abstract
The objective of the research presented here is to provide the empirical evidence about the impact of working capital management on the profitability of a sample of manufacturing firms in Pakistan. With this in mind, I picked 10 cement manufacturing companies covering the period of 2005-2009. In this regard, I studied the impact of different WCM’s variables (Cash Conversion Cycle, Number of days account receivables, Number of days of inventory, and Number of day’s accounts payables). I also measured impacts of Sales Growth and Size of the firm on profitability. I have found that there is a potential linkage between working capital and profitability in manufacturing firms. The results showed that there is an effect of size of the firm on the profitability, and no any impact of other variables. Through the extensive research, I have found that there is strong and positive relationship in high value addition firms. The relationship is significantly statistical.
Introduction:
Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital.
Working capital refers to that part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise.
Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital.
Working capital refers to that part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise.
Working capital, also known as net working capital, is a measurement of a company’s current assets, after subtracting its current liabilities. Working capital measures how much liquid assets a company has available to run its business. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations.
However the question is how a firm should increase its Working Capital? Should it decrease the current liabilities by increasing long term liabilities, or should it increase its account receivables? Both ways result in an increase in working capital, but both ways results in decrease in profits. Hence both are seen as inefficient ways of working capital management because we are downgrading the profitability objective to that of liquidity objective.
Working capital management (WCM) is the management of short-term financing requirements of a firm. Efficient WCM increases firms’ free cash flow, which in turn increases the firms’ growth opportunities and return to shareholders. Even though firms traditionally are focused on long term capital budgeting and capital structure, the recent trend is that many companies across different industries focus on WCM efficiency.
In order to determine the impact of increase in free cash flow, the firm needs to manage the Cash Conversion Cycle. Which is one of the measurements for Working capital management in terms of profitability, which is calculated by adding Days Accounts Receivable and Days in Inventory turnover and subtracting Days Accounts Payables? The shorter firm cash conversion cycle, the better a firm profitability. While, the longer cash conversion cycle will hurt firm’s probability. The reason is that firm having low liquidity that would affect firm’s risk.
However, if firm has higher level of account receivable due to the generous trade credit policy it would result to longer cash conversion cycle, In this case, the longer cash conversion cycle will increase profitability.
Because of the ambiguity in Cash Conversion Cycle’s result, Measuring WCM’s impacts over profitability can also rely on firm’s Sales Growth and Size of the firm. It means that there will be different results while comparing the relationship of WCM and profitability with respect of the Sales Growth and Size of the firm.
An other indicator of profitability of a company is relative to its total assets. If the firm has a good rate of return, it means that firm is managing its assets in a right way. Good WCM is a part of firms’ control over its assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.
In this study I will check the effects of WCM on the profitability of Cement and Textile industry in Pakistan. The intension of taking these industries is that, they contribute in major part of the country’s labor force and GDP.
Management of working capital:
A firm must have adequate working capital, i.e.; as much as needed the firm. It should be neither excessive nor inadequate. Both situations are dangerous. Excessive working capital means the firm has idle funds which earn no profits for the firm. Inadequate working capital means the firm does not have sufficient funds for running its operations. It will be interesting to understand the relationship between working capital, risk and return. The basic objective of working capital management is to manage firms current assets and current liabilities in such a way that the satisfactory level of working capital is maintained, i.e.; neither inadequate nor excessive. Working capital some times is referred to as “circulating capital”. Operating cycle can be said to be t the heart of the need for working capital. The flow begins with conversion of cash into raw materials which are, in turn transformed into work-in-progress and then to finished goods. With the sale finished goods turn into accounts receivable, presuming goods are sold as credit. Collection of receivables brings back the cycle to cash.
The company has been effective in carrying working capital cycle with low working capital limits. It may also be observed that the PBT in absolute terms has been increasing as a year to year basis as could be seen from the above table although profit percentage turnover may be lower but in absolute terms it is increasing. In order to further increase profit margins, SSL can increase their margins by extending credit to good customers and also by paying the creditors in advance to get better rates.
A firm must have adequate working capital, i.e.; as much as needed the firm. It should be neither excessive nor inadequate. Both situations are dangerous. Excessive working capital means the firm has idle funds which earn no profits for the firm. Inadequate working capital means the firm does not have sufficient funds for running its operations. It will be interesting to understand the relationship between working capital, risk and return. The basic objective of working capital management is to manage firms current assets and current liabilities in such a way that the satisfactory level of working capital is maintained, i.e.; neither inadequate nor excessive. Working capital some times is referred to as “circulating capital”. Operating cycle can be said to be t the heart of the need for working capital. The flow begins with conversion of cash into raw materials which are, in turn transformed into work-in-progress and then to finished goods. With the sale finished goods turn into accounts receivable, presuming goods are sold as credit. Collection of receivables brings back the cycle to cash.
