more smartly the firms have to boost up their cash receivings and slower their cash payments. The principal behind this tactic there is the technique of operating cycle and cash conversion cycle.We can reduce the cash conversion cycle by minimizing the working capital flow. It can be done through reducing the time of receivables of debtors and increasing the time of payables of creditors.

Figure#3Cash conversion cycle is considered as important tool to measure working capital and profitability of a firm. In accordance with (Lyroudi & Lazaridis, 2000) cash conversion cycle directly affects the liquidity position of a firm. Richards & Laughlin (1980) gives the thought of cash conversion cycle in important for calculating the effectiveness of liquidity management of a firm. It represents the gap between cash collections and cash payments .the equation for CCC is given below:Cash conversion cycle = operating cycle average payment period

And

Operating cycle = inventory days period + average collection period 1.4. Purpose of studyThe basic objective of our study is to examine the relationship between the cash conversion cycle and profitability of a firm

1.5. Period of studyWe analyze the financial statements of companies listed under Karachi stock exchange from the period of 2006 to 20111.6. Problem StatementCash conversion cycle is one of the most important techniques in working capital management and which affects the firms all financial operations. It directly affects the profitability of firm. The manager must consider cash conversion cycle while managing cash issues; how the firm will collect money from debtors and pay this cash to creditors. There are many researches on cash conversion cycle and financial performance of a firm but there is very little work on cash conversion cycle and profitability in food sector of Pakistan, this was our research problem to overcome this gap.To identify the impact of cash conversion cycle on a firms profitability1.7. Objectives

Following are our research objectives.

To determine the impact of cash conversion cycle on profitability.

To determine the impact of average payment period on return on asset and Gross Profit to total assets

To determine the impact of length of average collection period on return on asset and Gross Profit to total assets

To determine the impact of inventory days period on return on asset and Gross Profit To total Assets 1.8. Research Question:What is the nature of the relationship among Cash Conversion Cycle and Profitability of food sector of Pakistan?1.9. Research Model:

Figure#4INDEPENDENT VARIABLE Cash conversion cycle

DEPENDENT VARIABLE ProfitabilityCash conversion cycle includes

Account receivable period

Inventory days period

Accounts payable period

Profitability includes Return on assets

Return on equity

Net profit margin Gross profit to total assetsControl variables:Total asset turnover ratio

Natural log of sales

Cash ratio

Dividend coverage ratio Working capital to total assets 1.10. Research hypothesis: H1: There is a strong negative relation between profitability and cash conversion cycle

Ho: There is a strong positive relationship between profitability and cash conversion cycle

1.11. ImportanceOur study will contribute to the previous researches in the following ways. Firstly the good management of working capital is very valuable for shareholders of a firm. Secondly, the shareholders are more aware about all the operations of a firm related to working capital management due to digitalization.This research will contribute significantly towards the food sector of Pakistan and will provide base paper to future researchers in food sector.Chapter#22.1. LITERATURE REVIEW(SALEEM, 2012) conducted a research on cash conversion cycle and profitability of 32 companies from manufacturing sector of Pakistan , and they used regression and correlation analysis to find out the relationship between cash conversion cycle and profitability of firms and she conclude that there is a negative relationship between cash conversion cycle and profitability of firms (Bhutto, 2011) conducted a research on Relationship of Cash Conversion Cycle with Firm Size, Working Capital Approaches and Firms Profitability and they selected 157 companies from oil and gas sector of Pakistan registered at Karachi stock exchange to examine the relationship between cash conversion cycle and performance of a firm and they conclude that there is a strong negative relationship between cash conversion cycle and firms sales revenues, return on equity and return on assets (A) conducted a research on profitiability and working capital management of firms of Siri lanka and he chosed manufacturing sector , beverages sector of Siri lanka and he used pearsons correlation analysis he finds that shoter the cash conversion cycle greater will be the profitability of firm.(Nasr, 2007) work on Working Capital Management And Profitability they choose a sample 94 firms registered at Karachi stock exchange for the period of six years and uses Pearsons correlation and regression analysis in their model and suggested that there is a strong negative relationship between CCC and performance of a firm .(Zawaira, 2014) works on the association between working capital management and profitability of non-financial companies listed on the Zimbabwe stock exchange find out the relationship between working capital management variables and profitability of firms of Zimbabwe and they selected a sample of 32 non financial firm registered at Zimbabwe stock exchange , they used regression analysis in their model and finds that there is a inverse relationship between payable period and profitability.(Afza, 2008) concluded about is it better to be aggressive or conservative in

