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Impact of working capital management on profitability
By
USMAN HAMEED
MBA-14232

Abstract
The goal of this study is to investigate the affiliation between the Working Capital Management
(WCM) and the profit of a firm in the Cement Sector of Pakistan. An exceptional WCM is
expected to enhance a firms value and ratchet up its productivity and profitability, as it plays a
crucial role in the financial management and decisions of the firm. The impact that the Working
Capital Management has on the net income, as well as the impacts of the average collection
period, cash conversion cycle, and the current ratio of the firm are used as control variables to
help gain a deeper understanding of their effect on profitability (net income).
The annual reports of five Pakistani cement companies from 2009 to 2014are observed to
examine the relations of the WCM and net profitability. The relationship of the WCMs efficiency
and profitability is examined using stationary, regressive analyses and ANOVA (Analysis of
Variance) tests. The results reveala significantly strong, positive relation between the two
variables, proving that there is a significant relationship between working capital, average
collection period, cash conversion cycle, and the current ratio and profitability. However, the
results also suggest aclear negative relationship between the firms debt and its profitability.
These enhancements in the knowledge base of WCM help companies manage the working capital
more effectively. Furthermore, these findings will aid the policy making and decision making
authorities, by allowing them to improve their orientation towards considering and adopting
efficient ways to manage the working capital.

Introduction
The working capital management is vital, due to its direct relationship with a companys fluidity
and the productivity, as it muddles through current assets and liabilities. A substandard return on
investment is due the misappropriate level of CA. Firms whose current assets are insufficient are
likely to experience shortages and difficulties in operating smoothly (Barton& Simko 2002). In
order to maintain an effective working capital management it is necessary to be able to control
current assets and liabilities, thus eliminating the chances of missing the due dates of short term
obligations as well as avoiding excessive investments (Mackenzie 2003). Current liabilities of any
firm is expected to attend these responsibilities on regular basis.liquidity of assets have not
dependent of liquidity of firm, but these assets generated the operating cash flow (Petty & Guthrie
2004). In general, results of different level of working capital components make frequent & time
consuming

Corporate finance is utilized for three basic decisions: capital structure decisions, capital
Budget decisions, and working capital management decisions. In financial management working
capital management area is very sensitive which involves deciding regarding the composition,
amount and current assets financing (Leland 1998). Current assets include assets return to cash
from within a short time span, that is, in the normal course of business. Usually temporary
investment of this type will be rapidly converted into Cash whenever need. The WCM of any firm
partially affects its profitability
Although the main purpose of any firm is to maximization its profit, preserving the liquidity of
the firm is also essential. The issue arises when enhancing profits at the rate of liquidity start
bringing severe problems to the firm. Thus, these two goals of the firm must tradeoff. Both of
these are just as important as the other, and if one is to neglect profit, focusing entirely on
liquidity, the company will not be able to last for a long period of time. Whereas if one is to be
careless about liquidity, and remaining fixated upon profit, problems of insolvency and
bankruptcy are likely to occur. For these reasons and that it will make change the profitability of
firm & the firm has maximum level of working capital management which miximize the value of
firm
.
A well-known measure of the WCM is cycle of cash conversion. the time intervalamid the
expenditure for the purchases of raw materials and the collection of sales of finished goods. The
longer the time lags are, the greater the investment in the working capital (Gompers, 1995).A
lengthier Cash Conversion Cycle may further intensify profitable gain by directly raising sales
rates.
Corporate profitability could potentially also face a deduction in the Cash Conversion Cycle, if
the cost for greater investments in working capital rises more rapidly than the benefits of holding
more inventories and granting more trade credit to customers. The Cash Conversion Cycle is the

sum of days of sales outstanding (average collection period) and days of sales in inventory less
days of payables outstanding. Cash conversion cycle is likely to be negative as well as positive.
A positive result indicates the number of days a company must borrow or tie up capital while
awaiting payment from a customer. A negative result indicates the number of days a company has
received cash from sales before it must pay its suppliers (Gerald Epstein, 2003). Of course the
ultimate goal is having low CCC, if possible negative. Because the shorter the CCC, the more
efficient the company in managing its cash flow.

