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Analysis of the Effect of Working Capital Management on Profitability of the

Firm: Evidence from Indian Steel Industry

Article  in  Asia-Pacific Journal of Management Research and Innovation · December 2018

DOI: 10.1177/2319510X18812142

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Article

Analysis of the Effect of Working Asia-Pacific Journal of Management

Research and Innovation

Capital Management on Profitability

14(1–2) 1–7
© 2018 Asia-Pacific
Institute of Management
of the Firm: Evidence from Indian SAGE Publications
sagepub.in/home.nav
Steel Industry DOI: 10.1177/2319510X18812142
http://journals.sagepub.com/home/abr

Pinku Paul1
Paroma Mitra2

Abstract
Working capital is one of the important measures of a firm’s efficiency and represents the total liquid assets available with a firm.
It reflects a firms’ ability to meet day-to-day operating expenses and also acts as an indicator of a firm’s short-term financial health.
So a firm has to plan the effective utilisation of its working capital in order to maintain equilibrium between liquidity and profitability of
the business. Therefore, the present article tries to examine the impact of working capital management on profitability of the firms of
Indian steel industry. The study has taken into consideration four independent variables, that is, Current ratio, Quick ratio, Debtors
turnover ratio and Finished goods turnover ratio which act as the indicators of working capital use in the industry. Return on total
assets represents the profitability of the industry and acts as a dependent variable to develop an empirical model in order to establish
relationship between working capital management and profitability of the steel industry in India by using panel data regression. The
period of study is 17 years, that is, 2000–2016. The result of the study indicates that the impact of working capital management on
profitability of the firms of Indian steel industry has been significant.

Keywords
Working capital, return on assets, multi-collinearity, Levin–Lin–Chiu test, panel data

Introduction
The financial management decision of a firm has four
aspects, which include investment decision, financing
decision, dividend decision and liquidity decision. The
working capital management is considered to be a vital
issue in liquidity and short-term investment decision of the
firm. It has an effect on liquidity as well as on profitability
of the firm. The value of the firm is being created by optimal
working capital management (Baghci & Khamrui, 2012).
The term working capital refers to the quantum of fund
required to maintain day-to-day expenditure on operational
activities of a business enterprise. It is actually required to
run the wheels of the business (Mandal & Goswami, 2010).
Working capital management objective is to maximise the
profits, which results into reducing the risk of not able to
satisfy the maturing short-term debt. The efficacy of working
capital management depends on the balance between
liquidity and profitability (Faulkender & Wang, 2006).
A firm’s high liquidity risk results in high profitability. The
issue here is in managing working capital, a firm must take
into consideration all the items in both accounts and try to
balance the risk and return.
Among all the industries of the country, iron ore and
steel industry is one of the basic industries which plays an
important role in strengthening the economy. India holds
third largest position in crude steel production in the world
(up from eighth in 2003) and India overtook Japan to
become the second-largest steel producer in the world
after China in 2016, according to the data released by the

1 Assistant Professor (Accounting and Finance), Management Development Institute Murshidabad, Sakim-Katnai, Kulori, Murshidabad, West Bengal,
India.
2 Assistant Professor (Economics), Management Development Institute Murshidabad, Sakim-Katnai, Kulori, Murshidabad, West Bengal, India.