Managing working capital? they selected a sample of 208 public limited companies listed at Karachi stock exchange for the duration of 1998 to 2005 to find out the impact of aggressive as well as conservative working capital management policies on profitability of firms and finds out that there is a strong inverse relationship between working capital policy and performance of firm. (Bieniasz, 2011) conducted a research on The Influence of Working Capital Management on the Food Industry Enterprises Profitability they selected a sample from food sector of Poland to analyze the CCC and turnover cycle with the help of debtor, current liabilities, creditor, sales and finds out that the firms having shorter working capital cycle as compare to larger one have higher profitability ratio.(Attari, 2012) works on The Optimal Relationship of Cash Conversion Cycle with Firm Size and Profitability he choose manufacturing sector of Pakistan and selected 31 firms and collected the data for the period of 2006 to 2010 and used one way ANOVA and Pearson correlation method and find that there is a opposite relationship between CCC and profitability (Mehmet, 2009) have worked on Relationship between Efficiency Level of Working Capital Management and Return on Total Assets in ISE they collected the data from Istanbul Stock Exchange and concluded that there is inverse relationship between CCC and profitability (return on total assets) of any firm.(Sabri, 2012) conducted a research on Different Working Capital Polices and the Profitability of a Firm they collected the data of 45 industries from Amman Stock Exchange (ASE). From the period from 2000 to 2007.they analyzed the data with the help of T-Tests and Mann-Whitney-U Tests. They concluded that companies are different from each other on the basis of high and low cash conversion cycle because of their different profitability ratios.(QUAYYUM, 2011) have worked on the topic Effects of Working Capital Management and Liquidity: Evidence from the Cement Industry of Bangladesh they collected the data for 2005 to 2009 from the Dhaka Stock Exchange. The result of this research shows that there is a relative higher level of relationship between the profitability ratios and various liquidity ratios and working capital variables of the firm.(Chhapra, 2010) worked on textile sector of Pakistan to determine the impact of working capital management on profitability and he finds out a significant negative relationship between debt used and profitability of firm

(Malik, 2013) in Pakistan they conducted a study about working capital management and profitability of a firm they have very strong view that there negative relationship between net operating profitability and average collection time,

(DELOOF, 2003) examined that there is inverse relationship between profitability and number of collection days. He conducted this research in Belgian(Terrell, 2007) concluded that there is inverse relationship between accounts receivables and profitability (Uyar, 2009) studied the relationship between c ash conversion cycle and firm size. And he concluded that there is a strong inverse relationship between cash conversion cycle and the firm performance.

(Nobanee) examined that there is a strong inverse relationship between the cash conversion cycle and Return on asset in all the sectors of economy but not in FMCG and in service sector. (Anser, 2013) find out that there always an inverse relationship between a firm cash conversion cycle and return on investment of the firm. ( ZUBAIRI ,2010) conducted a research and find a relationship between cash conversion cycle and firm size .he focus on automobile sector of Pakistan and predict that larger firms work more efficiently for collecting there receivables. (Stine, 1993) conducted that there is a strong need in small businesses for managing properly their cash conversion cycle because in small businesses there is lack of cash. And he found out that cash conversion cycle increases profitability because there is less need of cash and also no need of external borrowing.

(NOBANEE, 2006) conducted a study in United States and he find that cash conversion cycle is related with working capital management. They both work hand by hand in contributing in the profitability of the firm. (VIJAYAKUMAR, 2011) examined that the relationship between cash flow and profitability of the firm. And he found that there is strong negative relationship between both of them.

(Garcia, 2007) concluded that there is a positive relationship between accounts payable payment cycle and profitability of a firm. The firms that pay their bills after a reasonable delay enjoy more profitability.