A financial benefit that is realized when the amount of revenue gained from a business activity
exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes
to the business's owners, who may or may not decide to spend it on the business.
Literature Review
Working capital management and net profitability:
(Rehman, 2003) Worked on effects of working capital management and conclude that increase of
cash conversion cycle will decrease the profitability of the firm so the comapny had a need to
decrease the period of cash conversion cycle to increase the profitability of the firm as possible.
(Elijelly, 2004) Explains that Working capital is a save way investment and provides the
guarantee of safety to invest for short term fund and elaborate that the capital is constraints
according to the financial performance.(Sanger, 2004) Determined that working management and
cash management shows the efficiency and profitability of the firm. Current ratio is most
important liquidity measure that effect profitability. Various the level of liquidity measure by
current ratio.(Sana, 2006) Suggusted that if managers can manage, working capital for
shareholders it can be the reason of positive returns for the companies. in emerging countries like
Pakistan, financial and capital markeets developing the intrest towards importance of capital
management.
(Padachi, 2006) Shed lite on working capital management, and elaburate that rate of internal cash
generation can be changed over time as working capital. he work on paper printing industry and
found that printing industry has been able to acheive effective progress working capital and
profitability of the industry.(Saad, 2010) highlites the importance of managing working capital to
contribute in concepts of firm market value and profitability and its impacts on company
strategies in order to operate efficently and in effective way. he found negative relationship
among working capital and market value of the firm profitability. (Martnez Solano, 2010)
explains that Working capital management is an important tool which effects the firms
profitability and risk, and market value as well. And working capital management is considered as
an important verification rule in small and medium size firms.(Bhaskar Bagchi1, 2012) discussed
that firms assets and liabilities should maintain a good harmony.Hetakes operating profit and
total assets as model for Indian FMCG firms, and concludes that working capital and profitability
are indirectly associated.

(Afza, 2010)elaborate that Current assets as a percentage of total assets with low levels of a firm
to adopt an aggressive working capital management policy, or even a high level of current
liabilities as a percentage of what can be the firm's financing decision is the responsibility
used.(Imran Omer Chhapra, 2010) worked in the field of textile capital of Pakistan and tried to
find the relationship between management and the profitability of the firm. Company's financial
management plays an important role in the decisions. "An excellent firm value and its positive
contribution are expected to generate increased profits. Working capital, value of fixed assets cost
of production, cost of debt, firm as a control variable effect on the profit and the size of the probe
are the variables that indicates the company financial profile."
(Ajilore, 2009)communicate that theaveragecollectionperiod ofthenetworkoperating
profitandasignificantnegativerelationshipbetweeninventorybusiness days. In addition, theworking
capitalmanagementbetweenlarge and smallfirmsvariationsfoundno significanteffects.(Melita
stephanou charitou, 2010)mentioned that recentglobal financialcrisison the forefront
ofresearchinstitutionshasusedresourceseffectively. Better use ofresourcesleads tovaluecreation.
Financialanalysts andbankersasexecutivesand keystakeholdersmust beveryimportant.
Effectiveitsuse ofresourcesleads toincreasedprofitsandvolatility, whichleads toa
reduction,reducestheDefaultriskand thusthe value ofthe companyis good.
Working capital Management; Average collection period and Net operating
profitability
(Gill, 2010)tried to optimize a policy that leads to profits maximization. He studied optimal study
when others were studying accounts receivable management. Also explore that slow recovery of
accounts receivable had direct relation with lower profits. And suggest that manager can reduce
credit period to its customers to maximize the profits. (Leland, 2004) believes that" working
capital of the organization is had positive significant impact on the profitabilities of studied
Belgiem's companies". To prove his logic he used corelation and regression on the data and it also
indicates the positive impacts among the veriables that are market size, sales growth, inventry,
ratio of financial debts and control veriables.
(Dr Ioannis Lazaridis, 2004)investigates the relationship between working capital management
and corporate profitability. Also investigates the relation between ASE companies and profit
figures in the cash conversion cycle. Findings of the study were statically significant among
above said variables. (Vida Mojtahedzadeh, 2011) check out the relations between the variables,
such as: negative relation among accounts payable's number of days and cash conversion cycle,
positive relation between sales and profits and relation between profitability and financial debt is
negative.
Working capital Management; Cash conversion Cycle and Net operating profitability
(Sharma, 2008)Studied in Indian Perspective and find out the relation between cash conversion
cycle and profitability. Author measured the profitability with return on assets with mediating
effect of current ratio, firm size, leverages and sales growth. and suggust that if the company