Corresponding author:
Pinku Paul, Assistant Professor (Accounting and Finance), Management Development Institute Murshidabad, Sakim-Katnai, Kulori, Uttar Ramna, Raghunathganj,
Murshidabad 742235, West Bengal, India.
E-mail: pinkupaul@mdim.ac.in/pinku.paul@rediffmail.com
2 Asia-Pacific Journal of Management Research and Innovation 14(1–2)
International Stainless Steel Forum (ISSF). ISSF said at
their annual conference in Tokyo, Japan that India’s stain-
less steel production rose to 3.32 million tons for 2016,
showing an impressive growth of about 9 per cent over 3.0
million tons achieved in 2015.
The present study focuses on the management of working
capital and its relationship with profitability of the firms
in steel industry of India. We can, therefore, expect that
the way in which working capital is managed will have a
significant impact on the profitability of firms. Both ways,
whether it has a positive impact or a negative impact, it
affects the overall efficiency and profitability of firms
(The Hindu, May 22, 2017).
The study is being presented in six sections, the second
section relates to the literature review which contains
the literature regarding the working capital management on
profitability. The third section discusses the objective of
the study. The fourth section discusses the methodology
which describes the data source and the method applied for
the analysis and the empirical model justification with the
hypotheses of the study. The fifth section shows the results
which include the analysis and the inferences of the study.
The concluding observations are summed up in the sixth
section.
Literature Review
The significance of working capital management has been
a common opinion among researchers. It was observed
by Venkatraman and Ramanujana (1987) that business
economic performance is being measured by using sales
growth, net income growth and return on investment.
Raheman, Afza, Qayyum, and Bodla (2010) analysed the
working capital management practices and their impact on
corporate performance. They took a sample of 204 manu-
facturing firms of Karachi Stock Exchange for the period
1998–2007 and found cash conversion cycle, net trade
cycle and inventory turnover affecting the performance of
the firms significantly. It was analysed by Van Horne and
Wachowicz (2004) that excessive level of current assets
may have a negative impact on a firm’s profitability. Ghosh
(2007) analysed in his study working capital management
practice in four different industries: (a) National Fertilizer
Limited (b) Textile Industry (c) Cement Industry and
(d) Pharmaceutical industry; and included the objectives
like to control source and size of working capital with
a review made in 98 small-scale textile firms of Punjab.
The study concluded other than the own capital, bank loans
are the most projecting source of working capital among
most of the selected units.
It was examined by Bose (2013) that the working capital
management impacts on firms’ profitability. It was found
in the study that in the electric equipment sector source of
the working capital management components widely vary.
Kaur and Singh (2013) study examined that the efficiency
and profitability can be managed through working capital
management. Their findings were in support to the earlier
studies that efficient management of working capital signi-
ficantly impacts profitability. Also Kumar and Ramanan
(2013) supported that there has been an impact of working
capital management on profitability of manufacturing firms.
They found a positive relationship between profitability
and debtors’ day and inventory days.
The influence of working capital management on the
firm’s liquidity, profitability and non-insurable risk was
examined by Mandal and Goswami (2010). This was a
case of ONGC, a leading public sector enterprise in India.
The study also stated that in order to achieve the goal of the
organisation, liquidity and profitability have to be considered.
Both liquidity and profitability are interrelated to each other.
Moreover, the risk dimension of liquidity has an impact on
the measurement of overall performance of the risk. Sharma
and Kumar (2011) investigated for 263 Indian firms for
the period 2000–2008, and inferred the link between the
working capital management and profitability of the firm.
The study found a positive relationship between profit-
ability and number of days accounts receivables whereas
a negative relationship with number of days accounts
payables. The evidence is mixed on whether a relationship
exists. Whereas, Bagchi and Khamrui (2012) investigated
and found that there is a strong negative relationship between
variables of the working capital management and profit-
ability of the firm. The study also stated that there is a
negative relationship between debt used by the firm and its
profitability.
Working capital management is often a dilemma between
the liquidity and profitability. The present study has made
an attempt to find out an optimum solution to the problems
of working capital management by identifying the gap in
the previous research findings mentioned earlier. Previous
research studies show that the working capital manage-
ment practices of the industries have contradictory impact
on the profitability. Some of the research findings stated
that the debtors’ days and inventory days have positive impact
on profitability whereas some research findings stated the
level of current assets and number of days accounts payable
have negative impact on profitability. This encouraged us
to make an attempt to establish an empirical model of
working capital management effect with respect to liquidity
aspect and operational activities of the firm on profitability
with respect to Indian steel industry. This study will be a
source of material for future research to the related topics
also. The findings of the study can be helpful to come up
with planning for the working capital business models.
Objectives of the Study
The broad objective of the present study is to identify the
effect of working capital management on firm’s profit-
ability in steel industry, especially in the Indian context.
Paul and Mitra 3

