The Impact of Inventory and Receivable Management on

Profitability of Selected Paper and Board Companies in Pakistan

Introduction
Working Capital (WC) is the flow of ready funds necessary for the working of a concern.
Working Capital Management is the administration of current assets and current liabilities. It
deals with the management of current assets and current liabilities, directly affects the
liquidity and profitability of the company (Deloof, 2003; Eljelly, 2004; Raheman and Nasri,
2007; Appuhami, 2008; Christopher and Kamalavalli, 2009; Dash and Ravipati, 2009).
Working capital management is the important function of financial management. The
financial manager must determine the satisfactory level of working capital funds and also
optimum mix of current assets and current liabilities. He must ensure that the appropriate
sources of funds are used to finance working capital and should also see that short term
obligation of the business are met well in time. After cash the inventory and receivables are
current assets which need proper management.
Inventory management involves the control of the assets that are produced to be sold
in the normal course of the firms operations. The general categories of inventory include raw
materials inventory, work-in-process inventory, and finished-goods inventory. The
importance of inventory management to the firm depends on the extent of its inventory
investment. The importance of effective inventory management is directly related to the size
of the investment in inventory. The effective management of these assets is essential to the
goal of maximizing shareholder wealth. To control the investment in inventory, managers
must solve two problems: the order quantity problem and the order point problem.
Accounts receivables represent money owed by entities to the firm on the sale of
products or services on credit. All firms by their very nature are involved in selling either
goods or services. Although some of these sales will be for cash, a large portion will involve
credit. Whenever a sale is made on credit, it increases the firms accounts receivable. Thus,
the importance of how a firm manages its accounts receivable depends on the degree to
which the firm sells on credit.

Receivables is one of the three primary components of working capital, the other two being
inventory and cash. Receivables occupy second important place after inventories and thereby
constitute a substantial portion of current assets in several firms. The capital invested in
receivables is almost of the same as that of the investment made in cash and inventories.
Accounts receivable typically comprise more than 25 percent of a firms assets. So the
management of accounts receivable means the management of one-quarter of the firms
assets. The cash flows from a sale cannot be invested until the account is collected, the
control of receivables takes on added importance in that it affects both the profitability and
liquidity of the firm. Effective management of receivables facilitates to increase the size of
the business activities by increasing total sales consequently increasing recycling of funds
and generating higher profitability.

Problem Statement
Most of the times it is noticed that firms does not hold the right amount of stocks, debtors and
cash. Due to this reason the firm is unable to meet its maturing short term obligations and its
upcoming operational needs. Lack of adequate working capital also means that a firm is
unable to undertake expansion projects and increase its sales, therefore limiting the growth
and profitability of the business. Proper management of inventory and receivables leads to the
increase profitability.

Research Question
1. Does Inventory control have an impact on firms profitability?
2. What impact Inventory management has on profitability of the paper and board sector
of Pakistan?
3. What impact receivable management has on profitability of the paper and board sector
of Pakistan?

Objective of the research

The objective of this study is as follow:
1. Examining how Inventory control effect profitability of an organization.
2. To study how Inventories and receivables are managed in paper and board sector.
3. To analyze the impact of Inventory management on profitability.
4. To analyze the impact of receivable management on profitability.

Significance of the study

There are many studies which are focusing on the impact of working capital management on
firm profitability. However, one can hardly find the study on combination with the impact of
inventory and receivable management on profitability. This study takes importance to
manage the inventory and receivable management practices for improving profitability of the
paper and board industry of Pakistan. The results will display the impact of inventory and
receivable management on profitability.

Limitation of the study

The limitations of this study are as follow:
1. The analysis of this study is mainly based on secondary data.
2. The study covers for 10 years from 2004- 05 to 2013 14.

Literature review
Management of inventories and receivables was found to have a significant impact on
profitability in studies from different countries.

