between current assets to total assets ratio, cash convention cycle and net profit ... Keywords: Working capital management, Profitability, Net profit margin ratio, ...
Relationship between Working Capital Management and Profitability of Listed Companies in the Colombo Stock Exchange in Sri Lanka Mrs. Safeena, M. G. Hassan, Mohamed Ismail Mohideen Bawa, & K. Risvi Yahzar 1
Senior Lecturer in Management, Department of Management, Faculty of Management and Commerce, South Eastern University of Sri Lanka, Oluvil 2 Senior Lecturer in Management, Department of Management, Faculty of Management and Commerce, South Eastern University of Sri Lanka, Oluvil 3 Risvi Yahzar, K, Accountant, Zonal Director of Education, Akkaraipattu. Abstract Working capital management occupies an important place in determining profitability. Several studies have been done in this regard. However, in this study concentrates on Sri Lankan context in a different way. The objective is to examine the relationship between working capital management and profitability. Analysis was based on data extracted from annual reports and accounts of the companies for the relevant period. Correlation and multiple regression analysis respectively were employed. The study covered 33 listed companies in Sri Lanka over the period of past 5 year from 2009 to 2013. The analyses were carried out on an overall basis. Their findings revealed that there was a significant positive relationship between net profit margin ratio and current ratio. The, there is a negative significant relationship between total assets ratio and net profit margin ratio. But, there were no relationship between current assets to total assets ratio, cash convention cycle and net profit margin ratio. Further, findings revealed that there was a significant impact working capital management on profitability. Keywords: Working capital management, Profitability, Net profit margin ratio, Cash convention cycle. Introduction Finance managers have to make decisions on long-term financial practice, dividend policy, capital structure, capital budgeting and short-term financial practice or working capital management. The net working capital indicates the different between current assets and current liabilities. The working capital management is important that typical manufacturing firms contains half of its total assets and also most of small medium enterprises support their assets though current liabilities as a means of external financing (Mehmet & Orue, 2009). Efficient working capital is essential for organizations are to ensure that yielding high return on investment and continuing smooth day-to-day operations. The organizations are required to maintain sufficient liquidity in its day-to-day operations to ensure the smooth running of organizations with meeting short-term obligation. But, this is not simple and straightforward task as it had to operate its businesses both efficiently and profitably. Organizations have to be carefully considering the working capital decision: inventories, debtors, creditors, and cash, this is because of the mismatch between liquidity and assets lead to effects its day-to-day operations and profitability (Van Horne & Wachowicz, 2004). It is clear from the above argument that the importance of working capital management
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cannot denied in an organization. Researchers all over world focused on this issue and discuss it in details in the perspective of many countries. Statement of the Problem Working capital management is considered an important decision in financial management. When financial people explain about importance of working capital management they talk relatively about relationship between level of working capital management and profitability. Working capital policy is an important issue in any organization because without a proper management of working capital components it is difficult for the firms to run its operation smoothly. Most of the studies used cash conversion cycle as a measure of working capital policy and as an independent variable. A dependent variable, researchers choose between gross operating profit, return on equity and return on asset as a measure of profitability. The results of the studies are different from each other in a way that companies from US, Europe, SMEs and the majority of the studies from the developing Asian countries show that profitability and working capital policies are negatively associated, while the studies from Talat &Nazir, (2006) show no association between profitability and the aggressiveness of Working Capital Policy. So, it becomes interesting to know that how the profitability of the Sri Lankan companies is associated with the working capital policy. Many researchers have been conducted research on working capital management and profitability in Sri Lanka and other countries. Some researchers found that there was a negative relationship between working capital management and profitability. Vijaykumar & Venkatachalam (1995)found that liquidity was negatively associated with profitability and Carcia (2011); Danuletive, (2010); Napompech, (2012); Mahammed & Saad, (2010); Farzinfar&Arani, (2012) andBarine, (2012) concluded that negative relationship between working capital management and profitability .While some researchers found that there was a positive relationship between working capital management and profitability. Lingesiys & Nalini(2011) found that the working capital management significantly influence on profitability of manufacturing companies and increase of the cash conversion cycle leads to less profitability. Further Current ratio and quick ratio were positively related to the profitability and Omer & Abbas (2010), Ali (2011), Prabath & Lakshan (2010), Mwalla (2012), Robert, Martin, Alphonce & Otieno (2012) have investigated that there is positive relationship between working capital management and profitability. Further Appuhami (2008); Azam & Haider (2011); Pouraghajan & Emamgholipourarchi (2012); Alipour (2011) and Jamali & Asadi (2012) found that there is no significant relationship between working capital management and profitability. Working capital policy is an important issue in any organization because without a proper management of working capital components it is difficult for the firms to run its operation smoothly generally most of the firm keep their attention almost with the short term financing source and specially about their working capital management. Therefore, in this study the researcher investigate the relationship between working capital management and Profitability of Sri Lanka listed companies. Research Question In the above problem statement, the researcher has a following research question.
