IMPACT OF WORKING CAPITAL MANAGEMENT

ON FIRMS’ PROFITABILITY IN DIFFERENT

BUSINESS
CYCLE: Evidence from Pakistan

Nida Shah
SUBJECT: FINANCIAL MANAGEMENT POLICIES
MBA

4/30/2017

TEACHER: SIR RAHEEL BHAGAR

GROUP NUMBER 2

Nuzzar Naseem 12243

Noman Hashmi 11081
Mohammad Shiraz 13035
Syed Rizwan Ali 16222
Wajahat Hussain 12542
CONTENTS

Summary

Presentation Slides

Research Paper
INTRODUCTION
 To maximize the shareholder's value, profit and survival
of business, companies need to find out all the reasons that
could affect their business profitability.

 Working capital management ensure the availability

of sufficient cash to ensure uninterrupted functioning
of business in day to day operations.
INTRODUCTION

 Working capital management is depended on

management of cash conversion cycle.

 Growth of Pakistan's economy is dependent on the

firm's operating in different sectors. When
Industrial growth increases GDP also increases and
vice versa.
 RESEARCH PROBLEM

• The purpose of this study was to find out the

impact of working capital management on the
profitability of firms under different business
cycles.
• No empirical study has been made before in
Pakistan addressing this topic.
RESEARCH QUESTIONS

 How cash conversion cycle impacts on the profitability

of non financial firms under different business cycle?

 What is the impact of the business cycle on the

working capital management and the
profitability relationship?
RESEARCH OBJECTIVES

 To investigate the influence of the working capital

management on firm's profitability under
different business cycles in 65 non financial firms
listed in KSE-100 for period 2004-2013.

 To analyze the long run relationship among variables,

to analyze long run coefficients.

 To analyze the impact of business cycle on working

capital management and profitability relationship.
LIMITATION

 Limited to listed 65 non financial firms at KSE-100

LITERATURE REVIEW

1) Developed Countries:
 Shin and Soenen 1998

 Enqvist Graham and Nikkimen 2014

2) Developing Countries:
 Shah and Sana 2005

 Addae and Nyarko Baasi (2013)

Developed Countries:

Shin and Soenen 1998

Examined the relationship between working capital
management and firm's profitability using data set of American
firms for period 1975-1994
Result:
negative relationship between cash conversion cycle and firm
profitability.
Enqvist Graham and Nikki men 2014
18 years data of non financial Finish companies to analyze
working capital and profitability relationship.
Result:
Business cycle affect the working capital management and
profitability relationship and profitability increases in recession
period.
Developing Countries:

Shah and Sons 2005

Investigated the impact of working capital on the
firm's profitability by using the data set of listed
companies on oil and gas sector of Pakistan for the
period of 2001-2005
Results:
They reported the negative relationship exists
between inventory, account receivable, cash
conversion cycle, sales growth and gross profit where
as positive relationship between accounts payable and
gross profit.
Addae and Nyarko Baasi (2013)
Applied the regression and correlation analysis on
the data of non listed Ghanaian firms comprising of
years 2004-2009
Results
They reported that inverse association exists between
profitability of firms and the cash conversion cycle.
RESEARCH METHODOLOGY

 10 years annual panel data 2004-2013 of 65 non-financial firm

listed in KSE-100 index of Pakistan.

 Hadri panel unit root test has been used to scrutinize the stationary
properties of variables.

 To analyze the long run relationship among variables,

Pedroni (1999) panel co integration technique has been used to

analyze the long run relationship between our considered variables.
The Pedroni's panel co-integration approach has several advantages
upon other co integration methods of panel data. This approach
controls the biasness from firms size and also solves the issue of
heterogeneity.
 RESEARCH METHODOLOGY
 Kao (1999) residual based panel co-integration test is used
to analyze the long run relationship between cash
conversion cycle and its components on the non-financial
firms profitability.

