Essay on the Effect Of Working Capital Management On Profitability
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To maintain efficient levels of components of
working capital, current liabilities and current assets is a strategy of
managerial level accounting with respect to each other. The management of
working capital will see that the company meets the minimum cash flow
requirement with respect to short-term debt and operating expenses.
The modification of useful working capital
management system is a profitable way for many firms to increase their retained
earnings. The two important course of working capital management are ratio
analysis and individual management options of working capital.
There are few applicable ratios which are
working capital ratio, inventory turnover and the collection ratio of working
capital management. Ratio analysis would train management to identify key areas
such as inventory management, cash management, account receivable and payable
management.
In past working capital was the money to making
goods and make attractive sales. The minimum working capital was about to
attract sales, the maximum was about on return on investment. Inventories
commercial and financial aspects, credit purchasing, marketing and royalty
investment policy are come under working capital management. There is a inverse
relationship of working capital engagement in creating and selling titles from
high to low. It depends on the level of efficiency if we speed-up the manufacturing
and selling of books then we will get higher return on investment. Whenever we
use phrase “investment” on the chapter on pricing, it meant to be working
capital.
Disclaimer
It is a financial metric which discuss about
operating liquidity, organization or different entity which already include
government entity. In operating capital fixed assets, plant and equipment are
also considered. By subtracting current assets from current liabilities we well
get net working capital. The discounted cash flow is also a valuation technique
which is used to derived working capital. In case your current assets are below
your current liabilities this is known as capital deficiency also called
working capital deficit.
Effect of working capital management on
Profitability of Japan:
The cash conversion cycle is a reliable tool to
gauge how well a corporation is handling its working capital. A short
conversion cycle other way around is engaged with firms value.
The short cash conversion cycle is the indicator
for the firm in collecting the receivables as early while delaying the amount
of supplier as late. There is co-relation between high net present value of
cash flow and high firm value. The definition of cash conversion cycle can be
varies. It is a composite metric elaborating the average days consist of
turning a dollar investment in raw materials intro a dollar received from
customer. It is also duration of time from the purchase of payment of raw
materials to develop a product until the collection of account receivable
related with the product sale.
There is an association between the shorter cash
conversion cycle and high profitability because it enhances the usage of
working capital. However the cash conversion cycle is an important measure to
gauge the performance of working capital management. There a little knows how
about the effect of cash conversion cycle on company profit ratio. The
important point for the insufficiency of this study because there are small no
of cash conversion cycle studies. The unawareness of managers is the important
reason to cash conversion cycle has been studied.
The research on shortening cash conversion
cycle, receivable collection period and the inventory conversion period in
Japan shows that managers can enhance the profit of the firms by using that
method. The outcomes gave the idea to managers to increase their profit by
increase the length of the payable deferral period. It should also taken into
account when lengthen the payable deferral period because it can harm the
credit reputation and sales in the long-run cycle.
The Japanese organizations show the relation
between the firms profit and cash conversion efficiency. It is also examine the
relation between the factors that create the cash conversion cycle and its
profit. Those factors include receivable collection period, inventory
conversion period and payable deferral period. This study could support in
gathering the efficiency of the Japanese corporations in arranging and managing
their account receivables, inventory and payables.
Return on investment differs throughout the year
of the research which shows Japanese companies in comparison have shorter cash
conversion cycle with European and American corporations on the other hand. This
study also shows that Japanese firms could be highly efficient when it comes to
managing working capital than from European or American firms. The high
profitability and better cash flow position is for those firms who wait longer
to pay their existing bills. It can also be a situation in the short-run cycle.
If the organization carries to slowdown its process of payments and increase
the time of payable deferral period there would be worse case scenario in its
reputation credibility in the long-run process. In Japan a research shows that
by shortening cash conversion, the receivable collection period and the
inventory conversion cycle a firm can easily make profit. The outcomes also
give the idea to the managers to increase the profitability by increase the
cycle of payable deferral period. Although, It is also taken into account that
by increasing the payable deferral period can minimize the reputation and
earning in the long-run.
Effect of working capital management on
Profitability of Athens:
A research of working capital management shows
that there is relationship of statistical significance with firms profit
earnings ratio gauge by gross earning profit and the cash conversion cycle. It
is also notified that managers can make profits by managing the cash conversion
cycle accurately and keep every single component to optimize it.