Methodology: Data Source, Sample and finished goods turnover ratio indicate the turnover
Frame and Empirical Model and operational activities of the firms. The details are
mentioned in the following:
Data Source: The study covers the different aspects of
working capital management and tries to establish a relation- 1. QR is the quick ratio of the firm which is stated as
ship between these aspects and profitability of the steel
current assets–inventories) on current liabilities;
industry. The period of the study has been considered for
2. CR is the current ratio of the firm stated as ratio of
17 years, that is, 2000–2016. The data has been collected
current assets to current liabilities;
from Centre for Monitoring Indian Economy (CMIE).
3. DTR is debtor turnover ratio which is calculated as
net sales by average debtors; and
Sample Frame: Sample unit of this study has been chosen
from the companies in the steel industry as per CMIE data- 4. FGTR is the finished goods turnover ratio which is
base. A multistage sampling technique was used where out sated as a ratio of cost of finished goods on average
of 576 steel companies, full-fledged data for the period of finished goods inventories.
study was available for only 35 companies. Hence, 35 has
been considered as our sample size for the study. The Steps to Develop the Model
period of the study has been considered for 17 years, that
is, 2000–2016. Step 1 Cross-sectional data
The analyses of data involve descriptive and panel data are arranged over the
analysis which has been used to establish an empirical time series
model which in turn establishes the relationship between Step 2 Whether pooled Pooled all the observations
working capital management and profitability of the steel OLS is fitted or not and run a panel data
industry in India. has been tested? regression analysis.
Step 3 Fixed effect is fitted To check whether the
Empirical Model: The empirical model has been deve- or not intercept may vary over the
loped to study the significant impact of the working capital variables but the slope is
ratios on the profitability of the steel industry firms in India fixed over time.
by using the panel data regression analysis. Panel data is a Step 4 Random effect is To check whether the
data set where both time series and cross sectional data fitted or not variables are having
have been pooled. The general model of panel data is as common mean value of
the intercept.
follows:
Step5 Fixed effect versus Hausman test is applied
random effect
Yit = β0 + β1 Ait+ β2 Bit+ β3 Cit + εit H0: Random effect model is
appropriate
Where ‘i’ represents number of firms and ‘t’ represents Ha: Fixed model is
appropriate
number of years. β0, β1, β2 and β3 represent coefficient of
explanatory variables. ‘εit’ represents the error term. Step 6 Random effect Breusch–Pagan Lagrange
According to Greene (2008), the main advantage of versus pooled OLS multiplier test is applied
panel data is that one can formally model the heterogeneity H0: Pooled OLS is
across groups that are typically present in panel data. appropriate
Baltagi (2005) confirms this in his statement that the Ha: Random effect model is
appropriate
first benefit of panel data is ‘controlling for individual
heterogeneity’.
Hypotheses of the Study
Choice of Variables The following hypotheses guided the study:
The regression model that we aim to predict has a depen-
dent variable, proxy for firm’s profitability and independent H1: There is no significant relationship between QR
variable, proxy for working capital. The dependent vari- and ROA.
able for the study is return on total assets (ROA) which has H2: There is no significant relationship between CR
been calculated as a ratio of profit after tax on total assets and ROA.
of the firm and indicates the profitability measure of the H3: There is no significant relationship between DTR
firm. The independent variables selected for the study and ROA.
include the quick ratio and current ratio which indicate the H4: There is no significant relationship between FGTR
liquidity position of the firms and the debtor turnover ratio and ROA.
4 Asia-Pacific Journal of Management Research and Innovation 14(1–2)