made policy of shorter time inventry, the company will earns more profits because the more
turnover can estabilished. (James Ghthrie, 2004) Examine relationships among profitability, cash
and current liquidity ratios in perspective of Saudi Arabia and studied the stock exchange of Saudi
Arabia to find the data to analyse.And said that "I have empirically examined the relationship
between profitability and liquidity, the current ratio and cash as joint stock companies in Saudi
Arabia". Difference between CCC (Cash Conversion Cycle) and cash dividend are strongly
effects the current ratio and firm size directly affecting the firms profit.
(Uyar, 2009) assessed dynamic aspects of two diffrent approaches based on strong side and
relates the working capital ratio and liquidity ratio with traditional ratio in context of corporate
liquidity. Firm size is an important factor in direction of CCC days. (Raza, 2012) Relate the
future expansion in business with reserved cash funds that effectively organized. If the company
wants to grow, should decrease in days of CCC. (NAIMULBARI, 2012) conclude that all
components of working capital had a significant effect on the profitability of pharmaceuitcal
companies in Bangladesh.
Working capital Management; Current ratio and Net operating profitability
(Appuhami, 2008), (Eljelly, 2004) Demonstrate that diffrence between CCC or cash dividend
effects the crunt ratio and measure of liquidity is most important to develop the plans relevent to
profitability of the company, firm size is positively related to the industry profits. (Soekhoe, 2012)
Investigates the Dutch listed companies and check out the impact of working capital management
on profitability. working capital management, performance, utilization and overall performance
was concidered as performance measuring tool for working capital rather than ratios.(Maji, 2003),
(Owolabi, 2009) worked on financial investigation strategy, working capital management and
firm's financial strategy. There is negative co-relation between the profitability and current ratio
which means that if the company reduces its current ratio ultimately the company shall increase
the profits.
Data collection
The results will be collected on the basis of information collected from all of the sources and
analyzed in order to obtain a final interpretation. In this data collection, an annual report tool was
chosen to collect data under every variable. There are data collection tools for secondary
organization, management, and finance research that are widely usedto acquiresecondary data. An
organization describes a population by providing a quantitative description a certain division of
the population, through the data analyses process of annual report of organization this enables a
researcher to generalize the findings from a sample of responses to a population. Adding together,
data collected with the help of annual report of organization useful for data analyses.

Pool unit root test: Summary
Date: 05/27/14 Time: 15:00

Sample: 2009 2013
Series: AVC_C1, AVC_C2, AVC_C3, AVC_C4, AVC_C5
Exogenous variables: Individual effects
Automatic selection of maximum lags
Automatic selection of lags based on SIC: 0
Newey-West bandwidth selection using Bartlett kernel
Balanced observations for each test

Cross-
Method Statistic Prob.** sections Obs
Null: Unit root (assumes common unit root process)
Levin, Lin & Chu t* -1.62846 0.0517 5 20
Breitung t-stat -1.08407 0.1392 5 15

Null: Unit root (assumes individual unit root process)
Im, Pesaran and Shin W-stat -0.19254 0.4237 5 20
ADF - Fisher Chi-square 8.94314 0.5375 5 20
PP - Fisher Chi-square 7.65226 0.6628 5 20

Null: No unit root (assumes common unit root process)
Hadri Z-stat 1.32408 0.0927 5 25

** Probabilities for Fisher tests are computed using an asympotic Chi
-square distribution. All other tests assume asymptotic normality.

Pool unit root test table is showing the stationary among average collection period and all related
variables data is computed for five years and results shows that there is no relationship between
average collection period and related variables because the approximate "p value=0.09" which is
greater than 0.05 which indicates no relationship between the variables. However, it can be said
that change in average collection period cannot effect on other said variables. Hence, H
o
is
accepted which indicates that there is no relation between the variables. Pearson test value
showing the negative sign which indicates that change in average collection period cannot affect
the relevant said impacts.