(ELJELLY, 2004) concluded in his research that there is inverse relationship between cash collection cycle and profit ratio of a firm.

(SEN, 2009) he conducted a study on 220 public limited firms and calculated that there is a negative relationship between longer cash conversion cycle and profitability. Longer CCC will lower the profits of a firm.

(HIJAZI, 2006) they conducted a research study on listed companies in Karachi stock exchange of Pakistan and conclude that there is inverse relationship between arrears inventory and profits of a firm.

(Sana, 2006) examined a study in oil and gas sector of Pakistan and resulted that there is a very strong inverse relationship between profitability and cash conversion cycle of a firm, And also examined that there is also a link between working capital and profitability of firms working in Pakistan.

(VISSCHER, 1998) done a research work on ten different sectors for the period of ten years. And find that small firms require a shorter cash conversion cycle as compared to larger firms. And in response the profitability of small firms increases.Filbeck and Krueger (2005) give focus on the performance of working capital management and worked on 32 industries in USA and find that there is variations in working capital tools from time to time.

Pandey and Parera (1997) provides a base on working capital management policies, they gather data from different manufacturing firms listed in Sri Lankan Stock exchange. They use questionnaire as their data gathering tool, and find that there is a unofficial link between working capital management policy and the size of a firm. And also finds that the profitability of a firm also great impact on the working capital management policies. They worked on the official data of Colombo stock exchange. Weinraub and Visscher worked on aggressive working capital management and finds out a relationship between risk and working capital policies and suggest that aggressive working capital management policies has higher number of risk and also higher volume of payoff and conservative working capital management policies has lower risk, and lower risk lead towards lower returns.

Gardner et al. 1986, Weinraub and Visscher (1998) there is much importance of Working capital management in firms operations because it has a direct relationship with the financial performance of a firm.

(Smith, 1980) Suggested that in order to lower the risk the firm will have to invest in their current assets heavily but due to lower risk the returns will fall down. (SOENEN, 1993) worked on working capital management and profitability of US firms and by using chi-square test and concluded that that there is strong inverse relationship between net cash conversion cycle and return on assets.

(Jose, 1996) worked on the working capital management and profitability and collected the data of US firms and find that aggressive working capital management will tends towards shorter cash conversion cycle. And by his findings there is a perfect negative relationship between profitability and cash conversion cycle of US firms. Shin and Soenen (1998) suggested that to get higher returns we have to invest fewer amounts in current assets; the purpose is to reap the higher risk which will lead towards higher profits.

(AlHajja, 2009) finds that the firm can increase their profitability by reducing the conversion cycle and cash conversion cycle is reduced by increasing the payment period to creditors and increasing the time of payment to debtors and inventory days period cycle, the receivable collection period and the inventory conversion period.

In contradiction with other studies (Lyroudi, 2000) finds out that there is a direct relationship between profitability of a firm and cash conversion cycle. and profitability is calculated by Return on assets (ROA) and net profit margin (Smith, et.al, 1997) used Chi-square test for analyzing the relationship between CCC and profitability and also finds out that there is a strong positive relationship between both of them and profitability is calculated by Return on investment (ROI)

Malitz and Ravid (1993) used open credit terms increases the sale volume of the firm but it effects the short term financial operations of a firm but narrow credit terms will reduce the sale volume of firm which lead towards lower profitability. Siddiquee and Khan (2009), concluded that the effective capital management policies may become firms competitive edge. And the firm will not need to get loan from outside sources. And find that there is a positive relationship between working capital management and performance of firm in term of profitability.

Richards & Laughlin (1980) gives the thought of cash conversion cycle in important for calculating the effectiveness of liquidity management of a firm.

Lyroudi & Lazaridis (2000) gives the idea that there is greater impact of working capital management and profitability and also concluded that cash conversion cycle directly affect the liquidity position of a firm.