Sinha .KP, Sinha.AK and Singh. SC (1988) in their study on the analysis of working capital
management in Fertilizer Corporation of India with reference to Gujarat State Fertilizer
Corporation revealed that a huge portion of funds was tied up in the form of working capital,
especially in inventories and receivables. The study revealed ineffective management of
working capital as the prime cause for erosion in profits. It found that the management of
receivables particularly was highly unplanned and ineffective, which resulted in unpredicted
cash inflows and huge amount of bad debts. The study strongly recommended urgent action
to avoid further deterioration.

Suk. H, Kim.SH and Rowland have conducted a survey among 94 Japanese companies
in USA (1992) found that they differed in working capital management practices from the US
companies in terms of lower levels of inventory and higher levels of accounts receivables.
The study revealed that the US firms piled-up their inventories; Japanese firms had higher
percentage of receivables to total assets.

Padachi. K (2006) examined the trends in working capital management and its impact on
firms performance. The results proved that a high investment in inventories and receivables
is associated with lower profitability. Further, he showed that inventory days and cash
conversion cycle had positive relation with profitability. On the other hand, account
receivables days and account payables days correlated negatively with profitability.

Deloof, M (2003) found a significant negative relation between gross operating income and
the number of days accounts receivables, inventories and accounts payables of Belgian firms.
These results suggested that managers can create value for their shareholders by reducing the
number of days accounts receivables and inventories to a reasonable minimum. The negative
relationship between accounts payable and profitability inconsistent with the view that less
profitable firms wait longer to pay their bills.

Ramachandran, A andJanakiraman, M (2009) analyzed the relationship between working

capital management efficiency and earnings before interest and tax of the paper industry in
India. The study revealed that cash conversion cycle and inventory days had negative
correlation with earnings before interest and tax. While accounts payable days and accounts
receivable days related positively with earnings before interest and tax.

Falope and Ajilore (2009) used a sample of 50 Nigerian quoted non financial firms for the
period 1996 2005. Their study utilized panel data econometrics in a pooled regression,
where time series and cross sectional observations were combined and estimated. They found
a significant negative relationship between net operating profit on one hand and the average
collection period (ACP) and average payment period (APP) on the other hand for a sample of
fifty Nigerian firms listed on the Nigerian Stock Exchange.

Mathuva (2009) examined the influence of receivables and payables management on

corporate profitability by using a sample of 30 firms listed on the Nairobi stock exchange
(NSE) for the periods 1993 to 2008. He used Pearson and Spearmans correlations, the
pooled ordinary least square (OLS), and the fixed effects regression models to conduct data
analysis. The key finding of his study was: there exist a highly significant negative
relationship between the ACP and Profitability.
N. Venkata ramana, K. Ramakrishnaiah and P. Chengalrayulu (2013) examined the
impact of Receivables Management on Working Capital and Profitability. To accomplish this
research objective data have been collected from the annual reports of select cement
companies for the period from2001 to 2010. The ratios which highlight the efficiency of
receivables management viz., Receivables to Current Assets Ratio, Receivables to Total
Assets Ratio, Receivables to Sales Ratio, Receivables Turnover Ratio, Average Collection
Period, Working Capital Ratio and Profitability Ratio, have been computed statistical tools
like ANOVA was also used to know the impact on working capital and profitability. Working
capital and profitability were considered as dependent variables. The investigation reveals
that the receivable management across cement industry is efficient and showing significant
impact on working capital and profitability.

Dr. Srinivas Madishetti and Mr. Deogratias Kibona (2013) determine the impact of
average collection period and average payment period on SMEs profitability In Tanzania.
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The study is carried out using dependent variable as gross operating profit and independent
variables as average collection period and average payment period employing relevant
information of 38 Tanzanian SMEs,s for the period from 2006 to 2011. This study employed
Regression analysis to determine the impact of average collection period and average
payment period on gross operating profit taking current ratio, size of the firm, financial debt
ratio as control variables. The results indicate that there is a significant negative relationship
between average collection period and profitability. Positive relationship is observed between
average payment period and gross operating profit. The relationship between two control
variables viz; current ratio, financial debt ratio and gross operating profit indicate the
expected negative relationship whereas the firm size indicate unexpected negative
relationship which may be due to gaps in managerial performance.