Analysis and Findings Table 2. Testing the Multi-collinearity

Collinearity Statistics
Nature of the Data VIF 1/VIF
Table 1 shows the nature of the variables by using the QR 7.52 0.13
descriptive statistics. It is evident from the result that there CR 7.05 0.14
is a wide variation in the variables across the companies
DTR 1.11 0.90
during the period. The ROA maximum and minimum
values are 28.69 and negative value of 200. While analysing FGTR 1.10 0.91
the working capital variables, it was clear that different Source: The authors.
companies have employed different working capital Notes: QR–quick ratio; CR–current ratio; DTR–debtors turnover
ratio; FGTR–finished goods turnover ratio.
measures. The highest variation was seen in FGTR where
the maximum value is 239.98 and minimum value is 0.02
with mean score being 28.87.
Table 3. Levin–Lin–Chu Unit-Root Test Results

Variables Adjusted t-Statistics p-Value

Test of Multi-collinearity
ROA –3.70 0.00*
The test for multi-collinearity has to be done before moving
QR –6.40 0.00*
to panel regression model. This will help us to check
CR –4.64 0.00*
whether the independent variables are highly correlated or
not. It is generally accepted that the variance inflation DTR –1.86 0.03*
factor (VIF) of more than 10 will lead to multi-collinearity FGTR –7.43 0.00*
problem. Source: The authors.
Because all the independent variables have VIF below Notes: *Significant at 5% level; ROA–return on total assets; QR–quick
10 and within the desirable limit, which is represented in ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–
finished goods turnover ratio.
Table 2, we have four independent variables for the panel
regression model.
After the test of multi-collinearity, the data set is subject
to unit root tests in order to test its stationary property.
In the present study, the Levin–Lin–Chu test is applied and Panel Data Analysis
the results are presented in Table 3. The empirical model developed to check the impact of
Because all the p-values are less than 0.05, null hypo- working capital on profitability of the firm considers both
thesis is rejected, that is, data has unit roots and accepting time series elements for which ‘t’ is used and cross-
the alternative hypothesis leads to the conclusion that data sectional elements captured using ‘i’. The model that is
are stationary at levels. Thus, the results obtained are not tested is as follows:
fictitious. Hence, the panel data regression has been carried
out for the purpose of analysis. ROAit = α + β1QRit + β2CRit + β3 DTR it
+ β4FGTRit + εit,

The panel data regression results can be analysed only after

finalising the model which we can apply. The following
Table 1. Descriptive Statistics of the Steel Industry in India steps are adopted for this purpose:
Standard In the first step, we pooled the time series data of 17
Minimum Maximum Mean Deviation years from 2000 to 2016 and cross- sectional data of 35
ROA –200.00 28.69 –0.59 13.75
steel companies of India. In the second step, pooled regres-
sion (OLS) was performed to estimated common intercept
QR 0.00 4.82 0.66 0.47 term and the common slope coefficient. Table 4 indicates
CR 0.08 9.17 1.16 0.73 that the explanatory power of the regression was extremely
DTR 0.00 73.27 9.76 9.07 low as R square is 0.15 with the coefficients QR, CR, DTR
FGTR 0.02 239.98 28.87 28.57 and FGTR. In the model only QR and DTR coefficients are
significant as the probabilities of both the coefficients are
Source: The authors.
Notes: ROA–return on total assets; QR–quick ratio; CR–current
less than 5 per cent. But the probabilities of the coefficients
ratio; DTR–debtors turnover ratio; FGTR–finished goods turn- of both CR and FGTR are more than 5 per cent. It is
over ratio. concluded that hypotheses H1 and H3 are not accepted,
Paul and Mitra 5