Filbeck & Krueger (2003) said that there are many other factors that affects the working capital management for example interest rate, and increase in interest rate will also show increase in cash conversion cycle

Chapter#3:Research Design and Methodology

3.1. Population

Our population is Food Sector of Pakistan.3.2. Research Approach/Design

Our research is quantitative in nature as we quantify our variables with the help of different questions. We use different dimensions of each variable, and then use different questions for each dimension. There is accurate evidence of reliability and validity about the scales is available that we used in our research.

3.3. Data Collection

Our population is Karachi stock for the year 2006 to 2011.The data which is used in this article is obtained from financial statements of companies registered in Karachi stock for the year 2006 to 2011. The sample consists of 54 firms in food sector.3.4. Analysis

We use Regression analysis for analyzing the results of our model.3.5. Regression analysisIs a statistical tool for finding the relationship between independent and dependant variable .There are many techniques in regression analysis by which we can check the relationship between variables. Regression analysis shows us that how much change accrued in dependant variable due to change in independent variable while other variables remain constant.3.6. Cash Conversion Cycle Operationalization Average receivables periodAverage receivables period provides information about liquidity of business; it also helps managers to develop their companys credit policy which is beneficial for company as well as for the customers. The time taken by firms to collect its accounts receivables from its debtors or customers is known as account receivable period. Following is the formula. The outcome of seasonal sales will be affected by this formula. Where:Days = Total no of days in yearAR = Average amount of debtorsCredit Sales = Total credit sales throughout the year

It is important for a firm to analyze the average receivable period , in how many days the company will collect its receivables to meet its long and short terms obligations.

Average payment periodTime required by a firm to pay its debts to the companys creditors is known as Average payment period. We can calculate the average payment period by It is a time between the purchase of goods and its payment (Arnold, 2008, p.531). We can calculate the average payment period by(AverageAccountpayable/Net CreditPurchase)*365

If the payment period of company is lengthy then the firm cannot take the advantage of trade discounts and other benefits. Companies always try to shorten their payment period for getting these benefits.APP helps firm to get a better judgment of the cash outflows for future planning. Judgment of cash outflows has significant role in successful business Average payment period determines past trends in the payment of the trade credit. Average payment period brings managements awareness to variables that must be explore to ensure that the business operations are working successfully Days Sales of InventoryA performance measurement tool which tells us about the in how many days the firm will able to convert its inventory (including raw material inventory, work in process & finished goods) into sales. Normally less days in sales inventory is good for company.

It is also an important tool to measure cash conversion cycle. Following is the formula of inventory in days period.

Inventory days = 365*(average inventory/cost of goods sales)

If a firm is unable to convert its inventory into sales quickly then its a danger sign for firms growth and it may create problems for firms survival. 3.7. Profitability OperationalizationNet Profit Margin

This ratio tells us how much rupee of profit is being generated by one rupee sales Net profit margin is commonly represented as a percentage. (Abdul Raheman, 2007) finds that the relationship between Net profit margin and CCC and concluded that there is a strong inverse relationship between both of them. Net profit margin is calculated by this formula

(Net Profit Margin = Net profit /Net sales)Return on assetReturn on asset is a tool which tells us about how much earnings are generating by company by usage of its assets. Greater the return on asset the greater will be the profitability. (Bhutto, 2011) concluded greater the cash conversion cycle of a firm greater will be the total assets and return on assets. This variable is also used by (SALEEM, 2012), (Afza, 2008), (Zawaira, 2014) and (Bieniasz, 2011)

The formula of return on asset is as follows. Return on equityWe can explain return on equity is the amount earned by firm by using shareholder equity. This ratio is an important tool for evaluating either the firm is working in the favor of shareholders or not, utilizing their investment effectively we can enhance the firms profitability. Bhutto, 2011) find that the length of cash conversion cycle has inverse relationship between return on equity and sales income . To measure the profitability of a firm this variable also used by (M.S Nazir), and (Zawaira, 2014) . The formula of return on equity is as follows. Return on Equity = Net Income/Shareholder's EquityGross Profit to Total AssetsThis ratio tells us how much dollars of GP is earned by each dollar of total assets. With the help of this ratio we can check that either the firm is using assets effectively for production of gross profit and net profit or not. To measure the profitability of a firm this variable is not being used by any other researcher. We calculated the firms profitability by this ratio

