0

Impact of working capital on firm’s profitability

A case study of sugar and leather sector of Pakistan

Impact of Working Capital Management

on profitability(Case study of Sugar and Leather Firms)

1

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 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,

2

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.

To measure the relationship among gain and

leverage.

3

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

As I previously described that the aim of my research

is the measurement of the effect of working capital

4

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

Alternative hypothesis:

Hypothesis:

H0 = Working Capital has negative impact on

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

decision on management of working capital. This

research provides a direction that profitability level

5

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 2003-

2007 and revealed the results that the cash conversion

cycle and return on assets are negative correlated

which mean cash conversion cycle increase when return

on asset decrease.

6

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 the effect of

working capital management on profitability. The

regression 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

7

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.

Zubair Arshad and Muhammad yasir ghondal in 2013

studied the working capital management and

profitability of Pakistan cement sector and revealed

8

that there is significant negative relation between

working capital management on profitability of firm.

In Pakistan there have been few researchers on 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

corporate profitability with reference to Pakistan but

it’s not enough. There is still lack of evidence of

relationship between the two variables.

9

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.

Sample size:

10

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 4 years from period 2008 to 2012.

Table 1: Selected sugar and Leather Companies

(Companies will be selected when research start)

Variables Selected:

In this study we identify different key variables that has effect on company’s liquidity and profitability.

11

Sr. No.

Sugar Companies

1

2

3

4

5

Sr No.

Leather Companies

1

2

3

4

5

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 Dependent Variable

1 Cash conversion cycle (CCC)

2 Interest Coverage Ratio (ICR)

3 Debt Equity Ratio (DER)

Return on Assets (ROA)

4 Age of Inventory (AI)5 Age of Debtors (AD)6 Age of Creditors(AC)

Table 3: method of computation

Variables Method of Computation

Cash Conversion Cycle (CCC) Stockholding Period +

Debtors Collection Period – Creditors Payment Period

Interest Coverage PBIT/ Interest

12

Ratio (ICR)Debt-Equity Ratio

(DER)External Equities or debts/Equity capital

Age of Inventory (AI) (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

Return on Assets (ROA)

PBIT/ Total assets

9. Bibliography

Kulkanaya Napompech effect of working capital on the profitability of Thai listed firms International 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

Zafar ullah Malik and athar Iqbal affect of working capital management of firm profitability in sugar industry of Pakistan mpra 1 may 2012

13

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 capital management affects profitability of Belgian FIRMS? JOURNAL OF BUSINESS FINANCE MANGEMENT 25 3 945-968

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