The company has been effective in carrying working capital cycle with low working capital limits. It may also be observed that the PBT in absolute terms has been increasing as a year to year basis as could be seen from the above table although profit percentage turnover may be lower but in absolute terms it is increasing. In order to further increase profit margins, SSL can increase their margins by extending credit to good customers and also by paying the creditors in advance to get better rates.
Types of working capital:
Working capital can be divided into two categories-
Working capital can be divided into two categories-
Permanent working capital:
It refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities.
Temporary working capital:
The amount of such working capital keeps on fluctuating from time to time on the basis of business activities.
It refers to that minimum amount of investment in all current assets which is required at all times to carry out minimum level of business activities.
Temporary working capital:
The amount of such working capital keeps on fluctuating from time to time on the basis of business activities.
Advantages of working capital:
• It helps the business concern in maintaining the goodwill.
• It can arrange loans from banks and others on easy and favorable terms.
• It enables a concern to face business crisis in emergencies such as depression.
• It creates an environment of security, confidence, and over all efficiency in a business.
• It helps in maintaining solvency of the business.
Disadvantages of working capital:
• Rate of return on investments also fall with the shortage of working capital.
• Excess working capital may result into over all inefficiency in organization.
• Excess working capital means idle funds which earn no profits.
• Inadequate working capital can not pay its short term liabilities in time.
• It helps the business concern in maintaining the goodwill.
• It can arrange loans from banks and others on easy and favorable terms.
• It enables a concern to face business crisis in emergencies such as depression.
• It creates an environment of security, confidence, and over all efficiency in a business.
• It helps in maintaining solvency of the business.
Disadvantages of working capital:
• Rate of return on investments also fall with the shortage of working capital.
• Excess working capital may result into over all inefficiency in organization.
• Excess working capital means idle funds which earn no profits.
• Inadequate working capital can not pay its short term liabilities in time.
Sources of working capital:
The working capital requirements should be met both from short term as well as long term sources of funds.
The working capital requirements should be met both from short term as well as long term sources of funds.
Financing of working capital through short term sources of funds has the benefits of lower cost and establishing close relationship with banks.
Financing of working capital through long term sources provides the benefits of reduces risk and increases liquidity
Financing of working capital through long term sources provides the benefits of reduces risk and increases liquidity
Objectives of working capital:
Every business needs some amount of working capital. It is needed for following purposes-
• for the purchase of raw materials, components and spares.
• To pay wages and salaries.
• To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc.
• to provide credit facilities to customers etc.
Every business needs some amount of working capital. It is needed for following purposes-
• for the purchase of raw materials, components and spares.
• To pay wages and salaries.
• To incur day to day expenses and overhead costs such as fuel, power, and office expenses etc.
• to provide credit facilities to customers etc.
Factors that determine working capital:
The working capital requirement of a concern depends upon a large number of factors such as
Size of business
Nature of character of business.
Seasonal variations working capital cycle
Operating efficiency
Profit level.
The working capital requirement of a concern depends upon a large number of factors such as
Size of business
Nature of character of business.
Seasonal variations working capital cycle
Operating efficiency
Profit level.
Other factors.
LITERATURE REVIEW:
Many researchers have studied the relationship of WCM and profitability of the firms. In this regard several researches are reviewed, some of which are discussed as follows;
Lozaridis I and D Try Fonidis (2006) studied Relationship between working capital Management and Profitability of the listed companies in the Athens Stock Exchange. The researchers investigated the relationship of corporate Profitability and Working Capital Management by using a sample of 131 listed companies in Athens Stock Exchange for the period of 2001-2004.
They have elucidated that the way that Working Capital is managed has significant impact on profitability of firms which indicates that there is a certain level of Working Capital requirement which potentially maximizes returns. A strong relationship exists between cash conversion cycle of a firm and its profitability.
The three different components of cash conversion cycle i.e. Accounts payable. Accounts Receivable and inventory can be managed in different ways in order to enhance growth of a company.
Trade credit is a way that attracts customers, it can stimulate sales because it allows customer to assess product quality before paying. While in order to have maximum value equilibrium should be maintained in receivable, payable and inventory.
Regression modeling has been used to relate profitability against component of cash conversion cycle.
The results obtained shows that there is a negative relationship between profitability and the cash conversion cycle, the lower gross operating profit is associated with an increase in the number of days Account Payable. A negative relationship between firms profitability and account receivable is been observed, similarly a negative relationship between number of days in inventory and corporate profitability is been obtained.
Further it could be concluded that a firm can create profit by handling correctly the cash conversion cycle and keeping different components i.e. Accounts receivable, Accounts payable and inventory to an optimum level.