The formula of this ratio is as follows

Gross profit to Total Assets = (Gross profit /Total Assets) Chapter#4Analysis4.1. Regression Equation: 1In 1st equation Return on assets has been taken as dependent variable, whereas Natural log of sales, Cash conversion cycle, working capital to total assets and dividend coverage ratio has been taken as independent variable Y= +1(NLofS) + 2(Cash cycle) +3(WCtoTA) + 4(dividend CR ) + = return on assets

1 = Natural log of sales

2 = cash conversion cycle

3 = working capital to total assets

4 =dividend carried ratio Analysis of variance R-SQUAREADJUSTED R-SQUAREPROB>F

0.23930.22970.0000

R-square shows 23.93% of variation in ROA which is explained with the help of four independent variables .The adjusted R-square is slightly lower than R-square which is 22.97%

F-statistics showing the normal validity of model as its value 25.08 which is significant and the probability of f is 0.0000

ROA

Coef.Std. Err.TP>|t|[95% Conf.Interval]

NLofSales.0115076.00323213.660.000.0051487.0178665

CCC.0000428.00013530.320.752-.00002234.000309

WCtoTA.00159.00028515.580.000.0010292.0021508

DividendCR.0095852.00289783.310.001.0038841.0152864

_cons-.1139518.0449506-2.540.012-.202389-.0255147

Results:

The above schedule shows the estimated coefficients of the variables. The Return on assets is positively related to cash conversion cycle, Natural log of sale, working capital to total assets and dividend coverage ratio .Natural log of sales is positively related with return on assets and the results are significant with respect to probability of t which is lower than 10 % which shows that our variable is significant. Cash conversion cycle is also directly related with return on assets but as compare to probability of t the results shows that the variable is insignificant. While the working capital to total assets also positively co-related with return assets which means that greater that ratio greater will be the profitability of a firm .Similarly dividend coverage ratio also positively linked with return on assets. Greater the dividend coverage ratio greater will be the profitability o a firm

Normally the f value more than 15 in considered as significant and shows good fit of regress model, here the value of f is 25.08 which is significant .Regress results indicates that slope coefficient is -.1139518 and Beta coefficient for natural log of sales is .0115076, Beta coefficient for CCC is .0000428, Beta coefficient for working capital to total assets .00159 and the beta coefficient for dividend coverage ratio is .0095852. Normally, prob. >T does not exceed 0.10 for statistical significance of parameter. Therefore, it can be concluded that the variables are significant below then at 10 percent. P>|t| natural log of sales 0.000, for CCC is 0.752, for Working capital to total assets is 0.000 and for dividend coverage ratio is 0.001. Normally the t value more than 3 shows that the parameter is significant, here the t value for natural log of sales is 3.66, for CCC .032, for Working capital to total assets is 5.58 and for dividend coverage ratio is 3.31 which means that the Natural log of sales, working capital to total assets, and dividend coverage ratio is statistically significant while the CCC is statistically insignificant 4.2. Regression Equation: 2

Y= +1(GrowtS)+ 2(CCC ) +3(CR) + 4(TATR) In 2nd equation profit to total assets has been taken as dependent variable, whereas growth (sales), Cash conversion cycle, current ratio and total assets turnover has been taken as independent variable Here is Gross profit to total assets = Gross profit to total assets 1 = growth (sales)

2 = cash conversion cycle

3 = current ratio

4 = Total assets turnover ratio R-SQUAREADJUSTED R-SQUAREPROB>F

0.45510.44820.0000

R-square shows 45.51% of variation in gross profit to total assets which is explained with the help of four independent variables which means that the dependent variable will change 45.51% with respect to independent variables .The adjusted R-square is slightly lower than R-square which is 44.82%

GPtoTACoef.Std. Err.TP>|t|[95% Conf.Interval]