The two main areas which are widely revisited by
academia to differentiate the firms profit are capital structure and working
capital management. There are no of ways to approach working capital
management. Different researchers defined the consequences of optimum level of
inventory management on the other hand different researchers defined the
optimum way to manage account receivables which will expand the profit. It is
very much important that how the working capital organized has a greater impact
on firm’s profitability. Other focus of working capital management is on daily
employed by organization. In this case, the focus of cash management by the
firms is high, with little cash sales, high seasonality and greater no of cash
flow inaccuracy and problems. The stock management is focused by smaller firms
and credit management routines are focused by low profit gaining firms. It is
advisable that the firms which have higher growth rate should approach more
accurate and lucrative policy towards their stock holders, and also knot more
capital in the inventory form. Meanwhile the better relation witch supplier
would definitely increase the accounts payable of financial institutions which
would divert benefits to clients of their financial cost. There would be a
strong relationship between the cash conversion cycle and profitability of
one’s firm. There are 3 different factors of cash conversion cycle which are
accounts receivable, inventory and accounts payable which can be organized in
different ways in order to expand the profit or increase the growing ratio of
company. Trade credit also tends to use to attract consumers. There are lots of
firms who are ready to change standardize credit terms to attract new customers
and to get large no of orders. By adding it can stimulate credit sales because
it allows customers to judge quality of product before paying an amount. Now
it’s a decision of the ones company whether or not a marketing approaching
behavior would lead while organizing working capital via credit extension.
Although the department of financial handling of those companies could bear
cash flow and liquidity issues because capital investment are in customers and
inventory management are parallel with each other. To gain maximum reputation
the maintenance in receivables-payables and inventory should be there. Credit
management determines to make, maintain and organize account receivable at par
quality.
It is important to students to learn the chapters:
ACCG 399 Accounting in contex
FIN 111 Introductory Principles of finance
It is important to students to learn the chapters:
ACCG 399 Accounting in contex
FIN 111 Introductory Principles of finance
The appropriate investment in account receivable
is a day to day practice of mostly large firms. For corporate value the key
implications are credit management policy options and practice. Resources of
efficient and effective management will leads towards the corporate gain, the
best description of working capital management defined by cash conversion cycle
which is need to develop a link between how to manage the cash conversion cycle
and profit ratio. This easy equation phrases those three important key points
of working capital management. It is indicator of how long a firm can keep if
there was a need to stop its operation or to show the distance of the gap of
time between the goods purchase and sales collection. The balance level of units
would have a straight forward effect on firm’s profit since it would leave
resources of working capital which turned to be the investment for the business
cycle or in order to give higher product demand level of inventory will
increase. Same in the case of supplier’s credit policy and their granted credit
period will have an impact on customer’s profitability. To analyze numerous
ways of how working capital managed cash conversion cycle and their factors.
Effect of working capital management on Profitability
of US:
A research found that American manufacturing
companies tagged on the New York stock exchange because there is relationship
between the working capital management and profitability of firms. The
profitability of the firms is a directly affected because working capital
management is a core factor of corporate financial management. The reference of
current assets and current liabilities is the management of working capital.
There are numerous to approach working capital by researchers. On the other
hand some researchers study the consequences of well versed or optimal
inventory management. Others show the account receivables management trying to
incorporate balanced policy that leads to maximum profit. The profit and growth
of the firms has an significant impact on how the working capital has been
managed, there are certain indicators which shows the appropriate level of
required working capital, which has a potential to expand profit returns. Firms
can have a balanced level of working capital that increases the growing value.
High sales can create and maintain by large inventory and generous trade
policy. It is also minimize the risk of stock-out. There is a direct
relationship between the trade credit and sales as sales increases trade will
also increase it is also allowed the accessibility of product quality without
paying in advance. Account payable is another component of working capital.
Flexible and inexpensive source of financing can be achieved by delaying
accounts payable payments to suppliers. On the contrary it can be expensive on
the other way around. From the same token it could create cash inflow hurdle
for the firm by the uncollected account receivables. A famous scale of working
capital management is the conversion of cash cycle, that is, the estimated time
between the expenses from the raw material purchases and the collection of the
sales of finished goods. Researcher found that there is high interdependency of
investment in working capital and lag of a time. Although corporate profit can
be minimize with the cash conversion cycle, if the cost of higher investment in
working capital structure increases it would lead towards the opportunities of
carrying higher inventories or allowing more trade credit to consumers.
Current assets account for many manufacturing
corporations for above half of their total assets. There are positive and
negative impacts of working capital on firms profit ratio, which can create
negative and positive consequences on stockholders equity. Those effects would
be thoroughly explored by the seeking behavior of present study.
2. Literature Review
Working capital management is also stated as
‘management of owners equity which current assets and current liabilities’ and
how to finance those current assets. It is very much important for developing
value for stakeholders. Different countries has studied that there is a
significant impact on profitability and liquidity by working capital
management.