that is, QR and DTR have significant impact on the profit-
ability of the industry whereas hypotheses H2 and H4 are
accepted, that is, CR and FGTR do not have significant
impact on the profitability of the industry.
The pool ability test was performed to test the null of a
common intercept and slope coefficient versus the alter-
native of running individual regressions for each cross
section. The calculated probability value of F statistics of
the regression equation indicates rejection of null hypo-
thesis as it is less than 5 per cent level of significance. So,
we can conclude that the data should therefore not be
pooled for regression purpose.
In the third step, the validity of fixed effects and fixed
time effects was then tested and is presented in Table 5.
The result indicates that the explanatory power of the
regression decreased more, that is, R square is 0.1395
which implies 13.95 per cent of the variation in the depen-
dent variable, ROA, can be explained by the variation in the
explanatory variables. Most of the slopes are very close to
each other. But on the other side the calculated probability
of F statistics indicates rejection of null hypothesis as it is
less than 5 per cent level of significance. That means, the
model is fitted well and the coefficients are not equal to
zero. But in this test DTR and FGTR coefficients are only
significant as the probabilities of both the coefficients are
less than 5 per cent, which indicates that only turnover
ratios were fitted well but both the cash ratios QR and CR
were not fitted well as the probabilities of the coefficients
are more than 5 per cent. So it is concluded that hypotheses
H3 and H4 are not accepted, that is, DTR and FGTR have
significant impact on the profitability of the industry
whereas hypotheses H1 and H3 are accepted, that is, QR
and CR do not have significant impact on the profitability
of the industry.
In the fourth step, the validity of random effects was
then tested and the results are presented in Table 6. The
results indicate that the explanatory power of the regres-
sion is better than fixed effect, that is, R square is 0.1462
which implies 14.62 per cent of the variation in the dependent
variable, ROA, can be explained by the variation in the
explanatory variables. The slopes are very close to each
other. The calculated probability of Wald Chi squared
statistics indicates rejection of null hypothesis as it is less
than 5 per cent level of significance. That means, model is
fitted well and the coefficients are not equal to zero. But in
this model also, QR and DTR coefficients are only signi-
ficant as the probabilities of both the coefficients are less
than 5 per cent. But CR and FGTR were not fitted well as
the probabilities of the coefficients are more than 5 per
cent. It is concluded that hypotheses H1 and H3 are not
accepted, that is, QR and DTR have significant impact on
the profitability of the industry whereas hypotheses H2 and
H4 are accepted, that is, CR and FGTR do not have signi-
ficant impact on the profitability of the industry.
In the fifth step, we checked which model (fixed effect /
random effect) is appropriate. To check the appropriateness

Table 4. Pooled OLS Regression Results

Model QR CR DTR FGTR Constant Adjusted

Specification Coefficient Coefficient Coefficient Coefficient Coefficient R-Squared Test p-Value
Data pooled 8.41 –0.74 0.38 –0.01 –8.47 0.15 F 0.000*
and common (0.00)* (0.62)* (0.00)* (0.67)* (0.00)*
intercepts and
slopes
(p-value)
Source: The authors.
Notes: *Significant at 5% level; QR–quick ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–finished goods turnover ratio.

Table 5. Fixed Effect Regression Results

Model QR CR DTR FGTR Constant Adjusted

Specification Coefficient Coefficient Coefficient Coefficient Coefficient R-Squared Test p-Value
Common 5.09 0.32 0.41 0.04 –9.09 0.14 F 0.000*
slopes with (0.06)* (0.84)* (0.00)* (0.02)* (0.00)*
cross section
specific
intercept
(p-value)
Source: The authors.
Notes: *Significant at 5% level; QR–quick ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–finished goods turnover ratio.
6 Asia-Pacific Journal of Management Research and Innovation 14(1–2)

Table 6. Random Effect Regression Results

Model QR CR DTR FGTR Constant Adjusted

Specification Coefficient Coefficient Coefficient Coefficient Coefficient R-Squared Test p- Value
Common 5.76 0.13 0.39 0.03 –8.93 0.15 Wald Chi 0.000*
mean value for (0.02)* (0.93)* (0.00)* (0.08)* (0.00)* squared
the intercept
(p-value)
Source: The authors.
Notes: *Significant at 5% level; QR–quick ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–finished goods turnover ratio.