Sushma Vishani and Bhupesh Kr. Shah (2007) studied the impact of Working Capital Management policies on corporate performance. The researchers conducted an empirical study on Indian Consumer Electronics Industry for assessing the Impact of Working Capital Policies and Practices on Profitability during the period 1994-95 to 2004-2005. The have emphasized on the importance of liquidity and Profitability by considering them as the important aspect of Corporate Business therefore it is necessary to maintain an adequate degree of liquidity for smooth and steady running of the Business operations. Excessive liquidity indicates accumulation of idle funds which do not earn profit for firm while inadequate liquidity affects the credit worthiness of the firm. There is always an inverse relationship between profitability and liquidity and up to certain level it holds true but beyond that decline in liquidity cause decline in profitability.
An important Working Capital policy decision is concerned with the level of investment in current assets. Determining the optimal level of investment in current assets involves a trade off between costs that rise with current assets viz. carrying cost and costs that fall with current assets viz. shortage cost. For examining the impact of Working Capital Management on profitability coefficient of correlation and regression analyses has been used between profitability ratios and some key Working Capital policy indicator ratios.
On the whole the result indicates that no established relationship between liquidity and profitability exists for the industry as a whole. The different companies in the industry represent different type of relationship between liquidity and profitability. Further it could also be concluded that Working Capital Management policies and practices have profound impact on companies profit performance.
Smith, in (1980) and Raheman & Nasr (2007) discussed that dilemma in working capital management is to achieve desired tradeoff between liquidity and profitability. Referring to theory of risk and return, investment with more risk will result to more return. Thus, firms with high liquidity of working capital may have low risk then low profitability. Conversely, firm that has low liquidity of working capital, facing high risk results to high profitability. The issue here is in managing working capital, firm must take into consideration all the items in both accounts and try to balance the risk and return.
In intention to discover the relationship between efficient working capital management and firm’s profitability (Shin & Soenen, 1998) used net-trade cycle (NTC) as a measure of working capital management. NTC is basically equal to the CCC whereby all three components are expressed as a percentage of sales. The reason by using NTC because it can be an easy device to estimate for additional financing needs with regard to working capital expressed as a function of the projected sales growth. This relationship is examined using correlation and regression analysis, by industry and working capital intensity. Using a Composted sample of 58,985 firm years covering the period 1975-1994, in all cases, they found, a strong negative relation between the length of the firm's net-trade cycle and its profitability. In addition, shorter NTC are associated with higher risk-adjusted stock returns. In other word, (Shin & Soenen, 1998) suggest that one possible way the firm to create shareholder value is by reducing firm’s NTC.
The study of (Shin & Soenen, 1998) consistent with later study on the same objective that done by (Deloof, 2003) by using sample of 1009 large Belgian non-financial firms for the period of 1992-1996. However, (Deloof, 2003) used trade credit policy and inventory policy are measured by number of days accounts receivable, accounts payable and inventories, and the cash conversion cycle as a comprehensive measure of working capital management. He founds a significant negative relation between gross operating income and the number of day’s accounts receivable, inventories and accounts payable. Thus, he suggests that managers can create value for their shareholders by reducing the number of day’s accounts receivable and inventories to a reasonable minimum. He also suggests that less profitable firms wait longer to pay their bills.
Finally, (Lyroudi & Lazaridis, 2000) use food industry Greek to examined the cash conversion cycle (CCC) as a liquidity indicator of the firms and tries to determine its relationship with the current and the quick ratios, with its component variables, and investigates the implications of the CCC in terms of profitability, intentness and firm size. The results of their study indicate that there is a significant positive relationship between the cash conversion cycle and the traditional liquidity measures of current and quick ratios. The cash conversion cycle also positively related to the return on assets and the net profit margin but had no linear relationship with the leverage ratios. Conversely, the current and quick ratios had negative relationship with the debt to equity ratio, and a positive one with the times interest earned ratio. Finally, there is no difference between the liquidity ratios of large and small firms.
Mian sajid nazir and talat afza (2009) studied the impact of Working Capital Management policies on firm profitability. The researchers conducted an empirical study on 204 Pakistani firms for assessing the Impact of Working Capital Policies and Practices on Profitability during the period 1998 to 2005. Using analysis of aggressive investment policies (AIP), aggressive financing policies (AFP), return on assets (ROA) and regression analysis. The study finds a negative relationship between the profitability measures of firm and degree of aggressiveness of working capital investment and financing policies. The firm report negative return if they follow an aggressive working capital policy.
Chapter # 03: Research Design & Methodology
Introduction:
Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital.
Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully with out an adequate amount of working capital.
Working capital refers to that part of firm’s capital which is required for financing short term or current assets such as cash, marketable securities, debtors, and inventories. In other words working capital is the amount of funds necessary to cover the cost of operating the enterprise.
Working capital, also known as net working capital, is a measurement of a company’s current assets, after subtracting its current liabilities. Working capital measures how much liquid assets a company has available to run its business. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations.