Date: 05/27/14 Time: 15:01
Sample: 2009 2013
Series: CCC_C1, CCC_C2, CCC_C3, CCC_C4, CCC_C5

Cross-
Levin, Lin & Chu t* -4.00533 0.0000 5 20
Breitung t-stat 0.03879 0.5155 5 15


Hadri Z-stat 5.00000 0.0000 5 25


Pool unit root test table is showing the stationary among cash conversion cycle and all related
variables data is computed for five years and results shows that there is relationship between cash
conversion cycle and related variables because "p value=0.0000" which is less than 0.05 which
indicates relationship between the variables. However, it can be said that change in cash
conversion cycle can effect on all variables and vise versa. Hence, H
1
is accepted which indicates
that there is relation between the variables. Pearson test value showing the negative sign which
indicates that change in cash conversion cycle can affect the relevant said variables.

Date: 05/27/14 Time: 15:01
Sample: 2009 2013
Series: CR_C1, CR_C2, CR_C3, CR_C4, CR_C5

Cross-
Levin, Lin & Chu t* -26.3140 0.0000 5 20
Breitung t-stat 0.70333 0.7591 5 15


Hadri Z-stat 2.70302 0.0034 5 25


Pool unit root test table is showing the stationary among current ratio and all related variables
data is computed for five years and results shows that there is relationship between current ratio
and related variables because "p value=0.0034" which is less than 0.05 which indicates positive
relationship between the variables. However, it can be said that change in current ratio can effect
on all variables and vise versa. Hence, H
1
is accepted which indicates that there is relation
between the variables. Pearson test value showing the positive sign which indicates that change in
current ratio can affect the relevant said variables positively or negatively.

Date: 05/27/14 Time: 15:02
Sample: 2009 2013
Series: NP_C1, NP_C2, NP_C3, NP_C4, NP_C5

Cross-
Levin, Lin & Chu t* -1.25098 0.1055 5 20
Breitung t-stat -2.18857 0.0143 5 15


Hadri Z-stat 3.91340 0.0000 5 25


Pool unit root test table is showing the stationary among Net profit and all related variables data
is computed for five years and results shows that there is relationship between Net profit and
related variables because "p value=0.0000" which is less than 0.05 which indicates positive
relationship between the variables. However, it can be said that change in Net profit can effect on
all variables and vise versa. Hence, H
1
is accepted which indicates that there is relation between
the variables. Pearson test value showing the positive sign which indicates that change in Net
profit can affect the relevant said variables positively or negatively.

Date: 05/27/14 Time: 15:02
Sample: 2009 2013
Series: WCM_C1, WCM_C2, WCM_C3, WCM_C4, WCM_C5

Cross-
Levin, Lin & Chu t* -4.94472 0.0000 5 20
Breitung t-stat 0.92110 0.8215 5 15


Hadri Z-stat 1.64872 0.0496 5 25


Pool unit root test table is showing the stationary among working capital
management and all related variables data is computed for five years and results
shows that there is relationship between working capital management and related
variables because "p value=0.00496" which is less than 0.05 which indicates
positive relationship between the variables. However, it can be said that change in
working capital management can effect on all variables and vise versa. Hence, H
1
is
accepted which indicates that there is relation between the variables. Pearson test
value showing the positive sign which indicates that change in working capital
management can affect the relevant said variables positively or negatively.

Dependent Variable: AVC?
Method: Pooled Least Squares
Date: 05/27/14 Time: 15:03
Sample: 2009 2013
Included observations: 5
Cross-sections included: 5
Total pool (balanced) observations: 25

Variable Coefficient Std. Error t-Statistic Prob.