 Regression analysis was used to analyze the long run

coefficients. Different interaction terms of cash
conversion cycle, inventory, account receivable and
account payable used to more validate their impact on
profitability of non financial firm in different cycles.
 FUNCTIONS

After reviewing the empirical studies, the model to analyze

the relationship between working capital management and
non-financial firms profitability in different business cycles is
determined by following functions:
 ROAi,t = β0 + β1CCCi,t + β2CRi,t + β3SALi,t + β4BY
Ci,t + i,t
 ROAi,t = β0 + β1INVi,t + β2CRi,t + β3SALi,t + β4BY Ci,t
+ i,t
 ROAi,t = β0 + β1AARi,t + β2CRi,t + β3SALi,t + β4BY
Ci,t + i,t
 ROAi,t = β0 + β1APi,t + β2CRi,t + β3SALi,t + β4BY Ci,t
+ i,t
Where,
 t is the error term, i represent the number of firms in the
panel and t represents the number of observations over
time.
 ROA is the return on assets and expressed in percentage
(%),
 CCC is the cash conversion cycle which is measured in
days,
 INV is the inventories in days,
 AAR is the accounts receivable in days,
 AP is the Account payable in days,
 CR is the current ratio and expressed in percentage (%),
 BYC is the business cycle which is used as a proxy
for recession period and boom period.
HYPOTHESIS OF STUDY

Pedroni panel co integration

Ho=No co integration between all considered variables
Ha=Co integration exist between all variables
Ho was rejected in favor of Ha ie. Co integration exist
between all variables
Long run relationship exists and all variables are co
integrated.
Kao residual based panel co integration

To analyze long run relationship between cash

conversion cycle and its components on non
financial firms profitability.

Ho=No co integration exist among series of variables

Ha=Co integration exist between variables

Ho rejected accepting Ha, co integration and long run

relationship exist between variables.
Regression Analysis Findings

Cash conversion cycle has a significant negative

impact on the profitability.

Inventory and profitability (Negative relationship or

inverse relationship)

Accounts payable and profitability (Negative

relationship or inverse relationship)
INTERACTIVE TERMS

Interactive terms of cash conversion cycle, inventories,

account receivable, accounts payable in the full
sample of non financial firm.

Analyzing influence of business cycle(recession and

boom) on the relationship of working capital
management and profitability.
RESULTS OF INTERACTION TERMS:

Accounts receivable and profitability (negative

relationship both in boom and recession)
Accounts payable and profitability(negative
relationship in boom)
Accounts payable and profitability(positive
relationship in recession)
Current ratio has less impact on profitability of non
financial firm.
Sales has significant impact on non financial
profitability

In all the models, current ratio(CA/CL) shows an

insignificant impact on non-financial firms'
profitability.

Sales have a significant impact on non-financial firms'

profitability.
 CONCLUSION

Cash conversion cycle and account receivable show the same

negative relationship with firms profitability in different
business cycle, where as the integration term of inventory
shows a significant positive relationship with firms
profitability in the boom period.

More over the interaction term of account payable shows a

significant positive relationship with firms' profitability in the
recession period.
CONCLUSION

Thus for increasing profitability firms should minimize

cash conversion cycle.

A firm should manage working capital for profitability

of firms.

At recession firms should delay payments at the

recession but at boom, firms should pay their
liabilities as soon as possible
CONCLUSION
 In the recession era firms should keep significant amount
of cash available for day to day business activities whereas,
the boom period companies should use excessive cash to
reinvest in short run projects.
 In boom firm should keep inventory in stock to make it
available for expected sales, whereas at recession firm
should shift their policy to JIT concept to avoid the
holding costs.
 Account receivable and profitability are having a
negative relationship in both recession and boom.
 Hence it is concluded by this research that one of the
solution to increase profitability of firm is,
proficient management of the working capital.
SHORTCOMINGS

The study doesn't indicate to the specification of data

to a sector, which is taken as a sample of non financial
firms. Therefore for further study there is ambiguity
that in what sector we could further research.