However the question is how a firm should increase its Working Capital? Should it decrease the current liabilities by increasing long term liabilities, or should it increase its account receivables? Both ways result in an increase in working capital, but both ways results in decrease in profits. Hence both are seen as inefficient ways of working capital management because we are downgrading the profitability objective to that of liquidity objective.
Working capital management (WCM) is the management of short-term financing requirements of a firm. Efficient WCM increases firms’ free cash flow, which in turn increases the firms’ growth opportunities and return to shareholders. Even though firms traditionally are focused on long term capital budgeting and capital structure, the recent trend is that many companies across different industries focus on WCM efficiency.
In order to determine the impact of increase in free cash flow, the firm needs to manage the Cash Conversion Cycle. Which is one of the measurements for Working capital management in terms of profitability, which is calculated by adding Days Accounts Receivable and Days in Inventory turnover and subtracting Days Accounts Payables? The shorter firm cash conversion cycle, the better a firm profitability.
While, the longer cash conversion cycle will hurt firm’s probability. The reason is that firm having low liquidity that would affect firm’s risk.
However, if firm has higher level of account receivable due to the generous trade credit policy it would result to longer cash conversion cycle, In this case, the longer cash conversion cycle will increase profitability.
Because of the ambiguity in Cash Conversion Cycle’s result, Measuring WCM’s impacts over profitability can also rely on firm’s Sales Growth and Size of the firm. It means that there will be different results while comparing the relationship of WCM and profitability with respect of the Sales Growth and Size of the firm.
An other indicator of profitability of a company is relative to its total assets. If the firm has a good rate of return, it means that firm is managing its assets in a right way. Good WCM is a part of firms’ control over its assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.
In this study I will check the effects of WCM on the profitability of Cement in Pakistan. The intension of taking this industry is that, they contribute in major part of the country’s labor force and GDP.
Methodology:
Research Design
The researcher was designed to find the effect of working capital management on profitability in manufacturing firms. It is also to cover all important aspect related to the matter. Furthermore, with the same objective I have gathered the data from various sources to carry out this descriptive research.
While designing this research study it was considered that it should serve the purpose of practical applicability and should be in line with the objective of the study. All the expenses and barriers were kept in consideration while designing this research.
Research Method:
This research was descriptive and quantitative. It is a correlation of two variables. Days of account receivable, days of inventory turnover, days for payables, cash conversion cycle, sales growth and size is independent and the return on assets is dependent variable. The method of conducting this research was based on primary as well as secondary data. Primary data is basically collected by various sources (books, research reports, library of paf_kiet and internet) and secondary data collected from the balance sheet of the randomly selected cement manufacturing firms.
SAMPLING PROCEDURE:
The sampling technique that is used for this study is convenient sampling.
SAMPLE:
Data used in this study was obtained from Web sites of 10 manufacturing companies.
INSTRUMENTATION:
My study is purely based on statistical analyses. Study is the effect of working capital management on profitability in manufacturing companies. So, best analysis tool for the study is the multiple regression models.
Regression analysis is a statistical method used to describe the nature of the relationship between variables, that is, positive or negative, linear or nonlinear.
DATA COLLECTION:
The data used in this study was acquired from Karachi Stock Exchange (KSE), internet and web sites of different firms. Data of firms listed on the KSE for the most recent five years formed the basis of our calculations. The period covered by the study extends to five years starting from 2009-2005.
Variables:
Return on Assets (ROA):
I used the return on assets (ROA) as the dependent variable. Which is defined as the ratio of net profits to assets?
Number of days accounts receivable (AR):
Number of days accounts receivable (AR) is calculated as 365 × [accounts receivable/sales]. This variable represents the average number of days that the firm takes to collect payments from its customers. The higher the value, the higher its investment in accounts receivable.
Number of days of inventory (INV):
I calculated the number of days of inventory (INV) as 365 × [inventories/purchases]. This variable reflects the average number of days of stock held by the firm. Longer storage times represent a greater investment in inventory for a particular level of operations.
Number of days accounts payable (AP):
The number of days accounts payable (AP) reflects the average time it takes firms to pay their suppliers. We calculated this as 365 × [accounts payable/purchases]. The higher the value, the longer firms take to settle their payment commitments to their suppliers.
Cash Conversion Cycle (CCC):
Considering the above three periods jointly, we estimated the cash conversion cycle (CCC). This variable is calculated as the number of day’s accounts receivable plus the number of days of inventory minus the number of days accounts payable. The longer the cash conversion cycle, the greater the net investment in current assets, and hence the greater the need for financing of current assets.
Size of the firm(S):
The size of the firm is measured as logarithm of assets.
Sales Growth (SG):
The sales growth is measured as: (Sales (T) – Sales (T-1)/Sales (T-1).
HYPOTHESIS
HYPOTHESIS TESTING:
H01 There is a positive relationship between working capital management and profitability.