Table 7. Fixed Effect versus Random Effect: Hausman Test

Model QR CR DTR FGTR Constant Adjusted

Specification Coefficient Coefficient Coefficient Coefficient Coefficient R-Squared Test p- Value
To check Chi squared 0.145*
whether the
model is fixed
effect or
random effect
Source: The authors.
Notes: *Significant at 5% level; QR–quick ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–finished goods turnover ratio.

Table 8. Pooled OLS versus Random Effect: Breusch–Pagan Lagrange Multiplier Test

Model QR CR DTR FGTR Constant Adjusted

Specification Coefficient Coefficient Coefficient Coefficient Coefficient R-Squared Test p-Value
To check BP LM 0.000*
whether (Chi squared)
the model
is pooled
regression
effect or
random effect
Source: The authors.
Notes: *Significant at 5% level; QR–quick ratio; CR–current ratio; DTR–debtors turnover ratio; FGTR–finished goods turnover ratio.

we applied Hausman test. The null hypothesis explains the
random effect model is appropriate against the alternative
hypothesis which explains the fixed effect model is appro-
priate. The result in Table 7 implies the probability value of
Chi squared is more than 5 per cent level of significance
and we accept the null hypothesis. Thus, random effect
model is more appropriate than fixed effect model.
In the sixth step, we checked which model (random effect/
pooled regression) is appropriate. To check the appropri-
ateness we applied Breusch–Pagan Lagrange multiplier
test. The null hypothesis explains the pooled regression
model is appropriate against the alternative hypothesis
which explains the random effect model is appropriate.
The result in Table 8 implies the probability value of Chi
squared is less than 5 per cent level of significance and we
accept the alternative hypothesis. Thus, random effect
model is more appropriate than pooled regression model.
For the random effect model, it was evident that quick
ratio and debtors turnover ratio have a significantly positive
influence on the firm’s ROA with the probabilities of both
the coefficients are less than 5 per cent. But the CR and
FGTR were not significant as the probabilities of the coef-
ficients are more than 5 per cent. The model depicts 14.62
per cent of the variation in the dependent variable, ROA,
explained by the variation in the explanatory variables. So
it is finally concluded that hypotheses H1 and H3 are not
accepted, that is, QR and DTR have significant positive
impact on the profitability of the industry whereas hypoth-
eses H2 and H4 are accepted, that is, CR and FGTR do not
have significant impact on the profitability of the industry.
 Paul and Mitra 7
Conclusion
It was indicated by Raheman and Nasr (2007) that working
capital management has been an essential part of financial
management and contributes significantly to a firm’s wealth
creation as it directly influences organisational profitability
and liquidity. The present study analysed the working
capital management on profitability of 35 steel companies
of India. It was found that there has been an impact of the
working capital on the profitability of the industry. Prior to
the application of the panel data regression, the test of
multi-collinearity and the unit root by using the Levin–
Lin–Chiu test was carried out. Then it was found that the
QR and the DTR have positive effect and are statistically
significant to the ROA. It was consistent with the findings
of Arunkumar and Ramanan (2013) regarding a positive
relationship between profitability and debtors’ day but
contrast to the positive relationship between profitability
and inventory days. It also goes with the findings of Sharma
and Kumar (2011) who found a positive relationship between
profitability and number of days accounts receivables. The
firms can invest more in the productive purpose and focus
on the credit sales of the company which in turn increases
the profitability of the company. The investment in the
liquid assets of the firm also has a positive impact on the
profitability of the firm. Hence, the study clearly asserts that
sample companies of the steel industry have enough scope
to enhance their profitability by the use of working capital
in a more efficient way.
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect
to the research, authorship and/or publication of this article.
Funding
The authors received no financial support for the research, author-
ship and/or publication of this article.
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