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Does working capital management have a relationship with profitability of listed companies in the Colombo stock exchange in Sri Lanka?
Objective of the Study Based on the above research question, the researcher formulated the following research objective.
Find out the relationship between working capital management and profitability of listed companies on Colombo stock exchange in Sri Lanka.
Significance of the Research Importance of working capital management is felt by all organizations in the global environment. There is no exception to Sri Lankan listed companies. Sales generally influence on working capital of an organization. An organization with higher income has to maintain higher percentage of working capital in compared with lower income organization. Profit depends on income of an organization. Income impacts on both profitability and working capital of an organization. Higher level of working capital reduces profit of an organization. In contrast, lower level of working capital cause liquidity problem for an organization so the organization has to take a decision that tradeoff between working capital and profitability. Review of Literature There are two concepts of working capital. Gross working capitals and net working capital. Gross working capital is defined as a firm’s investment in current assets such as cash, bank deposits, short-term securities, accounts receivable and inventories. And the “net working capital” is a more descriptive term in the context of working capital management, which refers to the subtraction of current liabilities from the current assets, for instance accounts payable and other short-term liabilities. (Karaduman, Akbas, Caliskan, & Durer, 2011). Gross working capital refers to a firm’s investment in current assets. Current assets are the assets which can be converted into cash within an accounting year and includes cash, short-term securities, debtors, bill receivable and stock. (Pandey, 2010) and also Van Horne &Wachowicz, (2004) stated that, gross working capital is firm’s investment in current assets like cash, marketable securities, receivable and inventories.Net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsiders which are expected to mature of payment within an accounting year and include creditors, bills payable and outstanding expenses. Pandey, (2010).Furthermore, net working capital is the surplus of current assets over the short-term liabilities and represents the liquidity margin available to meet the cash demands in order to maintain the daily operations and benefit from the profitable investment opportunities (Padachi, 2006).Net Working capital can be best described as the difference between current assets and current liabilities. This is one measure of the extent to which the firm is protected from 3
liquidity problem. Van Horne &Wachowicz, (2004), explained net working capital can be calculated in the following way. Net working capital = current assets – current liabilities Further they explained that, working capital can be either plus or minus value. When the current Assets exceed the current liabilities, it will indicate the working capital of a firm. On the other hand when it becomes minus value, it is unfavorable to working capital. Methodology Conceptual Framework
Independent Variables
Dependent Variable
(Working Capital)
(Profitability)
Current ratio(CR) Current assets to total asset(CATAR) Total assets ratio(TAR) Cash conversion cycle(CCC)
Net Profit Margin Ratio (MR)
Figure 1: Conceptual Framework Method of Analysis The purpose of this study is to evaluate the relationship between working capital management and profitability of the listed firm in Sri Lanka on Colombo stock exchange. This methodology enables to analyze the effects of different variables. Therefore the main works of the methodology is that the certain amount of models to be applied through multiple regression liner analysis, correlation and descriptive statistics by using the SPSS statistical package version of 16. Data collection In order to carry out the study the financial data were collected from 33non-financial listed companies during the study period of 5 years from 2009 to 2013. Data for research derives from two main sources. Original data, which is referred as primary data is collected at the first hand source. Data which is already exists is referred as secondary data, such as annual reports, books, published statistics and internal records 4