H11 There is no relationship between working capital management and profitability.
MODEL:
I used OLS and multiple regression analysis and the general form of model is:
1) ROA = B AR + BS + B SG
2) ROA = B INV + B S + B SG
3) ROA = B AP + B S + B SG
4) ROA = B CCC + B S + B SG
Chapter # 04: Data Analysis & Interpretation of Results
DATA ANAYSIS:
1. ROA = B AR + B S + B SG:
Dependent Variable: ROA | ||||||||
Method: Least Squares | ||||||||
Date: 10/28/10 Time: 12:59 | ||||||||
Sample: 1 50 | ||||||||
Included observations: 50 | ||||||||
Variable | Coefficient | Std. Error | t-Statistic | Prob. | ||||
C | 1.959675 | 0.420703 | 4.658100 | 0.0000 | ||||
AR | -0.002166 | 0.001905 | -1.136967 | 0.2614 | ||||
SG | 0.055723 | 0.050227 | 1.109415 | 0.2730 | ||||
SIZE | -0.261708 | 0.059537 | -4.395696 | 0.0001 | ||||
R-squared | 0.325842 | Mean dependent ver. | 0.074684 | |||||
Adjusted R-squared | 0.281875 | S.D. dependent ver. | 0.259476 | |||||
S.E. of regression | 0.219886 | Akaike info criterion | -0.114797 | |||||
Sum squared resid | 2.224092 | Schwarz criterion | 0.038164 | |||||
Log likelihood | 6.869934 | F-statistic | 7.411089 | |||||
Durbin-Watson stat | 1.154032 | Prob(F-statistic) | 0.000377 | |||||
Here I have checked the relationship of Return on Assets (ROA) with number of days accounts receivables (AR), sales growth (SG) and size (S) of the firm. I found that ROA has a negative relationship with AR and Size. While it has a positive relationship with SG.
The P-Value explains that there is no impact of AR and SG on ROA of the firms, but Size has an impact on ROA, because P-value of Size is less than 0.05.
R square shows 32.58% variance on ROA. The F-statistic is positive and its probability is also less than the desired 10% probability.
2. ROA = B AP + B S + B SG
Dependent Variable: ROA | ||||||||
Method: Least Squares | ||||||||
Date: 10/28/10 Time: 13:01 | ||||||||
Sample: 1 50 | ||||||||
Included observations: 50 | ||||||||
Variable | Coefficient | Std. Error | t-Statistic | Prob. | ||||
C | 1.941446 | 0.436263 | 4.450172 | 0.0001 | ||||
AP | 0.001544 | 0.003269 | 0.472259 | 0.6390 | ||||
SG | 0.056404 | 0.051037 | 1.105155 | 0.2748 | ||||
SIZE | -0.267157 | 0.060029 | -4.450431 | 0.0001 | ||||
R-squared | 0.310241 | Mean dependent ver. | 0.074684 | |||||
Adjusted R-squared | 0.265257 | S.D. dependent ver. | 0.259476 | |||||
S.E. of regression | 0.222416 | Akaike info criterion | -0.091920 | |||||
Sum squared resid | 2.275560 | Schwarz criterion | 0.061042 | |||||
Log likelihood | 6.297991 | F-statistic | 6.896656 | |||||
Durbin-Watson stat | 1.041989 | Prob(F-statistic) | 0.000624 | |||||
It was found that ROA has a positive relationship with no of days in payables (AP) and SG, but negative relationship with Size.
As P-value of size is less than 0.05, so size has an impact on ROA, while there is no impact of AP and SG on ROA of the firms.
R square shows 31.02% variance on ROA. The F-statistic is also positive and its probability is also less than the desired 10% probability.
3. ROA = B INV + B S + B SG
Dependent Variable: ROA | ||||||||
Method: Least Squares | ||||||||
Date: 10/28/10 Time: 13:04 | ||||||||
Sample: 1 50 | ||||||||
Included observations: 50 | ||||||||
Variable | Coefficient | Std. Error | t-Statistic | Prob. | ||||
C | 1.955838 | 0.455354 | 4.295202 | 0.0001 | ||||
INV | 0.000518 | 0.002572 | 0.201286 | 0.8414 | ||||
SG | 0.059502 | 0.050855 | 1.170019 | 0.2480 | ||||
SIZE | -0.266514 | 0.061779 | -4.313978 | 0.0001 | ||||
R-squared | 0.307507 | Mean dependent ver. | 0.074684 | |||||
Adjusted R-squared | 0.262344 | S.D. dependent ver. | 0.259476 | |||||
S.E. of regression | 0.222856 | Akaike info criterion | -0.087963 | |||||
Sum squared resid | 2.284581 | Schwarz criterion | 0.064999 | |||||
Log likelihood | 6.199083 | F-statistic | 6.808880 | |||||
Durbin-Watson stat | 1.068913 | Prob(F-statistic) | 0.000681 | |||||
In this regression modal relationship of Return on Assets (ROA) with number of days in inventory (INV), sales growth (SG) and size (S) of the firm, is examined. I found that ROA has a positive relationship with INV and SG, but negative relationship with Size.