A research developed a trade credit model shows
that the unbalance information leads top class firms to verify the quality of
product by extending its trade credit. It is defined as credit policy in which
average time receivables are outstanding and gauge this variability by
analyzing each and every firm day of sales outstanding, according to the daily
sales of account receivable/dollar. To minimize variability, they took an
average DSO and all other gauge material greater than three years. It is
founded consistent evidence along with the model. It is also very much advisable
that production firms may enhance the inner cost of extending trade credit via
financing their receivables by payable and short-term period borrowing within
cash collection and withdrawing. It is tending to analyze by taken an estimate
of inventory conversion period and receivable conversion period minus the
payable conversion period. Shin and Soenen in this study used net trade cycle
for measuring management of working capital. It is equal to the cash conversion
cycle where all the three factors are defined as a sales percentage. It can be
a proxy for extra working capital which acts as a projected sales growth. They
get the output of this relationship by using regression and correlation on SPSS
through industry and the intense working capital. There is negative
relationship between the approximate time of the net trade cycle and its
profitability by applying COMPUSTAT sample of 58,985 corporations covering the
period 1975-1994. Based on previous results, there is one possible way to
create stakeholders value is to minimize firms NTC. To examine the relationship
of working capital management and corporate profitability, A researcher Deloof
taken a sample of 1,009 big Belgian non-financing firms for a tenure of
1992-1996. It is founded that there is negative relationship between the no of
days account receivable, accounts payable, inventories and gross operating
income by applying correlation and simple linear regression test of Belgian
firms. Research based findings suggest that managers can maximize corporate
profitability by minimizing inventories and no of days in account receivables.
In 1992 - 93 to 2001 – 2002 Gosh and Maji suggest the working capital
management efficiency of Indian cement industries. By the study performance
index, utilization index, and overall efficiency index are calculated output
level of working capital management by rejecting those common practices of
working capital ratios. By applying regression analysis test it is defined as
the industry ethics is an individual firms efficiency level. Ghosh and Maji
Analyze the speed of http://astonjournals.com/bej
Business and Economics Journal, Volume 2010:
BEJ-10 individual firm’s achieved that threshold output level it is also taken
into account that many firms successfully enhance efficiency between these no
of years. Eljelly taken a sample of 929 joint stock corporations and found the
relationship between the profitability and liquidity measuring by current ratio
and cash gap. The firms which have high current ratio and longer cash
conversion cycle those firms have stronger relationship with each other. As far
as the industry level is concerned, researcher examined that cash conversion
cycle or the cash gap is highly important by measuring liquidity than current
ratio which usually affects the profitability.
There is significance impact on profitability at
industrial level by the firm size variable.
A cross sectional study was also conducted by
Lazaridis and Tryfonidis [1, p. 26] by taking a sample of 131 companies listed
on Athens stock Exchange between the period of 2001-2004 and derived the result
which shows statistical significance relation between profitability, measuring
by gross operating profit and the conversion of cash cycle and its factors
(accounts receivables, accounts payables, and inventory). It suggested that
managers can make profit by applying correlation and regression analysis test
which shows maintaining the cash conversion cycle and having key factors of
conversion cycle (accountsOrganisational Behaviour Principles
Receivables, accounts payables, and inventory)
at an equilibrium level. It has been studied by Raheman and Nasr [2, p. 279]
which shows the action of different variables of working capital management
which include ACP, inventory turnover in days, average period of payment and
conversion of cash cycle, and net operating profit of Pakistani firms based on
current ratio. After choosing the sample of 94 Pakistani firms tagged on
Karachi stock exchange from 1999-2004 and examined that there is strong and
negative relationship of firm profitability and working capital management.
When the cash conversion cycle goes upwards it force the profitability of the
firm goes downward and it suggested for the managers to create a value
positively for the stakeholders by minimizing the conversion of cash cycle to
the best possible level. From 1996-2002 Garcia-Teruel and Martinez-Solano [3,
p. 164] taken a panel of 8872 SME corporations from Spain. By using panel data
methodology it is examined effects of working capital management on small to
medium profitability ratio. This shows that output are more reliable to the
presence of endogenity which demonstrate that managers can make a valuable firm
by minimizing the level of inventories and no of days for which in the favor of
outstanding accounts. Also the firm’s profitability also increases the cash
conversion cycle. Falope and Ajilore [10, p. 73) from 1996-2005 they have taken
a sample of 50 Nigerian quoted non-financial corporations. The study utilizing
by pooled regression in panel data econometrics. Whereas the observations of
time series, cross sectional were together and estimated. There is negative
relationship between the net operating profitability and average collection
period, turnover of inventory in days and average payment period and cash
conversion cycle by having sample of non-quoted 50 non-financial Nigerian firms
tagged on the Nigerian stock exchange. Moreover, the management of working
capital between large and small firms found no significance variations with
each other. Mathuva [11, p. 1] taking the sample of 30 firms listed on Nairobi
stock exchange from the period 1993-2008 which accompanies the influential
perspective of working capital management factors on firm’s profitability
ratio.