C 0.627503 0.135428 4.633464 0.0001
WCM? 9.08E-12 8.30E-11 0.109356 0.9139

R-squared 0.000520 Mean dependent var 0.621529
Adjusted R-squared -0.042936 S.D. dependent var 0.606732
S.E. of regression 0.619620 Akaike info criterion 1.957199
Sum squared resid 8.830376 Schwarz criterion 2.054709
Log likelihood -22.46499 F-statistic 0.011959
Durbin-Watson stat 1.265397 Prob(F-statistic) 0.913869

Regression analysis is computed to predict casual link between combinations of dependent
variable average collection period (AVC) with working capital management (WCM). Above table
leads that P=0.0001<0.05 and F= 0.913869 so the "P" value is indicating that there is strong
relationship between the AVC and WCM; change in AVC can change the WMC and vise versa.
Adjusted R-square value = -0.042936, which mean approximately -4% of variance is explained
according to average collection period.

Dependent Variable: CCC?
Date: 05/27/14 Time: 15:03
Sample: 2009 2013


C -60952.38 1046987. -0.058217 0.9541
WCM? 0.001824 0.000642 2.842059 0.0092

R-squared 0.259910 Mean dependent var -1261117.
Adjusted R-squared 0.227732 S.D. dependent var 5450964.
S.E. of regression 4790241. Akaike info criterion 33.67868
Sum squared resid 5.28E+14 Schwarz criterion 33.77619

variable cash conversion cycle (CCC) with working capital management (WCM). Above table
leads that P=0.9541>05 and F= 0.009231 so the "P" value is indicating that there is no
relationship between the CCC and WCM; change in CCC cannot change the WMC and vise
versa. Adjusted R-square value = 0.227732, which mean approximately 23% of variance is
explained according to CCC.

Dependent Variable: CR?
Date: 05/27/14 Time: 15:04
Sample: 2009 2013


C 1.270340 0.121294 10.47326 0.0000
WCM? 1.74E-10 7.44E-11 2.344167 0.0281

Adjusted R-squared 0.157751 S.D. dependent var 0.604691

variable current ratio (CR) with working capital management (WCM). Above table leads that
P=0.0000<05 and F= 0.028075 so the "P" value is indicating that there is a good relationship
between the CR and WCM; change in CR can change the WMC and vise versa. Adjusted R-
square value = 0.157751, which mean approximately 16% of variance is explained according to
CR.

Dependent Variable: NP?
Date: 05/27/14 Time: 15:05
Sample: 2009 2013


C 4.344912 3.759116 1.155833 0.2607
AVC? 3.029773 2.697357 1.123238 0.2740
CCC? 1.23E-07 3.06E-07 0.402659 0.6913
CR? 2.590869 2.586985 1.001501 0.3280

Adjusted R-squared -0.029148 S.D. dependent var 7.383714

Regression analysis is computed to predict casual link between combination of variable net profit
for current ratio (CR), average collection period (AVC), cash conversion cycle (CCC) and current
ratio (CR) with working capital management (WCM). Above table leads that P=0.2607>05 and
F= 0.521832 so the "P" value is indicating that there is no relationship between the CR, AVC,
CCC and WCM. Adjusted R-square value = -0.029148, which mean approximately -02% of
variance is explained.
Discussion & conclusion:
After evaluating the whole cement sector of Pakistan it is concluded that WCM is greatly
affecting the productivity, efficiency and profitability of cement sector. InPakistan, cement sector
is considered the important investment sector, which greatly pushes gross domestic product
(GDP) and nationalincome (NI) of the country.
Therefore, to study such an important sector these(working capital, average collection period,
cash conversion cycle and current ratio)variables helped in evaluating the relationship of
efficiency level of WCM and profitability of cement companies and its impact on performance of
cement sector in Pakistan.

The hypotheses used in conducting this research show the positive impact on profitability (net
profit) of the cement sector in Pakistan. Therefore, it can be concluded that all variables shows
that positive relationship between the variables.
In view of the concluding remarks, it is suggested that particular norms for WCM should be
followed to reduce the market risk and liquidity management activities may be more organized
through using idle funds for productive investments.
Furthermore, financial information system should be introduced to develop financial discipline in
WCM and financial forecasting: planning and control devices are to be more intensive to enhance
the efficiency of cash management. Along with this, inter-firm comparison should be made from
time to time with similar organization, and horizontal and vertical analysis through ratio
techniques would be more meaningful for effective management of wcm and other control
variables. However, more researches need to be concluded on this topic in Pakistan to establish
better understanding of the relationship between profitability and WCM in different sector of
Pakistan in future.

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