G. Sekeroglu, M. Altan (2014) investigated as comparatively that the effect of inventory

management on the profitability of Turkish firms which operated in weaving industry,
eatables industry, wholesale and retail industry in between 2003 2012 years. Research data
consist of profitability ratios and inventory turnovers ratio calculated by using balance sheets
and income statements of firms which operated in Borsa Istanbul (BIST). In this research, the
relationship between inventories and profitability is investigated by using SPSS-20 software
with regression and correlation analysis. The results achieved from three industry
departments which exist in study interpreted as comparatively. Accordingly, it is determined
that there is a positive relationship between inventory management and profitability in
eatables industry. However, it was founded that there is no relationship between inventory
management and profitability in weaving industry and wholesale and retail industry.

Theoretical framework
Independent variable

Dependent variable

Account receivable
turnover in Days
Average collection period

Inventory Turnover in Days

NET OPERATING
PROFIT

Inventory Conversion Ratio

Cash Conversion Cycle

Research hypothesis

H1: The number of days accounts receivable are outstanding has no significant impact on the
profitability of Pakistani Paper and Board companies.
H2: There is positive and significant relationship between average collection period and
ROE.
H3: The number of days inventory are held has no significant impact on the profitability of
Pakistani Paper and Board companies.
H4: The Inventory conversion ratio has positive impact on the profitability of Pakistani Paper
and Board companies.

Research Methodology

Population and sample

Population of this study is total listed companies of Paper and Board industry in Karachi
stock exchange.

Data collection

Secondary data will be collected through through financial statements and URL of Karachi
stock exchange.

Data analysis

In order to analyze data SPSS software will be used. Descriptive statistics will be used to
calculate mean and standard deviation. Regression analysis is conducted to find out if there is
an association/ Relation between Inventory and Receivable Management on Profitability.

Measures of Profitability: According to Eljelly (2004), profitability is the ability to create

an excess of revenue over expenses in order to attract and hold investment capital. Four
useful measures of firms profitability are: the rate of return on firms assets (ROA), the rate
of return on firms equity (ROE), operating profit margin and net firm income. The ROA
measures the return to all firms assets and is often used as an overall index of profitability,
and the higher the value, the more profitable the firm. ROA is therefore an indicator of
managerial efficiency as it shows how the firms management converted the institutions
assets under its control into earnings (Falope and Ajilore, 2009).
The ROE measures the rate of return on the owners equity employed in the firm (Pandey,
2005). ROE indicates how well the firm has used the resources of owners. The operating
profit margin measures the returns to capital per naira of gross firm revenue. It focuses on the
per unit produced component of earned profit and the asset turnover ratio. The net income
comes directly on the income statement and it is calculated by matching firm revenue with
expenses incurred to create revenue, plus the gain or loss on the sale of firm capital assets
(Gitman, 2006).
Net Operating Profitability (NOP) which is a measure of Profitability of the firm is used
as dependant variable.
Average Collection Period (ACP) used as proxy for the Collection Policy is an
independent variable.
Inventory turnover in days (ITID) used as proxy for the Inventory Policy is also an
independent variable.
The Cash Conversion Cycle (CCC) used as a comprehensive measure of working
capital management is another independent variable
VARIABLE MEASUREMENTS
The following below are the measures pertaining Inventory management and firms
profitability:
No. of Days Inventory = (average Inventory/Net Sales) x 365
Firm Size = Natural Logarithm of Sales
Financial Debt Ratio = Total Debt/Total Assets
Current Ratio = Current Assets/Current liabilities
GOP = Operating Profit / Total Assets

Number of Days Inventory are held

Number of Days Accounts Receivable is outstanding (DAR)

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