There is no impact of INV and SG on ROA of the firms, but Size has an impact on ROA, because P-value of Size is less than 0.05.
R square shows 30.75% variance on ROA. The F-statistic is also positive and its probability is also less than the desired 10% probability.
4. ROA = B CCC + B S + B SG
Dependent Variable: ROA | ||||||||
Method: Least Squares | ||||||||
Date: 10/28/10 Time: 13:05 | ||||||||
Sample: 1 50 | ||||||||
Included observations: 50 | ||||||||
Variable | Coefficient | Std. Error | t-Statistic | Prob. | ||||
C | 2.006536 | 0.423605 | 4.736808 | 0.0000 | ||||
CCC | -0.000942 | 0.001200 | -0.785306 | 0.4363 | ||||
SG | 0.055259 | 0.050738 | 1.089098 | 0.2818 | ||||
SIZE | -0.270164 | 0.059572 | -4.535116 | 0.0000 | ||||
R-squared | 0.316066 | Mean dependent ver. | 0.074684 | |||||
Adjusted R-squared | 0.271462 | S.D. dependent ver. | 0.259476 | |||||
S.E. of regression | 0.221474 | Akaike info criterion | -0.100401 | |||||
Sum squared resid | 2.256343 | Schwarz criterion | 0.052561 | |||||
Log likelihood | 6.510013 | F-statistic | 7.085986 | |||||
Durbin-Watson stat | 1.084012 | Prob(F-statistic) | 0.000518 | |||||
In this modal the impacts of Cash Conversion Cycle (CCC), Sales Growth (SG) and Size (S) of the firm on ROA was checked. Here Return on Assets has negative relationship with Cash Conversion Cycle and size of the firm, while has a positive relationship with SG.
There is no impact of CCC and SG on ROA of the firms, but Size has an impact on ROA, because P-value of Size is less than 0.05.
R square shows 31.60% variance on ROA. The F-statistic is also positive and its probability is also less than the desired 10% probability.
Summary of findings:
From the result I conclude that, measuring profitability of firms observed do not rely on the factors of working capital management. The profitability of these firms mostly depends on their size.
The results showed that there is no impact of number of day’s accounts receivables, number of days in inventory, number of days in accounts payables, cash conversion cycle and sales growth on profitability. Rather it’s the size of the firm that influences the rate of return of the firms.
Chapter # 05: Discussions, Summary, Conclusion And Recommendations
INTRODUCTION:
Working capital management (WCM) is the management of short-term financing requirements of a firm. Efficient WCM increases firms’ free cash flow, which in turn increases the firms’ growth opportunities and return to shareholders. A firm must have adequate working capital, i.e.; as much as needed the firm. It should be neither excessive nor inadequate. Both the situation are dangerous. Excessive working capital means the firm has idle funds which earn no profit for the firm. Inadequate working capital means the firm does not have sufficient funds for running its operations. It will be interesting to understand the relationship between working capital, risk and return. The basic objective of working capital management is to manage firms current assets and current liabilities in such a way that the satisfactory level of working capital is maintained, i.e.; neither inadequate nor excessive. Working capital some times is referred to as “circulating capital”. Operating cycle can be said to be t the heart of the need for working capital. The flow begins with conversion of cash into raw materials which are, in turn transformed into work-in-progress and then to finished goods. With the sale finished goods turn into accounts receivable, presuming goods are sold as credit. Collection of receivables brings back the cycle to cash.
DISCUSSION:
HISTORY OF CEMENT INDUSTRY
The cement industry in pakistan has grown gradually with the passage of time. At thetime of independence there wew only four units with total production capacity of nearly half a million tons per annum. By 1972 the number of cement plants increased to 14 and the production capacity also increased to 2.5 million tons. Both public and private sector took iniciative to establish new plants. As was the case for thr other industries, the cement industry was also nationalized in 1972 and the state Cement Corporation of Pakistan (SCCP) was established and given the responsibility to manage the production of cement in the country. Considering the higher cement demand as compared to supply, cement imports was also allowed in FY 76-77 that continued until FY 94-95. With a change in policy of state control over industrial units, the state owned cement plants werw also put-up for privatization along with other industries. The private sector was allowed to invest in the cement manufacturing. Consequently, the role of SCCP as market leader vanished gradually and currently it owns only four plants, of which two have been closed down on efficiency and profitability grounds. In view of the higher demand during the period of de-regulation and liberalization, a number of new units were set up and many others invested heavily to increase their existing production capacity. As a result, the production capacity has reached 17.7 million tons per annum during 2003.