kept by companies. Individual company’s financial data is used for calculation of the financial ratio in order to examine the relationship between working capital management and profitability. The main source of data was gathered secondary data which is hand book of listed companies, published annual report of listed companies and web site of Colombo stock exchange in Sri Lanka. Population The population of this study based on companies listed in the Colombo stock exchange. There are 293 companies listed in different twenty business sector on Colombo stock exchange as at 30st June 2014. Samples Under this study the overall sample and the four sub samples were identified. Sub samples were formed based on the sector and each sector that consist of greater than or equal five companies. Analysis of Results and Discussion of Findings Results of Correlation of Overall Analysis of Sample Before start of regression analysis it is important to check the correlation between different variables, which we are going to use for the analysis. Correlation explains how two variables react to each other’s, what change will occur in one variables with the change in other variables (Kohler,1994). For efficient working capital management to increase the level of profitability, there are should be a negative relationship between the measures of Working Capital Management and Profitability variable. There is a negative relationship between gross operating profitability on the one hand and the measures of working capital management on the other hand. This is consistent with the view that the time lag between expenditure for purchases of raw material and the collection of sales of finished goods can be too long, and the decreasing time lag increases profitability (Raheman & Nasir, 2007). In statistics correlation indicated the strength and direction of liner relationship between two random variables. That is in contrast with the usage of the term in colloquial speech, which denotes any relationship not necessarily linear. The correlation is used to check multi-collinearity among independent variables. The following Table 1 shows the correlation among the independent variables. Table 1: Correlation Matrix Overall Sample Pearson Correlation
Sig. (1-tailed)
MR CR CATAR TAR CCC MR CR CATAR TAR CCC
MR 1.000
CR 0.910 1.000
CATAR 0.101 0.165 1.000
TAR -0.205 -0.167 0.561 1.000
.
0.000 .
0.099 0.017 .
0.004 0.016 0.000 .
**. Correlation is significant at the 0.01 level (2- tailed) *. Correlation is significant at the 0.05 level (2- tailed) 5
CCC 0.003 0.000 0.179 0.128 1.000 0.484 0.497 0.011 0.051 .
Correlation between Current Ratio (CR) and the Net Profit Margin Ratio (MR) is significant positive. Correlation between Current Assets to Total Assets Ratio (CATAR) and the Net Profit Margin Ratio (MR) reveals that there has no relationship. Correlation between Total Assets Ratio (TAR) and the Net Profit Margin Ratio (MR) shows is negative relationship. Correlation between Cash Conversion Cycle (CCC) and the Net Profit Margin Ratio (MR) is positive.
Conclusion Furthermore, the better understanding of correlation between different variables it is used Pearson correlation. It shows that CR and MR is strongly positively correlated that is confirmed that CR is effect of the profits of Sri Lankan companies, but consider CATAR and MR is positively correlated but the 0.099 level of significance. So, Sri Lankan companies to maintain same level of current assets as well next to consider TAR is negatively correlated with the profitability with very few level of significant, therefore Sri Lankan companies need to maintain a balance Trade-offbetween two variables MR and TAR. In addition, the Table 1 shows there exist very little positive relationship between margin ratios and cash conversion cycle and it is consistent with the view that a relax credit terms or larger credit period offer by the company will result into more sale and more sale will bring more profit. References
Carcia, J. F. L. (2011). The Impact of working capital management upon companies’ profitability: Evidence from European companies, FEP Working Papers.
Mehmet, S. E. N. & Oruc, E. (2009). Relationship between efficiency Level of Working Capital Management and Return on Total Assets, International Journal of Business and management, 4(10) pp. 1-10
Napompech, K. (2012). Effects working capital management on the profitability of Thai Listed Firms, international journal of trade economics and finance 3(3) pp. 10-16.
Talat, A. M. & Nazir, S. (2006). “Is it better to be aggressive or conservative in managing working capital?” at Department of Management Sciences, COMSATS Institute of Information Technology, M.A. Jinnah Campus, Lahore, Pakistan. Accessed from http://www.cosmats.ac.pk.
Van Horne, A. & Wachowicz, B. (2004), Fundamental of financial management, Pearson education.
Vijaykumar, A. & Venkatachalam, A. (1995). Working capital and profitability – An empirical analysis, Management Accountant, ICWAI, Kalkata, 1(2), pp. 748-750.
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