GrowthS-.0030989 .0044947 -0.69 0.491 -.0119418 .0057441

CCC.0003937 .0001351 2.91 0.004 0001278 .0006596

CR.0030443.0032717 0.93 0.353 -.0033926 .0094811

TARA.1746662 .0107789 16.20 0.000 .1534595 .1958729

_cons-.0519178 .019891 -2.610.009 -.0910518 -.0127837

Results From the regression results it is concluded that Growth is negatively related with gross profit to total assets which means that lower the growth (sales) greater the profitability of a firm. But the cash conversion cycle is positively related with the dependent variable which means that longer the length of cash conversion cycle greater will be the profitability of a firm. While current ratio is positively related with the gross profit to total assets which means that greater the investment in current assets will leads towards higher corporate profits. And Total assets turnover ratio is also positively related with gross profit to total assets Normally the f value more than 15 in considered as significant and shows good fit of regress model, here the value of f is 66.60 which is significant. Normally the t value more than 3 shows that the parameter is significant, in accordance with our regression analysis results the parameters growth (Sales) , CCC and Current ratio are insignificant but total assets turnover ratio is highly significant . Normally, prob. >T does not exceed 0.10 for statistical significance of parameter. Therefore, it can be concluded that the variables are significant below then at 10 percent. P>|t|. From our results growth (Sales) and current ratio are insignificant but the CCC and total assets turnover ratio are perfectly significant.

Chapter#5Limitations, Recommendations & Conclusion5.1. Recommendation & limitations For managing working capital effectively there must be a proper match between account receivables period and accounts payment period. The main objective of every firm is to increase their profitability, and companies decrease their cash conversion period by decreasing there receivables period and increasing their payment period. We can apply more than one statistical test on this study for increasing its significance

We can also use cross sectional data and can increase our research work validity.

We can collect data from more than one stock exchange like Islamabad and Lahore stock exchange.

In this study we collect date from our country we can increase importance of our study by collecting data from another country. The total time available for this research was too short.

This research includes data only from Pakistan food sector; we can take data from other countries as well.5.2. Conclusion

There is much importance of Cash conversion cycle in every business because it assists managers for decision making regarding collection of receivables from debtors and payment to creditors, it provide direction regarding how many days a company should hold its inventory. The greater the inventory holding period there will be more problems like storage, damages etc. Cash conversion cycle is very important for a company to analyze its efficiency in working capital management.According to Gardner et al. 1986 there is much importance of Working capital management in firms operations because it has a direct relationship with the financial performance of a firm.

Companies can increase their profitability by Decreasing the period of cash conversion cycle by decreasing the accounts receivables collection time period, and increasing the time period of cash payments or credit payments. The basic objective of every company is to increase the profitability of the company so the company focuses on all the factors which affect the profitability of firm. (AlHajja, 2009) concluded that the firm can increase their profitability by reducing the conversion cycle and cash conversion cycle is reduced by increasing the payment period to creditors and increasing the time of payment to debtors and inventory days period cycle, the receivable collection period and the inventory conversion period. There should be balance between current assets and current liabilities so that the company can work efficiently with its finances. If the cash will be managed efficiently then there will be less chances of shortage of cash and insolvency. (Smith, 1980) Suggested that in order to lower the risk the firm will have to invest in their current assets heavily but due to lower risk the returns will fall down. (SOENEN, 1993) worked on working capital management and profitability of US firms and by using chi-square test and concluded that that there is strong inverse relationship between net cash conversion cycle and return on assets.In our research we concluded that there is strong positive relationship between cash conversion cycle and profitability of a firm. In our results Gross profit to total assets and return on assets is significantly affected by cash conversion cycle. Greater the length of CCC greater will be the profitability of food sector of Pakistan. our results are in accordance with Katerina Lyroudi they concluded that The cash conversion cycle is directly related with return on assets and the net profit margin . References1. DELOO, M. (2003). Does Working Capital ManagementAffect Profitability. journal of Business Finance .

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Profitability

Cash conversion cycle

Account receivable period

Return on assets

Inventory days period

Return on equity

Accounts payable period

Gross profit to total assets

H1 (Negative relationship)

Profitability

Cash conversion cycle

Ho (Positive relationship)

Profitability

Cash conversion cycle

Table#4

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