SECTOR OVERVIEW
There are 29 cement production units in the country. Up to may 2007, the total installed cement production capacity is 36.841 million tones. By the end of june 2011, the installed cement production capacity will touch to the level of 49.579 million tones. Due to political instability and lack of allocation of funds for public sector development program, cement industry of pakistan was in the recession phase had registered an average growth rate of 2.96% for the period from 1990 to 2002. For the period from 2003 to 2007 cement industry of pakistan had registered an average growth rate of 20%, the boost in cement sector is because of the rising construction activity in the country, reconstruction activity in afghanistan and increasing development expenditure by the government.
IMPLICATIONS:
Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are ratio analysis and management of individual component of working capital. Thus the importance of adequate of working capital in commercial undertakings can never be over emphasized. The various studies conducted by the bureau of public enterprises have show that one of the reasons for the poor performance of public sector undertakings in our country has been the large amount of funds locked up in working capital. This result in over capitalization. Over capitalization implies that a company has too large funds for its requirement, resulting in a low rate of return a situation which imolies a less than optimal use of resources. Insolvency risk is there in the case under caitalization of working capital. Hence working capital management plays a vital role in growth or to sustain in the market for any organization.
CONCLUSION:
From the result I conclude that, measuring profitability of firms observed do not rely on the factors of working capital management. The profitability of these firms mostly depend on their size.
Therefore I applied the model measuring the impacts of components of working capital separately. In the first model effects of number of days accounts receivables were measured, and respectively with number of days in inventory, number of days in accounts payables, and cash conversion cycle. At the same time the impacts of sales growth and size of the firm on profitability were also calculated.
The results showed that there is no impact of number of days accounts receivables, number of days in inventory, number of days in accounts payables, cash conversion cycle and sales growth on profitability. Rather it’s the size of the firm that influences the rate of return of the firms.
The reasons for this result may be the difference of the firm’s sizes which were selected for the study or maybe there are ambiguities in firm’s financial statements that are published periodically.
RECOMMENDATIONS:
There are several recommendations to improve the profitability.
First, a successful business should always think through business decisions by producing a complete and effective business plan.
Second, businesses should find sufficient working capital and financing that manages the finances efficiently. The business should established tight financial controls; good budgeting practice and accurate book keeping and accounting methods that are backed by an attitude of frugality.
APPENDIX:
VARIABLES | ||||||||||
Years | ROA | NO. Of Days Account Reciveable | No. of Days Inventories | No. Of Days Accounts Payables | Cash Conversion Cycle | Sales Growth | Size | |||
ATTOCK Cement | 2009 | 0.2141 | 1.9723 | 38.6322 | 11.0523 | 29.5521 | 0.7016 | 6.8434 | ||
2008 | 0.0741 | 3.5821 | 38.4003 | 22.7066 | 19.2758 | 0.0967 | 6.7687 | |||
2007 | 0.1377 | 1.5921 | 33.5216 | 12.5081 | 22.6056 | 0.3133 | 6.7624 | |||