To gathering the data researcher used the
Pearson and Spearman’s correlation which required pooled ordinary least square
and fixed affect regression model to conduct the data analysis. The key point
of the researcher study were 1) the process of collecting cash from customers
for the firms which shows that there is highly significant negative
relationship (accounts collection period) and profitability 2) there is a
significantly positive relationship to change inventories into sales
(Conversion period of inventory) profitability 3) it is also shows the strong
relationship in which firm takes the time period to pay their creditors(
average period of payment) and profitability ratio.
By summarizing it, the literature review has a
great indication stated that working capital management has a significant
impact on the firm profitability but still there are some vague arguments about
the significant variables which may provide services as proxies for the
management of working capital. One of the recent studies also determine the
relationship of those variables with the profitability for the American
manufacturing corporations. Below the table 1 describes theoretical forecasted
signs and definitions. Note that previous study didn’t facilitate any straight
signs about the relationship of any variables with company profitability.
Effect of working capital management on
Profitability of Vietnam:
2. Literature Review
Lots of past research material highlighted the
different environments which indicate the significant relationship between
firms profitability with working capital management. Shin and Soenen (1998)
taken a random sample of 58,985 between the periods of 1975-1994 to find out
the relationship of net trade cycle which was taken to measure the sufficient
amount of output of working capital management and firm’s profitability. In all
past scenarios it is stated that there is a strong and negative relation
between the lengths of the company net trade cycle with its profitability.
Deloof(2003) taken a sample 1009 large Belgian non-financial corporation’s for
the period of 1992-1996 which shows there is a relationship of corporate
profitability with working capital management. The running outcomes stated that
there was negativity between profitability which was measuring through a gross
operating income and conversion of cash cycle also stated the no of days in
account receivables and in inventories. Small profitability corporations wait
much longer to pay their dues and bills.
Sings and Pandey(2008) from 1990 to 2007 studied
the working capital factors and the consequences of working capital management
on the profitability cycle of Hindalco Industries limited. Outcomes of the
study found that liquidity ratio, current ratio, receivable turnover ratio and
working capital to overall assets had a significant level of impact on the
Hindalco industries limited profitability cycle.
Lazaridis and Tryfonidis (2006) taken a sample
of 131 listed corporations between the period of 2001-2004 in the Athens stock
exchange which stated the relationship between the firms profitability and
working capital management. After running the test of regression analysis it
incorporated that there was a statistical significance between the firm
profitability measurements by using annual operating profit and conversion of
cash cycle. Those outcomes show that managers can develop unique value for
stakeholders by managing accurately the conversion of cash cycle and holding
every component to an advanced level.
It has been studied by Raheman and Nasr(2007)
which shows the action of different variables of working capital management on
the net operating profitability which include ACP, inventory turnover in days,
average period of payment and conversion of cash cycle, and net operating
profit of Pakistani firms based on current ratio. After choosing the sample of
94 Pakistani firms tagged on Karachi stock exchange between 1999-2004 and
examined that there is strong and negative relationship of firm profitability
and working capital management. By using natural algorithm of sales which
indicate firms size had straight and positive relationship with each other.
Afza and Nazir (2009) conducted an study by
taking the sample of 204 non-financial Corporations listed on KSE 100 index
between the year of 1998-2005 which showed the working capital management
relationship with the company’s profitability. This study stated that different
industries had a significant level of difference in terms of their financing
policies and requirement of working capital. The regression test found that
there is negative relationship of firm’s profitability and level of
assertiveness of financing terms and investment of working capital. Research
also suggest that the firms value could be increase but if the managers use the
approach to financing terms of working capital and working capital investment.
Effect of working capital management on
Profitability of India:
Conclusion
There is both positive and negative association
disclosed by profitability of the firm and working capital management. CTSR, WTR
and DTR are those ratios which has been selected for the research from the nine
ratios which attempted the correlation negatively with opted profitability
ratio, ROI. The RIO equation slope shows that positive and negative influential
variations and those independent variable which has a vital role in the
profitability of the firm. The coefficient of the ROI line is the only
regression test out of 5 regression analysis which has an association with DTR
shows negative influence on the firm’s profitability index. It makes rule of
thumb that 68.50 percent of the overall variation of the coefficient of
multiple determination (R2) in the favor of firms profitability. It is
concluded by WCL that the growth of firms profitability was not greater than
the proportion to minimize it in working capital.
Following are the useful links:Working capital cycle
Working capital - its importance
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