2006 | 1.5806 | 2.4321 | 33.7612 | 22.6791 | 13.5143 | 0.0207 | 5.7596 | |||
2005 | 0.8926 | 0.5513 | 37.9213 | 23.4814 | 14.9912 | 0.2157 | 6.0141 | |||
D.G KHAN Cement | 2009 | 0.0123 | 10.4 | 3.4937 | 7.6872 | 6.2065 | 0.4493 | 7.6307 | ||
2008 | -0.001 | 10.7386 | 4.9456 | 9.959 | 5.7252 | 0.9387 | 7.7159 | |||
2007 | 0.0314 | 8.2013 | 13.4756 | 32.0169 | -10.34 | -0.1931 | 7.7139 | |||
2006 | 0.0705 | 3.4026 | 4.5894 | 37.323 | -29.3309 | 0.5069 | 7.5353 | |||
2005 | 0.0934 | 5.2707 | 23.1204 | 23.6429 | 4.7482 | 0.2981 | 7.2557 | |||
FAUJI Cement | 2009 | 0.047 | 2.8683 | 2.3823 | 19.3833 | -14.1328 | 0.4641 | 7.3314 | ||
2008 | 0.0332 | 2.0695 | 1.3853 | 8.2967 | -4.8419 | 0.3713 | 7.0953 | |||
2007 | 0.101 | 2.0612 | 1.3781 | 16.8105 | -13.3711 | -0.192 | 6.8062 | |||
2006 | 0.1942 | 2.1694 | 1.56 | 10.4241 | -6.6947 | 0.5065 | 6.7923 | |||
2005 | 0.082 | 13.7565 | 2.1075 | 9.475 | 6.389 | -0.3683 | 6.7941 | |||
PAK CEMENT | 2009 | -0.064 | 3.4397 | 13.7969 | 15.1822 | 2.0544 | 0.0928 | 8.2946 | ||
2008 | -0.056 | 1.6645 | 9.99 | 19.0451 | -7.3906 | 0.7748 | 8.3421 | |||
2007 | -0.024 | 6.4751 | 15.3389 | 24.8898 | -3.0758 | 3.76 | 8.332 | |||
2006 | -0.002 | 2.4508 | 17.183 | 15.4057 | 4.2281 | 0.1208 | 8.2594 | |||
2005 | -0.008 | 28.7354 | 16.5059 | 18.5958 | 26.6455 | 0.4493 | 8.2781 | |||
Dandot Cement | 2009 | -0.118 | 27.1508 | 28.3675 | 16.8621 | 38.6562 | 0.2395 | 7.5066 | ||
2008 | -0.135 | 27.6733 | 25.6204 | 14.377 | 38.9167 | -0.3919 | 7.4916 | |||
2007 | -0.144 | 12.1372 | 39.221 | 5.1313 | 46.2269 | -0.352 | 7.4806 | |||
2006 | -0.006 | 8.3127 | 50.5694 | 5.4126 | 53.4695 | 0.2997 | 7.3564 | |||
2005 | 0.0331 | 13.1616 | 33.8203 | 14.7094 | 32.2725 | 0.4641 | 7.3594 | |||
Lucky Cement | 2009 | 0.1197 | 16.5877 | 19.8836 | 17.7831 | 18.6883 | 0.5527 | 7.5842 | ||
2008 | 0.0782 | 15.504 | 20.7909 | 14.7476 | 21.5474 | 0.3543 | 7.5345 | |||
2007 | 0.099 | 13.8944 | 19.8668 | 15.0211 | 18.7401 | 0.5683 | 7.4104 | |||
2006 | 0.082 | 19.7216 | 13.0543 | 32.7223 | 0.0536 | 1.0061 | 7.3733 | |||
2005 | 0.0558 | 10.6169 | 13.1216 | 37.215 | -13.4765 | -0.192 | 7.1705 | |||
Maple leaf Cement | 2009 | -0.038 | 16.3276 | 16.487 | 20.2911 | 12.5235 | 0.9513 | 7.4093 | ||
2008 | -0.025 | 34.7153 | 14.5894 | 24.7847 | 24.52 | 1.1061 | 7.4175 | |||
2007 | 0.0018 | 19.1384 | 14.9675 | 20.6839 | 13.422 | -0.35 | 7.3699 | |||
2006 | 0.0564 | 10.4492 | 17.03 | 39.492 | -12.0128 | 0.3307 | 7.274 | |||
2005 | 0.0698 | 7.877 | 16.0433 | 26.0727 | -2.1524 | 0.2395 | 7.0182 | |||
DADABHOY CEMENT | 2009 | 0.0243 | 5.2351 | 13.9301 | 15.1839 | 3.9813 | 0.5849 | 6.5982 | ||
2008 | -0.064 | 6.2205 | 26.8305 | 14.3063 | 18.7446 | -0.4558 | 6.6147 | |||
2007 | 0.0424 | 2.2996 | 8.5787 | 11.8881 | -1.0097 | -0.5266 | 6.5463 | |||
2006 | 0.0347 | 2.4268 | 4.5508 | 15.8402 | -8.8626 | 0.1767 | 6.5369 | |||
2005 | 0.0249 | 14.9846 | 11.9403 | 13.487 | 13.4379 | 0.3543 | 6.5103 | |||
Gharibwal Cement | 2009 | -0.032 | 108.5987 | 38.4857 | 10.1478 | 136.9366 | 0.1099 | 7.0616 | ||
2008 | -0.03 | 25.1939 | 33.8696 | 11.4172 | 47.6463 | 1.1591 | 7.0215 | |||
2007 | -0.027 | 22.0057 | 41.499 | 11.8734 | 51.6314 | -0.6716 | 6.9152 | |||
2006 | 0.0389 | 31.1872 | 37.3716 | 24.7137 | 43.845 | 0.0809 | 6.6337 | |||
2005 | 0.078 | 6.0101 | 30.2504 | 29.1512 | 7.1092 | 0.9513 | 6.3841 | |||
Pioneer Cement | 2009 | 0.0035 | 2.7302 | 21.9168 | 43.9095 | -19.2625 | 0.0302 | 7.0148 | ||
2008 | -0.017 | 3.0173 | 28.3184 | 30.0559 | 1.2798 | 0.5237 | 7.0201 | |||
2007 | -0.01 | 3.4051 | 34.6271 | 24.6429 | 13.3893 | 0.0356 | 6.935 | |||
2006 | 0.0804 | 1.4821 | 28.8501 | 43.0495 | -12.7173 | 0.5307 | 6.9245 | |||
2005 | 0.0482 | 3.4411 | 28.3003 | 34.0488 | -2.3075 | -0.5266 | 6.8381 | |||
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